Economy

Decoding the Effects of Demonetization

This November marks the third anniversary of the historic ban of the Rs 500 and Rs 1000 notes, which is considered to have left a permanent impact on the Indian Economy. India’s Prime Minister Sri Narendra Modi had made an announcement on 8th November 2016 regarding the ban of Rs 500 and Rs 1000 notes, which would cease to be legal tender with immediate effect, and the citizens had roughly around 50 days to deposit all their old notes into their bank accounts. This was done in order to root out their circulation in the economy with the prime objective of curbing black money, a check on illegal terrorist funding activities and to make the Indian economy a cashless one. India being a high cash economy, demonetization can be regarded as a very massive step, as 86% of the cash circulation of our economy constituted of those notes.

Demonetization can be understood as a situation where the currency notes of a particular denomination cease to be legal tender. Legal tender refers to money which is legally used to make payments of purchase, debts and other obligations.

The Indian economy is not very unfamiliar to demonetization. The highest denomination currency notes to be ever printed by the Reserve Bank of India were the Rs 10,000 notes. They were printed in the year 1938 and 1954 and were first demonetized in 1946 and then in 1978. However, because not many people had access to such notes at that time, this did not have a huge or even significant impact on the economy. The latest demonetization process was obviously of a very colossal scale and had undoubtedly affected the common public, bankers, and the economy as a whole. However, the latest operation was done on such a large scale that it almost shook the entire economy, affecting all sections both in the short and long term.

 Effects of Demonetization on the Indian economy

 We know that the Indian Economy is a cash driven one, where most of its population does not have access to institutional banking and financial sectors. The ban on the currency notes was one of the key reasons for the slowdown of the Indian economy. The GDP growth rate, which was 8.01% in 2015-2016, dropped to 7.11% in 2016-2017 after demonetization. This was majorly due to less availability of cash in cash intensive industries like manufacturing and construction. It also impacted the functioning of banks in terms of issuing loans and put pressure on them as current account holders demanded large sums of cash.

Demonetization obviously had a long-lasting effect on medium, small and micro industries. Although the medium and small enterprises turned towards digitalization, the micro industries were affected in the worst manner. These small businesses are low capital ones with high liquidity preference. Demonetization affected the revenue collection as the demand dropped steeply and also threatened their very existence. The growth rate of these small, micro and medium scale industries had gone as low as 1%. Statistics also showed that many of these industries being run on a daily wage basis completely shut down because of this sudden economic shock and lack of available cash.

The core objective of Demonetization was to curb the growing black money problem in India. However, 99% of the money was deposited back to the RBI making the operation a complete failure. Statistics hence proves that either these hoarders found a way to legitimize their black money or did not hold them in the form of cash. Another speculation is that they might not have hoarded those particular denominations. Various finance experts claim that hoarders do not hold money in cash and only a small portion of this black money is held in the form of cash while av majority of it held in the form of physical assets like gold, diamond, land, real estate etc.

Whenever the utter failure to curb the black money circulation in the economy was highlighted time and again, the government always publicized the role of demonetization in curbing terrorism. What we need to consider is how well demonetization performed in terms cleaning up the economy, wherein strict checks were conducted on the FICN or the Fake Indian Currency Notes. Its motive was to control all the illegal funding which was taking place by terrorist organizations over the states of Jammu and Kashmir, the North-Eastern states as well as those infiltrated by Naxalites. Now, it was believed that the terrorist organizations who used these FICN to fund their illegal projects, and the government strongly thought that demonetization would bring these illegitimate activities to a halt. Hence, we can say that during the initial days of Demonetization, the cash ratios of these terrorist organizations were severely affected.
Another primary objective of demonetization was to transform India into a digital or cashless economy. The absence of liquid cash has indeed pushed the people to shift to cheque and account transfers. People have also shifted to different virtual payment methods like Paytm or Google Pay which are methods of electronic transfer of money. Thus, with the transactions being properly and systematically recorded, there could be a transformation to a white economy and the governments’ tax revenue could also be increased with.

One good outcome of this was that digitalization was embraced by all sections of the society during this hour of crisis. People turned towards digital transactions for everything- from buying groceries from a road side vendor to paying utility bills during the time of demonetization and even after that. A lot of small-scale shopkeepers and vendors were also seen using the electronic method of money transfer.

 Present day impact

 Demonetization has been praised as well as criticized time and again. We know that it did have a significant short and long term effect on the economy. In the short term, various disturbances with respect to the liquidity crunch such as unemployment, loss of growth momentum, and a temporary halt to major economic activities were observed. All this is evident from the data provided by the RBI.

Coming to the long term effects, demonetization contributed majorly to the present economic slowdown that is being faced by the country. This policy severely affected the agrarian sector, where farmers and laborers did not have adequate access to the digitalized world or even proper banking institutions. Former Agriculture Secretary, Mr Siraj Hussain had opined that the crop prices had crashed during that time and with no cash in hand farmers settled for distress sales. We know that agriculture is the backbone of the Indian economy where 18% of it constitutes our GDP. All other activities like manufacturing or services are highly dependent on agriculture. This steep and massive hit on the farmer’s income level had a snowball effect on the slowdown on the economy as a whole.

Again, this policy did curtail the consumer demand in the economy and a lot of small, medium and large-scale industries were shut down, leaving a huge section of the population unemployed. It was observed that demonetization had increased the unemployment level in the country by at least 2-3% in the first quarter of the ban, which further led to the economic slowdown.

Pranab Sen, Director of International Growth Centre had also stated that Demonetization has curbed the movement of lower income groups to higher income categories, leading to the current economic crisis. He further added that people from lower income groups had been earning more and subsequently moving to higher income bracket, and hence their consumption levels shifted with their increased income. However, this mobility ceased and affected the economy, which is the reason for the stagnation of demand in the urban sector.

An interesting change in the attitude of people which has been observed is that they now opt for savings accounts in banks and increasing their bank balances, instead of stashing emergency cash in different corners of their houses. People finally have begun to trust the digital payment system and now utilise the boons of digitalization effectively. Demonetization has thus proved that Indians can strive and adapt to any changes and it has made people financially aware about the different spending options available to them. The Government’s efforts to revamp the currency system provided people with a boost to use the cash that was lying around and invest it, which is obviously more productive for them as well as for the economy. The conservative people have also opened up to the era of e-cash and this process has made several Indians technology friendly.

 Picture Courtesy- WeForNews



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