Top Impact of demonetisation over Indian Economy

The demonetisation of the Rs. 500 and Rs. 1000 notes by the Modi government was announced on November 8, 2016. It has been over a month now that this came into effect and whether it is a masterstroke or hit and miss, is something that the Indian economy is bearing the brunt of. The government claimed that it is a move to stop the counterfeiting of the notes which was being used to fund terrorism and also to crack down on the black money that has been hoarded by the people in the country.

Demonetization affects the economy through the liquidity side. Its effect is enormous because nearly 86% of currency value in circulation was withdrawn without replacing the bulk of it. As a result of the withdrawal of Rs 500 and Rs 1000 notes, there occurred a huge gap in the currency composition as after Rs 100; Rs 2000 is the only denomination. Furthermore, there is an acute shortage of the new Rs. 500 notes with the ATMs dispensing only the new Rs. 2000 notes. All this had led to a huge hue and cry in the nation, which is not unjustified.

Demonetization technically is a liquidity shock which has caused a sudden shortage in terms of currency availability. It has created a situation where lack of currency has caused blockage of consumption, investment, production, employment etc.

The intensity of demonetization effects clearly depends upon the duration of the liquidity shocks. Following are some of the major impacts of demonetisation in the Indian economy-

1. Hit Economic activities: Demonetization is definitely not as big a disaster like the global banking sector crisis of 2007 but at the same time, it will act as a liquidity shock that will disturb the economic and trade activities in the country.
2. Liquidity crunch: This is a short term effect which means that people are not able to get sufficient volume of popular denomination especially Rs 500.  This currency unit is the favourable denomination in daily life. It constituted nearly 49% of the previous currency supply in terms of value. Higher the time required to resupply Rs 500 notes, higher will be the duration of the liquidity crunch. Current reports indicate that all security printing presses can print only 2000 million units of Rs. 500 notes by the end of this year. Nearly 16000 million Rs 500 notes were in circulation at the end of March 2016. Some portions of this were filled by the new Rs 2000 notes. Towards the end of March approximately 10000 million units will be printed and replaced. All these indicate that currency crunch will be in our economy for the next four months.Due to this liquidity crunch, the common man is feeling the pinch as he is unable to carry out his basic daily chores due to lack of cash and its unavailability in the ATMs. Further, problems in the ATMs due to the difference in the size of the new notes from the old ones has caused more than half of the ATMs to be out of cash or out of order. The only way available to man to get cash is by going to the bank and withdrawing limited amounts of cash. This is not only bothersome but in case of medical emergencies, it can lead to more difficult problems.
3. Welfare loss for people dependent on cash transactions: Most active segments of the population who constitute the ‘base of the pyramid’ use cash to meet their transactions. The daily wage earners, other labourers, small traders etc. who reside out of the formal economy uses cash frequently. These sections will lose income in the absence of liquid cash. Cash stringency will compel firms to reduce labour cost and thus reduces income to the poor working class. There will be a trickle up effect of the liquidity chaos to the higher income people with time. Such people do not have means to go cashless and use digital banking methods for payment. They are being affected daily as they have no money to buy their basic commodities and are feeling helpless.
4. Consumption will be hit: When liquidity shortage strikes, it is consumption that is going to be adversely affected first. People have less cash with them, hence they will decrease their consumption of commodities despite no shortage of it. Less purchase of commodities will lead to less production and eventually less revenue in the long run. There have been reports about the fall in purchase of new homes.
5. Loss of GDP: India risks its position of being the fastest growing largest economy. During the period of the first quarter of fiscal year 2016-2017, the GDP (gross domestic product) rose 7.1%. The fall in economic activity due to demonetization could last from two to three quarters. As a result, GDP growth in the quarters from September to December 2016 and January to March 2017 could be significantly lower than previous years. Some bounce back should be seen in the first quarter of fiscal 2017–2018.
6. Impact on bank deposits and interest rate: Deposit in the short term may rise, but in the long term, its effect will come down. The savings with the banks are actually liquid cash people stored and it cannot be assumed that such ready cash once stored in their hands will be put into savings for a long term. They saved this money into banks just to convert the old notes into new notes. These are not voluntary savings aimed to get interest which will be converted into active liquidity by the savers when full-fledged new currency supply takes place. Banks may reduce interest rate in the short/medium term but they can’t follow it in the long term once the people withdraw their deposits later on.
7. Impact on black money: Only a small portion of black money is actually stored in the form of cash. Usually, black income is kept in the form of physical assets like gold, land, buildings etc. Hence the amount of black money countered by demonetization depends upon the amount of black money held in the form of cash and it will be smaller than expected. But more than anything else, demonetization has a big propaganda effect. People are now much convinced about the need to fight black income and a nationwide awareness has been launched which will urge and encourage the government to come out with even stronger measures.
8. Impact on counterfeit currency: The real impact of the demonetisation is on counterfeit/fake currency as its circulation will be checked after this exercise. There have already been reports that stone pelting and other terror fund activities has taken a downfall in Kashmir due to lack of counterfeit notes being supplied to the terrorists by their backing agencies.

Demonetization as an unprecedented move may prove to be beneficial for many purposes in the economy and our country as a whole. However, simultaneously, it is creating a burden on the poor sections of the society by causing them to lose their income and daily wages. Many people have also lost their lives due to the side effects of demonetisation and this change has more or less changed the entire gamut of Indian economy which will be studied for ages to come.  The benefits will be long term if the black money and counterfeit problems will show a decline. Any change for the development of the nation is never easy and the same can be said about demonetisation too.