The Government of India hasimplemented a big change in the environment of Indian Economy by demonetizingthe high value currency notes of Rs.
500 and Rs. 1000 denominations. Thesecurrency notes were ceased to be legal tender from the midnight of 8thNovember 2016. This proposal by the Indian Government involved replacement ofold currency with a set of new ones. The money circulation in the economy wasconsequently squeezed as the limits were placed on the withdrawn amounts by theindividuals. The reasons for the implementation of this process are two fold-first to eliminate black money present in the economy and second to counterfeitnotes that were contributing to terrorism.
The current study attempts tounderstand the implications of this decision on the Indian economy and itsimpact on GDP, different macro-economic variables as well as different sectorsof the economy. The paper also aims at evaluating the impact of such a moveover the different time horizons- very short term, short term and medium termperiod. Keywords-Economy, Demonetization,Money, GDP Demonetisation: Impact on Indian Economy Demonetisation could be a generations’ unforgettable experience and goes to be one in many of the economic events of our time. Its impact is felt by each individual bringing aneffect in the economy through the liquidity aspect.
As a result of the withdrawal of Rs five hundred and Rs one thousand notes, there occurred immense gap within the currency composition as when Rs 100; Rs 2000 is the sole denomination ending technically could be a liquidity shock; a explosive stop in terms of currency handiness. It creates a state of affairs wherever lack ofcurrenciesjamsconsumption,investment,production,employmentetc.Duringthis context,theexercise might bringfollowing short term/long term/,consumption/investment, welfare/growth impacts on Indian economy. The intensityof ending effects clearly depends upon the length of the liquidity shocks. Following are the most impacts over the various time horizons.Veryshort-term impact The activity, by removing eighty six per cent of thecurrency in circulation, has resulted terribly into very severe contraction in finances within the economy.This contraction, by wiping out money balanceswithin the economy, can eliminate variety of transactions for awhile since there’s noor not enough of a medium of exchange on the market. There arelikely to be 2 spin-offsfrom this variation –one, there would be some increase in tax collections within the short term, andsecond; varied IOUs might emerge as currencysubstitutes.
Short term impactThe short-run impact on the economy would rely on the speed with which and the extent to which the money will be fastly replaced bythe authorities. If the whole money is replaced within a short spanof time, the consequences on the far side the terribly short term of 1-2 months can be very little. However many sectors are possible to be seriously affected. If, on the opposite hand, the authorities opt to replace solely a fraction of the whole money that was relinquished by the people to the banking sector, then one would witness another effects within the economy. Medium term impactIn the medium term, the results would be associated with the extent to that the currency isn’t replaced among the economy. If the whole currency is replaced, there wouldn’t be any major effects on the economy.
However, it’s to be expected that the whole currency wouldn’t get replaced – to the extent currency is destroyed and to the extent a number of the currency remains as bank deposits, there would be someimpact on the economy. The primary impact would be a compression ofthe economy to the extent the destroyed currency was operating as a medium of exchange. The currency that’s placed in the banks however not withdrawn, it’s argued, would generate associate degree growth in deposits within the economy. EFFECT OF DEMONETISATION ON MACRO-ECONOMIC VARIABLES Effect on parallel economy : The removal of those five hundred and a thousand notes and replacement of an equivalent with new five hundred and two thousand rupee notes is predicted to take away black cash from the economy as they’ll be blocked since the home owners won’t be during a position to deposit an equivalent within the banks that will quickly stall the circulation of huge volume ofcounterfeit currency and curb the funding for antisocial components likeimporting, terrorism, espionage etc.Impact on black money: Solely a tiny portion of black money is truly hold on within the form of money. Usually, black money is stored in the form of physical assets like gold, land, buildings etc.
Therefore the quantity of black cash countered by demonetisation rely upon the quantity of black cash stored in the form of money and it’ll be smaller than expected. However people are now convinced with the requirement to fight black financial gain. Such a nationwideawareness and urge can encourage government to come out with sturdy measures.Consumptionwill be hit:When liquidity shortage strikes, it is consumption that is going to beadversely affected first.Consumption?? Production ?? Employment ?? Growth ?? Tax revenue ?Effect on gross domestic product : The gross domestic product formation may come down withreduction in the consumption levels but with the recent rise in competition, demandis predicted to offset this fall in overall impact. Moreover, this expectedimpact on gross domestic product might not be vital.Effect on monetary resource : With the older five hundred and a thousand Rupees notes being scrapped, till the new five hundred and two thousand rupees notes get widely circulated within the market, monetary resource is predicted to cut back within the short run.
To the extent that black cash (which isn’t counterfeit) doesn’t get into the system, reserve cash and the monetary resource can decrease for a while but step by step because the new notes get circulated within the market and therefore the match gets corrected, monetary resource can devour. Effecton Demand :The overall demand isexpected to be affected to an extent. The demand in following areas is to beimpacted particularly:Consumer goods ? Real Estate and Property ? Gold and luxury goods ?Automobiles (only to a certain limit) Effect on Prices Price level is expected to be lowered due to moderation fromdemand side. This demand driven fall in prices could be understood as follows: ?Consumer goods: Prices are expected to fall only marginally due to moderationin demand as use of cards and cheques would compensate for some purchases. ? Real Estate and Property: Prices in this sector are largelyexpected to fall, especially for sale of properties where major part of thetransaction is cash based, rather than based on banks transfer or chequetransactions. In the medium term, however the prices in this sector couldregain some levels as developers rebalance their prices (probably charging moreon cheque payment).
Immediate Impact: Heavy DeflationInitially there’ll be significant deflation as people that have attained cash through outlaw suggests that like importing, people would beafraid to declare the cash as they may be prosecuted by Govt/Income Tax Deptt on thelegitimacy of their financialgain. Thiswill scale back the full currency circulation within the economy – resulting in deflation. Deflation willincrease the worth ofcash that we’ve got as a result of the full finances goes down however the commodities and things obtainable within the market haven’t gone down. Gold costs, stocks &commodities can drop.
Impact onBank Deposits and interest rate: Depositwithin the short term might rise, however within the long run its results cancome down. New savings with banks are not permanent or can be said to be shortrun deposit. It’s going to be encashed by the savers at the acceptable level.It’s not necessary that the government can turn out massive savings within theindustry in the medium term.
Most of the savings are obtained by large publicsector banks like SBI. They will scale back rate of interest within theshort/medium term. However they cannot follow it within the long run. Impact of Demonetisation on Different Sectors of the EconomyRealEstate SectorThesubstantial move by the Indian government to demonetise high-value currency notes to bring outblack money is expected to have a deep impact on the capital-intensive realestate sector where a significant amount of transactions still involveunaccounted money. Now when the government is laying so much focus oneliminating black money, the cash component in real estate transactions will godown. This will result in a substantial drop in the property prices and deals.
High End Retail Demand tofall: We expect a high impact on fashion, retail and luxury goodsas discretionary demand in this segment will be curtailed. A limited impact tobe caused on the food and grocery retail sub-segment, given thenon-discretionary nature of purchases in this segment. Slowdown in Discretionary Spending to Hurt Consumer Durable Sales: The Sales of White Goods industrycomprising mainly of TV, Refrigerator& Washing Machine could face a slowdown as 70% of the transactions in thisindusty are done on cash basis. But prices are expected to go down onlyslightly, due to slump in demand, because of the use of cards and cheques.
Agriculture sector : Ascash is the primary mode of transaction in agriculture sector, demonetisationis likely to cause crunch in the system. However, in the short term, the sectorhas to wait to reap the benefits of demonetization. In the transitional phase,farm produces with limited shelf-life like fruits and vegetables, whichsignificantly contribute to overall farm output, will be hit due to cashcrunch. Impacton Gold : People started hoarding gold as soon as the announcementregarding demonetization was made by Prime Minister Narendra Modi. Gold wasbought at exceptionally high prices overnight . The thinking behind this wasbuy gold today and in a year or so sell the gold for cash once new notes becomeavailable.
Due to this tendency, gold prices could completely crash in futurebecause of oversupply of gold. Impacton Stock Markets : The move has had a big impact on the stock markets. Alot of investors are withdrawing capital from stocks.
Some because they are outof funds (since the currency they had at home no longer works) and others becausethey expect a crash, perhaps an opportunity to buy at lower levels.Impacton Banking Sector- This is the sector that is going to be most benefittedby this move. As the deposits of the banks have increased , the liquidityposition of the banks have also increased. With the increase in deposits of thebanks, the CASA level will also increase that will increase the Net InterestIncome and net earnings of the banks.The increased liquidity in the hands of the banks will enable them to lendmoney at cheaper rates of interest leading to bringing out the borrowing ratesat a low level. CONCLUSION The demonetization process undertaken by theIndian economy has great implications some of which have been discussed in thisstudy.
The move had a big spontaneous effect on several aspects such as instanthoarding of gold and consequent spur in gold prices, sudden increase in bankdeposits , crashing stock markets in several sectors of the economy , liquidity crunch in the market etc. Theimpact of this decision in the medium term is dependent on how much of thecurrency will be replaced at the end of the replacement process and the extentto which currency in circulation is extinguished. While it is being assumed thatthe cash that is planned to be extinguished would be “black money” and hence,should be tactfully extinguished to set right the regulatory and incentivisedstructure in the economy, this statement is based more on impressions ratherthan on actual facts. The efforts will bring massive amounts of cash into the banking system –which is a big benefitin itself. Once the money is in the legitimate channels, it should be betterutilized and revenue will be generated from its use.
These demonetization measureshave had significant and immediate impact on the state of the Indian economy.These measures are also expected to result in long-term impact on certainindustries and sectors. These measures have resulted in a significant decreasein liquidity in the short term, which is expected to ease gradually with the introductionand circulation of the new currency notes.