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Economic Survey 2016-17 for IAS Prelims: Demonetisation To Deify or Demonize Part 3

Feb 21, 2017 15:41 IST

    Economic Survey on demonetisation part 2According to the survey via demonetisation government announced a historic measure, with profound implications for the economy. The two largest denomination notes, Rs 500 and Rs 1000, were “demonetized” with immediate effect, ceasing to be legal tender except for a few specified purposes. The Economic Survey of India is an annual document of the Ministry of Finance, Government of India.

    Economic Survey 2016-17 for IAS Prelims: Demonetisation To Deify or Demonize Part 2

    Demonetisation was aimed at signalling a regime change, emphasizing the government’s determination to penalize illicit activities and the associated wealth.

    ECONOMIC SURVEY 2016-17 IMPORTANT QUESTIONS

    Here, we provide exclusive questions on demonetisation from the Economic Survey 2017 which can prove to be extremely helpful in IAS Prelims 2017 preparation.

    1. Consider the following statements regarding the impact of demonetisation on the GDP:

    1) Growth slowed, as demonetisation reduced demand, supply and increased uncertainty, but could be beneficial in the long run if formalization increases and corruption falls.
    2) In the long run, the informal output could increase and recorded GDP would increase as the economy becomes more formalized.
    3) In the immediate effect, the recorded GDP will be overstated because banking sector value added is based on deposits which have bloomed temporarily.

    Which of the above statements is correct?

    a. 1 and 3
    b. 1 and 2
    c. 3 and 2
    d. 1, 2 and 3

    Answer: a

    Explanation:

    The impact of demonetisation the GDP would be as follows:

    • Growth slowed, as demonetisation reduced demand (cash, private wealth), supply (reduced liquidity and working capital, and disrupted supply chains), and increased uncertainty.

    • Cash-intensive sectors (agriculture, real estate, jewellery) were affected more.

    • Recorded GDP will understate the impact on informal sector because informal manufacturing is estimated using formal sector indicators (Index of Industrial Production). But over time as the economy becomes more formalized the underestimation will decline.

    • Recorded GDP will also be overstated because banking sector value added is based on deposits which have surged temporarily.

    But in the long run, demonetisation could be beneficial if formalization increases and corruption fall and as the informal output could decline the recorded GDP would increase as the economy becomes more formalized.

    Union Budget 2017 Questions for IAS Exam

    2. The most conclusive evidence on the extent to which Rs 500 and Rs 1000 notes are used for transactions comes from data on soil rates. Which of the following statements best describes the meaning of soil rates?

    a. A soil rate is the rate at which notes are considered to be too damaged to use and have been returned to the central bank.
    b. A soil rate is the rate at which notes are considered to be low in value of a long term transaction.
    c. A soil rate is the rate at which notes are considered to be not relevant for currency circulation and have to be again borrowed from the central bank.
    d. None of the above.

    Answer: a

    Explanation:

    The most conclusive evidence on the extent to which Rs 500 and Rs 1000 notes are used for transactions comes from data on “soil rates,” that is the rate at which notes are considered to be too damaged to use and have been returned to the central bank. RBI data show that in India low denomination notes have a soil rate of 33 percent per year. In contrast, the soil rate for the Rs 500 note is 22 percent and the Rs 1000 just 11 percent.

    The lower soil rates for the high denomination notes could arise if they are used in the same way, but just less frequently because there are fewer high value transactions. If the Indian soil rate is instead lower, this suggests that a fraction of the notes are not being used for transactions, but rather for storing black money.

    Using relative soil rates for the US $50 and $20 notes and applying them to comparable Indian high denomination notes, yields an estimate of the amount not used for transactions, and hence potentially black, of about Rs. 3 lakh crore. This is substantial, as it represents about 2 percent of GDP.

    Economic Survey 2016-17 Fiscal Rules

    3. To understand the benefits and costs of demonetisation requires spelling out the analytics of demonetisation. Consider the following statements regarding the long term impact on the accounted and unaccounted income/wealth:

    1) The financial system savings will increase, to the extent that the cash deposit ratio falls permanently.
    2) Formalization should reduce the flow of unaccounted income.
    3) RBI’s wealth will decrease and increase liabilities.

    Which of the above statements is correct?

    a. 1 and 3
    b. 1 and 2
    c. 3 and 2
    d. 1, 2 and 3

    Answer: b

    Explanation:

    Understanding the benefits and costs of demonetisation requires spelling out the analytics of demonetisation, which are rich and complicated. Broadly, there will be a number of effects, which are sketched out schematically in the table below:

    Sector

    Impact(Long Term)

    Financial System Savings

    Increase, to the extent that the cash deposit ratio falls permanently.

    Corruption

    Could decline, if incentives for compliance improve

    Unaccounted income

    Formalization should reduce the flow of unaccounted income.

    Private Wealth

    Wealth could fall further, if real estate prices continue to decline.

    Public Sector Wealth

    Government/RBI’s wealth will increase when unreturned cash is extinguished, reducing liabilities.

    Economic Survey 2016-17 for IAS Prelims: The Economic Vision for Precocious Cleavage India Part 2

    4. Which of the following statements is true regarding the short term impact of demonetisation on the interest rates?

    a. Interest rates on deposits, loans, and government securities declined.
    b. Cash increased sharply.
    c. Return of currency reduced the central bank’s deposit liabilities to commercial banks but increased its cash liabilities.
    d. All of the above

    Answer: a

    Explanation:

    The impact of Demonetisation on the money/interest rate sector is as follows: on the short term phase the cash declined sharply. Bank deposits increased sharply, RBI’s balance sheet largely unchanged: return of currency reduced the central bank’s cash liabilities, but increased its deposit liabilities to commercial banks and interest rates on deposits, loans, and government securities declined; the implicit rate on cash increased.

    On the other hand the long- term benefits are that the cash will recover, but settle at a lower level, Deposits will decline, but probably settle at a slightly higher level. The RBI’s balance sheet will shrink, after the deadline for redeeming outstanding notes and loan rates could fall further, if much of the deposit increase proves durable.

    5. Which of the following statements is true regarding the short term and long term impact of demonetisation on the Tax collection?

    1) At first the Income taxes rose because of increased disclosure, but in the long run Indirect and corporate taxes could decline, to the extent growth slows.
    2) Payments to local bodies increased because demonetised notes remained legal tender for tax payments.
    3) Over the long run, taxes should increase as formalization expands and compliance improves.

    Which of the above statements is correct?

    a. 1 and 3
    b. 1 and 2
    c. 3 and 2
    d. 1, 2 and 3

    Answer: d

    Explanation:

    The short run impact of demonetisation on the tax collection would be that income taxes rose because of increased disclosure and payments to local bodies and discoms increased because demonetised notes remained legal tender for tax payments/ clearances of arrears
    But on the long run the indirect and corporate taxes could decline, to the extent growth slows and taxes should increase as formalization expands and compliance improves.

    In short, the uncertainty increased, as firms and households were unsure of the economic impact and implications for future policy, but credibility will be strengthened if demonetisation is accompanied by complementary measures.

    Current Issues and Events

    Sector

    Impact(Long Term)

     

    Financial System Savings

    Increase, to the extent that the cash deposit ratio falls permanently.

    Corruption

    Could decline, if incentives for compliance improve

    Unaccounted income

    Formalization should reduce the flow of unaccounted income.

    Private Wealth

    Wealth could fall further, if real estate prices continue to decline.

    Public Sector Wealth

    Government/RBI’s wealth will increase when unreturned cash is extinguished, reducing liabilities.

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