MACRO ECONOMICS CIA 1723567

INTRODUCTION – DEMONETISATION

Demonetisation is defined as the process of stripping the status of ‘legal tender’ from any currency unit. It generally takes place wherever there is a change in the units of national currency; when the present form of currency/money is removed from circulation and/or retired, in most cases to be replaced by new notes or coins. Sometimes, an economy may completely replace its old currency with the new one.

In India, demonetisation took place on November 8, 2016, when the Prime Minister Narendra Modi took to the news channels to announce the demonetisation of all the ₹500 and ₹1,000 bank notes, at 20:00 IST. He also declared the issuance of new ₹500 and ₹2,000 bank notes. According to the Government of India, this untimely demonetisation was done to bring down the use of fake and counterfeit currency in order to fund illegal actions and terrorism. Due to the sudden and untimely nature of demonetisation, there were prolonged shortages of cash in the following weeks that disrupted the economy, while threatening the economic output.

In its initial stages, demonetisation received a great support from several bankers and international economists and more eminent personalities. However, this process was also heavily criticised as it was poorly planned, and perceived as unfair, and saw a lot of protests, litigations and strikes against the Indian Government across the country. The process of demonetisation also reduced the industrial production of the country, as well as the growth rate of GDP.

This wasn’t the first time the process of demonetisation was initiated in the Indian economy. Its history can be traced back to the year 1946, and again in 1978. In both the cases, the objective was to fight the tax evasion by black money, which is usually held outside of the formal economic and financial system.

THE PROCESS OF DEMONETISATION

·         FORMAL PUBLIC ANNOUNCEMENT – On November 8, 2016, Narendra Modi took to the major Indian news channels to announce the process of demonetisation in an unscheduled and untimely live national television address. In that, he declared the circulation invalid of all the ₹500 and ₹1,000 bank notes that would be in effect from midnight of the same day.

·         EXCHANGING THE OLD NOTES – The next step in the process of demonetisation was the exchange of the old notes. The Reserve Bank of India brought forward a stipulation that the demonetised notes would need to be deposited with banks over a fifty-day time period, until December 30, 2016. There were limits imposed on these exchanges in order to avoid shortages of cash, which was inevitable.

·          WITHDRAWAL LIMITS ON CASH FROM BANKS – Limits were also set on the withdrawal of cash from banks to avoid shortage of cash as demonetisation was a sudden act. The limit was initially ₹10,000 per day, which was later increased to ₹24,000 per day.

EFFECT OF DEMONETISATION

The sudden withdrawal of legal status of ₹500 and ₹1,000 notes created a ruckus in the country, hugely impacting the economy of India. The process of demonetisation was initiated to curb the illegal funding of terrorist groups and identify black money hoarders in the economy. However, the process of demonetisation impacted each and every person, sector, unit of the economy of India.

·         IMPACT ON GDP/ GROWTH RATE OF THE INDIAN ECONOMY

The short-term impact of demonetisation affected the GDP of India negatively, causing a notable decline in the GDP for the quarters that followed, due to a reduction in the demand of consumers, as a result of irregularity in cash flow post demonetisation.

However, the situation was brought under control as the cash flow became normal and regular.

Demonetisation caused a major setback in the Indian economy. Cancelling the legal tenders of ₹500 and ₹1,000 greatly affected the Indian economy, where more than 85 per cent of the financial transactions take place in cash. Ultimately there was a decline in the GDP by 1 per cent.

·         IMPACT ON THE STOCK MARKETS

Stock markets all over the world work on the principal of speculation in the markets. Any major event, related to financial, regional, political or legal nature, can hence affect the speculation in the financial markets, thus influencing the stock market. Due to demonetisation and the US presidential election happening during the same time, there was a drop in the indices of the stock market to a six-month low. BSE SENSEX crashed almost 1,689 points the day that followed the announcement of demonetisation.

·         SHORTAGE OF CASH

The Indian economy relies heavily on cash transactions. Estimates have shown that more than 85% of the financial and economical transactions in India take place in cash. Hence, there inevitably was a huge shortage of cash, post demonetisation, worsened by the untimely and sudden nature of the same. To add to the same, the limitations imposed by the Reserve Bank of India on the value of notes that could be exchanged or withdrawn per day worsened the situation, adding to the shortage of cash.  All this resulted in the ATMs running out of cash, and banks and ATMs experiencing huge queues outside, making the entire issue uncontrollable and chaotic.

·         IMPACT ON THE AGRICULTURE SECTOR

The agriculture sector was greatly impacted by the sudden and untimely nature of demonetisation. This is because most of the financial transactions in the agriculture sector are made in cash. Hence, ceasing the circulation of ₹500 and ₹1,000 banknotes resulted in a setback in the agriculture sector. The farmers faced difficulty in purchasing seeds, fertilisers, and other necessities for the plantation of rabi crops, which is usually done in mid-November, hence just days after the announcement of demonetisation. All these factors led to a huge drop in the prices of common vegetables like tomatoes and onions due to reduced demand.

·         IMPACT ON TAX COLLECTIONS

The demonetisation of ₹500 and ₹1,000 bank notes was done primarily to curb the illegal funding of terrorist groups and solve the issue of black money, that is the money that is not accounted for or the money on which taxes are  not paid. Hence, a huge impact was expected on the tax collections post demonetisation. The income tax department carried out raids across the country to identify and bust tax-evasive businesses. Huge sum of cash was seized from states such as Chhattisgarh, Punjab, Maharashtra and Delhi.

Since the government permitted the use of demonetised notes to pay the municipal taxes, the revenue collections saw an all-time high.

DEMONETISATION: MERITS AND DEMERITS

MERITS

·         There was a fall in the rate of inflation post demonetisation. The country saw a fall in prices of commonly used commodities like pulses, vegetables, fruits, etc.

·         There was a shift towards a cashless economy thanks to demonetisation of ₹500 and ₹1,000 banknotes. Since the supply of new ₹500 and ₹2,000 banknotes was limited, people had no choice but to resort to online transactions.

·         The stock market experienced a bullish phase post demonetisation.

·         There was an increase in bank’s lending for small businesses. 

·         The also was an increase in the sales of automobiles.

DEMERITS

·         The economic growth slowed down post demonetisation. The growth fell from 9.1% to 5.7% within a year. 

·         The percentage of stalled projects in real estates experienced an all-time high, thanks to demonetisation, GST and RERA. Demonetisation also hampered the sale of luxury housing segments.

References

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Krishnan, A. (2018). What Demonetisation did to tax collections . The Hindu .

MBA Universe . (2018). Retrieved from MBA Universe : http://www.mbauniverse.com/group-discussion/topic/business-economy/demonetisation

The Quint . (2018). Demonetisation: Where It Worked and Where It Didn’t.

The Times of India . (2018). Demonetisation. The Times of India.