The Government of India has
implemented a big change in the environment of Indian Economy by demonetizing
the high value currency notes of Rs. 500 and Rs. 1000 denominations. These
currency notes were ceased to be legal tender from the midnight of 8th
November 2016. This proposal by the Indian Government involved replacement of
old currency with a set of new ones. The money circulation in the economy was
consequently squeezed as the limits were placed on the withdrawn amounts by the
individuals. The reasons for the implementation of this process are two fold-
first to eliminate black money present in the economy and second to counterfeit
notes that were contributing to terrorism. The current study attempts to
understand the implications of this decision on the Indian economy and its
impact on GDP, different macro-economic variables as well as different sectors
of the economy. The paper also aims at evaluating the impact of such a move
over the different time horizons- very short term, short term and medium term
period.

Keywords-
Economy, Demonetization,Money, GDP

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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 an
effect 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 of
currenciesjamsconsumption,investment,production,employmentetc.Duringthis context,theexercise might bringfollowing short term/long term/,
consumption/investment, welfare/growth impacts on Indian economy. The intensity
of ending effects clearly depends upon the length of the liquidity shocks. Following are the most impacts over the various time horizons.

Very
short-term impact

The activity, by removing eighty six per cent of the
currency in circulation, has resulted terribly into very severe contraction in finances within the economy.
This contraction, by wiping out money balances
within the economy, can eliminate variety of transactions for a
while since there’s no
or not enough of a medium of exchange on the market. There are
likely to be 2 spin-offs
from this variation –
one, there would be some increase in tax collections within the short term, and
second; varied IOUs might emerge as currency
substitutes.

Short term impact

The short-run impact on the economy would rely on the speed with which and the extent to which the money will be fastly replaced by
the authorities. If the whole money is replaced within a short span
of 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 impact

In 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 some
impact on the economy. The primary impact would be a compression of
the 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 of
counterfeit currency and curb the funding for antisocial components like
importing, 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 nationwide
awareness and urge can encourage government to come out with sturdy measures.

Consumption
will be hit:
When liquidity shortage strikes, it is consumption that is going to be
adversely affected first.

Consumption
?? Production ?? Employment ?? Growth ?? Tax revenue ?

Effect on gross domestic product : The gross domestic product formation may come down with
reduction in the consumption levels but with the recent rise in competition, demand
is predicted to offset this fall in overall impact. Moreover, this expected
impact 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.

 

Effect
on Demand :The overall demand is
expected to be affected to an extent. The demand in following areas is to be
impacted 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 from
demand side. This demand driven fall in prices could be understood as follows:

?
Consumer goods: Prices are expected to fall only marginally due to moderation
in demand as use of cards and cheques would compensate for some purchases.

? Real Estate and Property: Prices in this sector are largely
expected to fall, especially for sale of properties where major part of the
transaction is cash based, rather than based on banks transfer or cheque
transactions. In the medium term, however the prices in this sector could
regain some levels as developers rebalance their prices (probably charging more
on cheque payment).

Immediate Impact: Heavy Deflation

Initially there’ll be significant deflation as people that have attained cash through outlaw suggests that like importing, people would be
afraid to declare the cash as they may be prosecuted by Govt/Income Tax Deptt on the
legitimacy of their financial
gain. This
will scale back the full currency circulation within the economy – resulting in deflation. Deflation will
increase the worth of
cash 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 on
Bank Deposits and interest rate: Deposit
within the short term might rise, however within the long run its results can
come down. New savings with banks are not permanent or can be said to be short
run 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 the
industry in the medium term. Most of the savings are obtained by large public
sector banks like SBI. They will scale back rate of interest within the
short/medium term. However they cannot follow it within the long run.

 

Impact of Demonetisation on Different Sectors of the Economy

Real
Estate Sector

The
substantial move by the Indian government to  demonetise high-value currency notes to bring out
black money is expected to have a deep impact on the capital-intensive real
estate sector where a significant amount of transactions still involve
unaccounted money. Now when the government is laying so much focus on
eliminating black money, the cash component in real estate transactions will go
down. This will result in a substantial drop in the property prices and deals.

High End Retail Demand to
fall: We expect a high impact on fashion, retail and luxury goods
as discretionary demand in this segment will be curtailed. A limited impact to
be caused on the food and grocery retail sub-segment, given the
non-discretionary nature of purchases in this segment. 

Slowdown in Discretionary Spending to Hurt Consumer Durable Sales: The Sales of White Goods industry
comprising mainly of  TV, Refrigerator
& Washing Machine could face a slowdown as 70% of the transactions in this
industy are done on cash basis. But prices are expected to go down only
slightly, due to slump in demand, because of the use of cards and cheques.

Agriculture sector : As
cash is the primary mode of transaction in agriculture sector, demonetisation
is likely to cause crunch in the system. However, in the short term, the sector
has to wait to reap the benefits of demonetization. In the transitional phase,
farm produces with limited shelf-life like fruits and vegetables, which
significantly contribute to overall farm output, will be hit due to cash
crunch.

Impact
on Gold : People started hoarding gold as soon as the announcement
regarding demonetization was made by Prime Minister Narendra Modi. Gold was
bought at exceptionally high prices overnight . The thinking behind this was
buy gold today and in a year or so sell the gold for cash once new notes become
available. Due to this tendency, gold prices could completely crash in future
because of oversupply of gold.

Impact
on Stock Markets : The move has had a big impact on the stock markets. A
lot of investors are withdrawing capital from stocks. Some because they are out
of funds (since the currency they had at home no longer works) and others because
they expect a crash, perhaps an opportunity to buy at lower levels.

Impact
on Banking Sector- This is the sector that is going to be most benefitted
by this move. As the deposits of the banks have increased , the liquidity
position of the banks have also increased. With the increase in deposits of the
banks, the CASA level will also increase that will increase the Net Interest
Income and  net earnings of the banks.
The increased liquidity in the hands of the banks will enable them to lend
money at cheaper rates of interest leading to bringing out the borrowing rates
at a low level.

 

 

 

CONCLUSION

 

The demonetization process undertaken by the
Indian economy has great implications some of which have been discussed in this
study. The move had a big spontaneous effect on several aspects such as instant
hoarding of gold and consequent spur in gold prices, sudden increase in bank
deposits , crashing stock markets in several sectors of the economy , liquidity crunch in the market etc. The
impact of this decision in the medium term is dependent on how much of the
currency will be replaced at the end of the replacement process and the extent
to which currency in circulation is extinguished. While it is being assumed that
the cash that is planned to be extinguished would be “black money” and hence,
should be tactfully extinguished to set right the regulatory and incentivised
structure in the economy, this statement is based more on impressions rather
than on actual facts. The efforts will bring massive amounts of cash into the banking system –which is a big benefit
in itself. Once the money is in the legitimate channels, it should be better
utilized and revenue will be generated from its use. These demonetization measures
have had significant and immediate impact on the state of the Indian economy.
These measures are also expected to result in long-term impact on certain
industries and sectors. These measures have resulted in a significant decrease
in liquidity in the short term, which is expected to ease gradually with the introduction
and circulation of the new currency notes.