Demonetization is a process of withdrawing the currency from the market which is no longer accepted as a legal currency for the exchange of goods and services in the country. Demonetization mainly occurs to replace old currency with new currency for the purpose to develop new payment methods in the country or to stop or control various inefficient activities going on in the economy like an increase in the inflation rate, tax evasion, increase in the circulation of duplicate currency, etc.
Get complete CFA Online Course by experts Click Here
How does it work?
First of all, the government analyzes various activities happing in the economy, that result in inefficient growth for the economy. They will try to control the flow of money in the market. If this does not show any result for the improvement of the economy and if various players in the economy use money as a tool to decrease the cash balance in the economy; then the government decides to the demonetized whole or a part of currency in the market to stabilize the flow of cash in the market. For a short period of time, this may affect the working of the economy and condition of citizens, but in long run, this step may be in a huge favor for the common citizens. However, if the government has not analyzed the condition of its economy properly before implementing this step; then this step may result in a big problem for that country.
There is a various example of a country who have demonetized their currency for the betterment of economy which is as follow:
- In 2015 Zimbabwean government replaced the Zimbabwe dollar with the American dollar to make the economy stabilized from the hyperinflation occur in the country.
- In 2010 North Korea had replaced its old currency to improve the economy from a black market that has created a downward in the economy.
- In India demonetization had occurred 3 times in 1946 in which the circulation of Rs.1000 and Rs. 10000 was removed. The ban had no effect because such high-denomination currency was not readily available to the general public. Both notes, however, were reintroduced in 1954, along with the inclusion of Rs 5,000 currency. The next demonetization happened in 1978 in which the circulation of Rs.1000, Rs.5000, and Rs.10000 in order to reduce the supply of black money in the country. Recently in 2016 third demonetization occurred in the country for the same reason, to reduce the black money and in this, the circulation of 1000 and 500 was stopped and a new currency of 500 and 2000 was introduced in the market.
Get complete FRM Online Course by experts Click Here
Effects of demonetization:
Demonetization is not a simple process for any country, but to remove the black money and to gain control over the economy from the downfall it becomes necessary for the government to take such steps. There are the various effects of the demonetization process which is as follow:
- There will be a downfall in the country’s GDP for that particular quarter or half-year.
- The flow of money or the supply of money will be reduced for a short period of time but in long run, this results in to increase in the revenue of the government because money deposited in the bank will be people will be increased.
- A short recession can also be observed in the country.
- The rate at which capital formation occurs in the country will be slow down for short time.
- Middle and Lower class people may suffer for a particular time because suddenly the money they have earned and save becomes worthless for a short period of time.
- A negative impact on the disposal income of people is seen in the country for a short period of time.
- After the process of demonetization the real income of the various individual is shown and this result in high tax collection and help in increasing the government revenue.
- In long run, this will help to create a better environment for business and help in the transparency in the economy.
- If demonetization has occurred to develop a new payment method in the country; then this will help the citizen to accept a new method.
Demonetization is a process that the government takes to increase the long-term efficiency of the economy. Some of the evil activities carried out by various players in the market can be stopped and the fresh start of the economy is made by the process of demonetization. This also helps the government to take control of the flow of money again in the market.
Author: Charmi Mehta
About the Author: Charmi Mehta is currently pursuing MBA with a specialization in Finance from the Department of Business Administration, Bhavnagar. Charmi is very much interested to work with data and its analysis and she is also fascinated by the financial market.