A Study on Impact of Demonetization of Currency Notes on the Functioning

of Indian Economy
Mr. K Deepak Rao Mrs. Rashmitha R Kotian
Assistant Professor Assistant Professor
A.J Institute of Management A.J Institute of Management
Mangalore, 575006 Mangalore, 575006
Mobile No: 8147618678 Mobile No: 9740548095
Email Id: [email protected] Email Id: [email protected]
Abstract:
Demonetization is the process of stripping a currency from general usage, or circulation.
Demonetization is one of the boldest movements taken by Government of India under the
leadership of our Hon. Prime minister, Sri Narendra Modi in the history of Indian economy
which came into effect from November 8, 2016 midnight.
This initiative will have huge impact on Indian economy, GDP of India and the functioning of
various industries. Thus, in this paper an attempt has been made to understand the impact of
demonetization of higher denomination currency notes on the functioning of Indian economy. In
addition to this the study also examines the impact of demonetization on GDP of India.
Key words: Demonetization, Impact on Indian economy, GDP
Introduction:
Demonetization is the process of stripping a currency from general usage, or circulation. This is
usually done whenever there is a change of national currency or replacing the old unit with the
new one. A similar step was taken when the European Monetary Union nations decided to adopt
Euro as their currency. The old currencies were allowed to convert into Euros for a period of
time allocated, in order to ensure a smooth transition through demonetization. Zimbabwe, Fiji,
Singapore and Philippines are the other countries who have opted for demonetization.
Demonetization is one of the boldest movements taken by Government of India under the
leadership of our Hon. Prime minister, Sri Narendra Modi in the history of Indian economy
which came into effect from November 8, 2016 midnight. The idea behind this move of
demonetization was to declare Rs 500 and Rs 1,000 notes will be no longer legal tender. The
aim is to curb the corruption and get into lawful, banked and taxable part of economy.
According to the RBI’s database on the Indian economy currently there are Rs 17, 54,000 crore
worth of notes are in circulation, of which Rs 500 notes constituted almost 45% of the currency
in circulation while 39% of the notes were of the Rs 1,000 denomination in value terms, which
means demonetization of high denomination currency notes will definitely affect the economy
through the liquidity side. This impact would immediately press a pause button on transactions
that were planned in black money.
It is also fascinating to note that this was not the first time the Government of India has gone for
the demonetization of high-value currency. It was first implemented in 1946 when the Reserve
Bank of India demonetized the then circulated Rs. 1,000 and Rs. 10,000 notes. The government
then introduced higher denomination bank notes in Rs. 1,000, Rs. 5,000 and Rs. 10,000 in a fresh
avatar eight years later in 1954 before the Morarji Desai government demonetized these notes in
1978.
Objectives of the study:
 To study the impact of demonetization of higher denomination currency notes on the
functioning of Indian economy
 To study the impact of demonetization on GDP of India
Impact of Demonetization on Indian Economy
Demonetization had a very important impact on the functioning of Indian economy. This move
helped in eradication of black money. With this move black money holders either have to show
their income source from which they earned their black money to the department or to burn the
stacked income. RBI data shows that in 2015-16; almost 6.5 lakhs counterfeit notes were
detected in commercial banks of which almost 4 lakhs were in the Rs 500 and Rs 1,000 category.
Apart from that it also helped in curbing of counterfeit currencies. This initiative will help to
fight against counterfeit currencies that are being used for financing terrorism activities.
It should be noted that only a small portion of black money is actually stored in the form of cash.
Most of the black income is kept in the form of physical assets like gold, land, buildings etc.
Hence demonetization can help in curbing only the amount held in hand in form of cash.
Demonetization has indisputably aided banks high accretion of deposits. According to the data,
between October 28, 2016 and December 23, 2016, banks deposits have shot up from around Rs.
107 lakh crore to Rs. 112.6 lakh crore, which is an increase of about Rs. 5.5 lakh crore in two
months. This is nearly twice the amount of deposits that flowed into banks between April and
October 2016. But what is much important to know is how much of this increased liquidity will
stay in the banking system, once currency flow normalizes and various caps on withdrawal are
lifted. This scenario of banks flushed with funds and low interest rate is a perfect recipe for
boosting lending. But a moderate borrowing appetite on the part of highly-leveraged Corporates
and banks’ reluctance to lend have failed to spur loan growth, even after a substantial fall in
lending rates over the past year. According to the RBIs latest figures (as on December 23),
credit growth has fallen to a meager 5.1 percent, down from 10-odd percent levels last year. The
growth had already fallen to 5 percent levels in the end of November, as credit to Corporates
shrank by 3 percent. Even within the modest 10-11 percent credit growth in 2017-18, the growth
will be concentrated in pockets. In the last three years, PSBs have grown at a far slower pace,
because of their huge exposure to the corporate segment. Credit growth of PSBs plummeted to 4
percent in 2015-16 from 7 percent in 2014-15. In contrast, private sector banks were able to
clock a robust 26 percent year-on-year rise in lending in 2015-16. This disparity is likely to
continue and the growth in 2017-18 too will be driven by private banks. The biggest setback in
terms of costs for banks due to demonetization has been on account of recalibration of ATMs
and logistics costs involved in transporting currency, in a short-period of time. Also, post
demonetization, between November 9 and December 30, banks had to waive ATM charges for
all transactions (irrespective of the number) and merchant discount rate for debit card
transactions, etc. These will have short-term impact on costs. However, over the long run, the
sector as a whole will benefit from increased use of digital modes of transactions, which will
improve operational efficiency.
No doubt, there was rise in short term deposits, but in the long run, its effect will come down.
The deposit made by the people with the banks was actually liquid cash which they had in hand
to meet their emergency needs. One can’t assume that the cash once stored in their hands will be
put into savings for a long term with bank. People were compelled to save this money into banks
as they had to replace their old notes with new notes. These are definitely not voluntary savings
done with the aim of investment.
Reserve Bank of India has made few amendments like ATM withdrawals limits which were
earlier restricted to Rs 2,000 per day have been increased to Rs 10000 per day per card. The
restrictions on current account is also shifted to Rs. 1, 00,000 per week from Rs. 24000, whereas
the restrictions on withdrawals from savings bank account is at present unchanged to Rs 24,000 a
week which is signaling that the post-demonetization cash crunch is easing as currency supplies
have raised over the past few weeks.
The aim to make Digital India can be seen and felt as most of the transactions are started to
happen through e-commerce. Online shopping portals like paytm, PayPal etc have seen a surge
in adoption of their digital wallets and many big organized retail stores which have card payment
options have started experiencing an upsurge in their usage patterns. Demonetization has resulted
in people adopting virtual wallets such as Paytm, Ola Money, Future Pay Wallet and so on. This
change of e-wallet transactions have seen surge in makers of point-of-sale machines as there is
platform has increased to 2000%. This behavioral change could be a game changer for India.
Digital transactions in banking sector have also seen an upliftment as the point of sale
transactions in State Bank of India surged 300 percent in numbers and 200 percent by value. But
on the other side of the coin, most active segments of the population who constitute the ‘base of
the pyramid’ use currency to meet their transactions may feel the pinch of demonization. The
daily wage earners, other laborers, small traders etc who reside out of the formal economy uses
cash frequently. These sections will lose income in the absence of liquid cash as they get income
based on their daily work and those who doesn’t have the digital transaction culture. Liquidity
crunch will compel firms to reduce labour cost, which will surely lead to reduced income for
poor working class. This will also bring liquidity chaos even to the higher income people with
time.

Demonetization has brought the real-estate market to a complete stand-still. As these

developments take their toll, the housing market will experience stillness in the coming months.
The housing market is a hot-bed for the indiscriminate use of black money. The real-estate sector
is estimated to have suffered notional revenue loss of Rs. 22,600 crores in the fourth quarter of
2016 due to demonetization as home sales plunged 44% as compared with the same period last
year and new projects fell by a massive 61% year-on-year during the same period (according to
real estate consultancy Knight Frank India). Demonetization will also bring down interest rates
and force cuts in real estate prices. Buying a dream house would be no longer be a dream as it is
expected that property prices would come down in near future.
Apart from real-estate, demonetization also put brakes on automobile sales. Automobile demand
was hit hard by withdrawal of high-value currency, with total sales of cars, two-wheelers and
commercial vehicles shrinking to 18.7% which is the steepest drop since December 2000. Light
commercial vehicles emerged as the only segment that managed to grow in December, rising
1.15 percent. Vehicle sales across categories declined to 12, 21, 929 units from 15, 02, 314 units
in December 2015. Sales of scooters, which are more popular in urban markets, saw the biggest
decline in more than 15 years, falling 26.4 percent to 2, 84,384 units in December (According to
data released by the Society of Indian Automobile Manufacturers, SIAM).
Demonetization has wiped out the gains made by the mutual fund industry in the equity market
in the last one year. The sharp fall in stock prices post-demonetization resulted a 3.3% decline in
equity market assets for the first time in nine months in November. The assets under
management of mutual funds in equity schemes were down from 16000 crores to 4.68 crores in
November. Apart from these, the huge volatilities in the performance of our stock market as the
market valuation took a beating due to a spate of events such as global commodity meltdown,
Brexit and demonetization in India which resulted in drop in economic activity.
Demonetization made Indians to go through liquidity shock, as people were not able to get
sufficient volume of popular denomination especially Rs 500. It constituted to 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. As per the reports only 2000 million units of
Rs. 500 notes could be printed by the end of December 2016 whereas around 16000 million Rs
500 notes were in circulation as on end March 2016. Some portion of this has been filled by the
new Rs 2000 notes. Towards end of March 2017 approximately 10000 million units will be
printed and replaced which indicates that currency crunch will be there in our economy for the
next few months.
The Centre’s fiscal deficit remained high in the first eight months of the financial year with gross
tax revenues somewhat muted in November. This is the first set of official data on government
finances since the decision to demonetize high value currency on November 8. The Centre’s
fiscal deficit amounted to Rs. 4, 57,996 crore, or 85.8 percent of the budget estimate, between
April and November 2016. It was slightly lower at 79.3 percent of the full fiscal deficit was at
87 percent of the budget estimate in November 2015. The revenue deficit shot up to Rs. 3,
48,211 crore, or 98.4 percent of the full-year target by November 30. It stood at 87.5 percent of
the budget estimate a year ago but was 92.6 percent of the target in October 2016.
Impact on GDP
The assumption is that immediate impact of demonetization towards economy will be a heavy
deflation as people who have earned money through illegal means such as smuggling, corruption
would be fearful to declare the money as they might be prosecuted by Government/Income Tax
Department on the legitimacy of their income. This will reduce the total currency circulation in
the economy leading to deflation. Deflation increases the value of money because the total
money supply goes down but the commodities and things available in the market would not
decrease.
The Gross Domestic Product (GDP), is one of the primary indicators used to gauge the health of
a country's economy as it represents the total dollar value of all goods and services produced
over a specific time period. It is expected that demonetization will see a decline in the GDP of
India but this is going to be a temporary phenomenon. Consumer spending activity chopped
down to a near halt as consumers are refraining from making any purchases except essential
items. Food item inflation which is measured by changes in the Consumer Food Price Index,
accounts for 47.3% of the overall CPI. Due to 86.4% of the value of the currency notes in
circulation going out of the financial system and re-monetization being slow, the supply and
demand of food items will fall and wield more downward pressure on inflation. Ambit Capital, a
respected Mumbai-based equity research firm, has officially estimated that the demonetization-
driven cash crunch will result in GDP growth crashing to 0.5% in the second half of financial
year 2016-17. This means the GDP growth for six months, from October 2016 to March 2017,
could decelerate to 0.5%, down from 6.4% in the previous six months.

MSMEs play a very important role in its contribution to the total GDP, but post demonetization
it has also melt down. The cash-dependent micro-small and medium enterprises (MSMEs)
across the country have also borne the brunt of the ongoing demonetization exercises as most of
the transactions in un-organized SMEs will be cash based.
Growth in the Indian economy remained firm in the quarter from April to June 2016 which is the
is the first quarter of fiscal 2016–2017. During this period, the GDP (gross domestic product)
rose 7.1%, while the GVA (gross value added) rose 7.3%.
The fall in economic activity due to demonetization could last from two to three quarters. As a
result, GDP and GVA growth in the quarters from September to December 2016 and January to
March 2017 could be significantly lower than previous years. There could be some recovery in
the first quarter of fiscal 2017–2018. In the medium term, the Indian economy can grow
considerably after curbing the debilitation caused by counterfeit money and an increase in
economic activity.
A fall in discretionary consumption will hurt companies operating in this space (TTM) (VEDL).
However, a rise in tax flow and lower interest rates, are expected to help the Indian economy
(PIN) (EPI) (INDA) grow stronger.

Conclusion:
Demonetization of currency in India will have an important role to play in Indian economy as the
repercussions caused by the demonetization-driven cash crunch that is playing out in India will
paralyze economic activity only in the short term and has a dynamic and important role towards
the upliftment of the economy. It will definitely bring structural changes in the longer run and
lead to a greater formalization of the modern economy. So, one should always look at the bigger
picture which will definitely fetch results in the long term. This is what the people of India have
been asking for a long time which has finally happened.
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