Demonetization is changing of a currency unit of its status as legal tender. Whenever a country changes its national currency, it has to demonetize the old unit of currency to replace it with a new monetary unit.
There are several reasons why countries demonetize their local currency. Reasons include change inflation rate, to minimize corruption and to discourage a cash payment system. The idea supports replacing the old currency with a new currency permanently.
In 2016, the Indian Prime Minister Narendra Modi decided to demonetize the 500 and 1000 rupee notes. India’s 80% of cash supply was based on these records. To prevent frauds and duplicate production, to fight tax evasions, to eliminate black money being earned by money laundering and scams the Indian government turned down all 500 and 1000 rupee notes. The trick was that individuals would turn to banks to convert their money and would get caught up as they would be required to submit tax information from the entity. If the entity fails to provide proofs of making on-time tax payments, then they would have to face a penalty of 200% of the tax owed was imposed.
Although proper preparations were not made to make this step a success. The government has not later ATM’s causing problems in currency exchange as there was no adequate supply. On the other hand, the common man would face difficulties in their daily livelihood for days until new currency launches.
Zimbabwe, a country higher in inflation demonetized the Zimbabwean dollar to reduce the hyper-inflation. In a couple of months, the Zimbabwean dollar was eliminated altogether, and the US dollar was used to stabilize the economy.
Another example of demonetization occurred when the European Monetary Union took euro as their currency in 2002. Fixed exchange rates were set to equalize the worth of other national currencies into euro. The old national currencies were demonetized yet still were convertible for smooth flow of liquidity in the economy.
Demonetization will make a country suffer a decrease in its Gross Domestic Product as a result. This demonetization will inevitably increase the cost those products which were previously cheaper as the service or good provider was evading tax to some extent which is not possible after demonetization. Due to lack of cash supply in the economy, the demand is affected which impacts directly on the growth opportunities in the economy. An expense that the economy had to bear is the cost equipment required in the printing of new currency and destroying the old one. Raids by income tax, sales tax, and excise companies can create problems for businesses as they have to prove their punctuality proper law and order. Due to a high number of currency converters, some banks are unable to handle the public pressure, and the currency notes become out of supply.
Demonetized currency can be used in placed like government hospitals, transport stations, gas stations, post offices, ticket counters and authorized milk booths.