Impact of Demonetization in India economy
Demonetization is the removal of legal tender status from circulating cash.
Nations frequently implement demonetization policies in expectation of economic benefits.
On November 8, 2016, the Government of India enacted a demonetization policy.
On November 8, 2016, Prime Minister Narendra Modi announced this strategy at 8 p.m. (often called "Mr. 8 PM") while addressing the nation.
In accordance with this policy, high-denomination Indian currency notes of ₹500 and ₹1000 were declared to no longer be legal tender, meaning they were no longer valid for transactions.
After this, the RBI announced the introduction of redesigned new ₹500 and ₹2000 currency notes, which were launched on November 10, 2016 and have been in circulation since November 10.
India implemented demonetization to fight a variety of issues, including corruption, the black money or parallel economy, terror funding, counterfeit currency, money laundering and hoarding, tax evasion, etc.
In this study, we look at how demonetization affects banks and the economy, as well as how much this strategy can help solve the problems listed above.
Currency Demonetization in India
The term "demonetization" refers to the removal of a coin or currency from circulation as legal tender.
Current currency is frequently withdrawn from circulation and replaced with fresh notes or coins.
When a country wishes to replace its old currency with a new one, demonetization occurs.
- Demonetisation Year: 2016
- Demonetisation Date: 8 November 2016
First Currency Revaluation in India:
It occurred in 1946 to eliminate ₹1000 and ₹10,000 from circulation.
On November 8, 2016, Prime Minister Narendra Modi demonetized ₹500 and ₹1000 denominations, two of the country's largest currency notes.
The currency was withdrawn from circulation and no longer accepted as payment.
Causes for Currency Replacement
Demonetisation was implemented in India for a variety of reasons, with curbing black money and endemic corruption being the primary objectives.
The objective was to minimise counterfeit currency used to fuel criminal activities and establish a cashless society.
The Reserve Bank of India also recognised and supported these objectives.
Demonetization's primary purpose was to gain control over black money, counterfeit currency, terror financing, and tax evasion.
The Impact of India's Demonetisation
In the past six years, Demonetisation has had both beneficial and negative effects on the Indian economy.
One has a wide range of beneficial effects, including the digitalization of transactions, a reduction in terrorist activities, etc.
But there were also negative effects, such as a slowdown in economic growth and widespread job losses in the private sector.
Certain industries in India were hit particularly hard by Demonetisation because of the reduction of liquidity and cash flow brought about by the policy.
The following are some significant effects of demonetisation:
The number of monetary transactions completed online has grown rapidly throughout the years.
Benefits of Demonetisation include:
- Diminished GDP growth
- Falling real estate prices
- Lower inflation
Demonetization in India has had varying effects on the country's economy and GDP over the past few years.
With both the Supreme Court and the Reserve Bank of India backing demonetization, it seems like a good idea.
Throughout its history, demonetization has been seen both favourably and negatively.
Let's take a look at disadvantage and advantage separately.
Advantages of Demonetization
1. Recovery of Black Money
"Black money" or "dirty money" refers to cash that is not subject to taxation by the government and so fails to generate revenue for the state over the course of the country's tax assessment period.
Many believe the government's demonetization efforts will help reduce the prevalence of illegal funds in the economy.
Tossing out illegal funds has the added benefit of decreasing corruption.
More than 99 percent of the invalid money was returned to banks by individuals, according to the Reserve Bank of India's declarations.
The government's ability to trace the origin of untraceable cash was aided by the demonetization policy.
Anyone who came into a large sum of money were expected to declare it and pay taxes on it.
In 2019, then-Finance Minister Piyush Goyal claimed that all anti-black money actions, including demonetisation, had recovered ₹1.3 lakh crore in black money.
2. Restricted Anti-National and Anti-Terrorist Activities
As a result of demonetization in India, money for terrorist organisations and other criminal organisations stopped flowing.
The demonetization that took place in the country had this result.
It also helped put a stop to money laundering by making it simpler for the IRS to track out the source of the funds.
3. Taxpayer numbers increase
Increasing the number of people who pay taxes in India was another consequence of the demonetization policy.
For the fiscal year 2017–2018, the Income Tax Department had an increase of 1.07 crore new taxpayers.
The total number of tax returns submitted in FY 2017–18 increased by almost 25% from the previous fiscal year (FY 2016–17).
4. Made a Wide Way for Digital (Online) Transaction
The demonetization move pushed India in the direction of a cashless economy.
Since demonetization, digital payments in most tier-II and tier-III cities in India have doubled.
More taxes are paid, and the amount of untaxed cash in circulation is reduced, thanks to this method of transaction.
Disadvantages of Demonetization
The sudden announcement of demonetisation in India caused panic and anxiety throughout the nation.
It impacted hourly wage earners. Due to the cash shortage, their employers were unable to pay them in cash, causing a significant number of people to lose their jobs.
The government's expenditure on currency printing increased.
In 2016 and 2017, when demonetisation was implemented, the jobless rate reached a four-year high.
The cash shortage affected businesses and slowed the economy for a period of time.
1. Effect on GDP:
The GDP decreased as a result of decreased currency circulation caused by a cash shortage.
This measure could have an effect on the formation of the GDP as a result of a decrease in consumption demand.
Furthermore, this expected impact on GDP may not be considered, as a portion of this demand will be deferred and then re-enter the stream once the cash situation returns to normal.
Reduced Inflation: Inflation results from increased market liquidity.
Due to demonetization, there is less liquidity and cash flow on the market, which reduces inflation.
It was expected by government-supported economists that once black money leaves the system, the money supply will decrease to some extent.
In the absence of open market actions by the Reserve Bank of India, this will cut inflation. Inflation can take four different forms.
Inflation on the Rise | 2 to 4% |
Walking Inflation | 5 to 10% |
Accelerating Inflation | 10 to 20% |
Hyperinflation | above 20% |
2. Effect on Purchasing Power
This mostly affected long-term investment assets, such as real estate, automobiles, and the cement and steel industries.
The stock values of companies in these industries were negatively affected.
Due to the fact that 90% of transactions in the Indian economy are conducted in cash, the consumer's purchasing power is also affected by the cash shortage.
3. Effects on the Real Estate Sector:
Demonetization destroyed the real estate market, resulting in a decline of more than 50 percent that persisted for more than 1 year.
Analysts anticipate that rate decreases in the following months will increase home sales, notwithstanding the negative short-term effects.
4. Effects on Banks and Financial Institutions
The demonetization of the currency has both positive as well as negative effects on the banking sector.
Yet, the long-term outcome is expected to be more favourable.
In accordance with government directives, people must deposit their cash in banks, which temporarily enhanced the institutions' liquidity.
This liquidity can be utilised by banks for long-term lending purposes.
As the liquidity of banks improves, it is predicted that they will expand the borrowing cycle by lending money at a reduced interest rate.
Yet, the negative impact also has a negative effect on the bank's earnings for the following two to three quarters.
Although banks will be preoccupied with helping the demonetization process, we may not observe a rise in the loan book.
5. Effect on Lending Rate:
The lending rate fell as a result of banks receiving funds at the repo rate and lending funds at the base rate.
In this circumstance, the Repo Rate decreased, the Base Rate decreased automatically, and because banks had sufficient funds to lend, the loan rate may also decrease.
The majority of the effects of demonetization on e-commerce are negative, while some are positive.
In the first few weeks following the demonetization, the gross merchandise value (GMV) of players in the online retail market decreased by 40–50%, in the midst of their strongest sales quarter.
Things could be grim until March next year. Even high-value commodities such as expensive smartphones have experienced a decline in sales.
Merchandise returns had increased by 50%. Yet analysts believe that consumer sentiment will not recover rapidly.
However, the increase in digital payments (100% increase in transactions) has given the sector optimism for the medium term.
Also, supermarkets and food delivery services are thriving because they sell necessities.
Some saw an increase in new customer orders from the typical 15-16% to 25%.
6. Effect on tourism:
The cash crunch negatively impacted the tourism industry.
It was extremely difficult for people to withdraw money from banks and ATMs. The travel and hospitality sectors were experiencing difficult times.
The peak tourism months of November and December were severely impacted.
For tourist locations outside of major cities, the business went down by as much as 40 percent.
The metropolitan tourism industry declined by 10%. The lack of cash at airports and hotels is a major issue.
And many national monument entry stations do not accept credit cards.
Western nations have issued currency warnings. Availability of liquid assets in India
Demonetization is projected to have a beneficial effect on digital transactions and other modes of payment.
The government's goal is to go cashless, and demonetization had a positive effect on digital transactions and other ways of payment.
As cash transactions decline, the demand for other forms of payment increases.
Digital transaction systems, E-wallets, online transactions utilising E-banking, use of Plastic money (Debit and Credit Cards), UPI, EFTPOS, Net Banking, Aadhar cards, etc., unquestionably experienced significant demand growth.
This should eventually result in the improvement of such systems and the necessary infrastructure.
History of India's Demonetization
Demonetization is not a new concept in India.
In the years leading up to 2016, the country went through two separate demonetization periods.
In such instances, such as in 2016, the government's primary objective was to counter black money and tax evasion.
1946 Demonetisation in India
In 1946, ₹ 1000 and ₹ 10,000 banknotes were demonetized for the first time.
Since these high-value currencies were unavailable to the majority of the population, the ban had a little public impact.
In 1954, ₹ 5000 banknotes were launched again.
1978 Demonetisation in India
In 1978, the then-prime minister, Morarji Desai, declared a ban on denominations of 1,000, 5,000, and 10,000 rupees.
The objective was to eliminate black money. Also, they hoped to fight the counterfeit currency circulating on the Indian market.
Demonetisation Process
The demonetization process is a lengthy one. Executing a plan of this magnitude is tough and requires more time for planning and execution.
The full process of demonetization can be broken down into four stages:
- Preparation
- Announcement
- Currency Exchange and Withdrawal
- Statutes and Laws
Preparing for the Process of Demonetisation
In India, preparations for the demonization began well in advance of the official announcement and implementation of the changes.
That began six to ten months ago. The RBI prepared new banknotes in May 2016, coupled with 2000 notes in August 2016.
The printing process did not begin until October 2016.
Announcement of Demonetisation in India
The information about the new currency changes was presented to the Union cabinet on November 8, before Prime Minister Narendra Modi's live, nationally televised announcement.
At midnight, the 500 and 1,000 banknotes became invalid, and fresh 500 and 2,000 banknotes were issued.
Currency Conversion and Withdrawal
The citizens were instructed to exchange their old currency notes with the banks no later than December 30, 2016.
A 50-day window was granted to the people. The following exchange limitations were formed:
₹ 4,000 per person | 8 to 13 November |
₹ 4,500 per person | 14 to 17 November |
₹ 2,000 per person | 18 to 25 November |
These restrictions were placed on cash withdrawals:
₹ 20,000 every week | November 10-13, 2016 |
₹ 24,000 per week | 14 November, 2016 |
Regulation and Acts
The 2016 Specified Bank Notes Ordinance was introduced.
This removed the government's obligation for the demonetized notes.
The penalties were also levied on those carrying obsolete currency beyond December 30, 2016.
Conclusion
Whether or whether demonetization benefited the nation is disputed.
While some economists support the bold action, others claim that demonetization has failed to achieve its objectives in numerous areas.
The primary objective of demonetisation in India was to prevent the circulation of black money and tax evasion.
The Supreme Court also backed the decision, stating that the Reserve Bank of India was consulted and that substantial preparations, including a well-considered new design, consideration of new security inks, etc., were made to implement demonetisation in India.
Hence, demonetization was a policy decision
Demonetization has both positive and harmful long-term effects, although the negative effects do not surpass the favourable ones.
Certain industries were unaffected by demonetization, including Pharma, FMCG, Education, Agriculture, Healthcare, Energy, and Telecommunications.
In the medium to long term, this action would be favourable for the Banking and Infrastructure sectors from a stock market standpoint.
This would be detrimental to Real Estate, Consumer Durables, and Luxury Goods in short to medium term.
Demonetization can lead to the removal of counterfeit cash and corruption; this is a historic move by the Modi government that everyone should applaud.
This government action will unquestionably bear fruit in the long run; this is the stepping stone to/sustainable economic growth in the long run.
FAQ : Demonetization 2016 in India
A government or central bank could demonetize a currency unit for a number of different reasons.
One of the reasons is to control inflation. Demonetization can be used to remove extra currency units from circulation, which can help to control inflation if prices are rising too quickly.
The history of demonetized currency in India dates back to 1978 when the government demonetized high-denomination notes in an attempt to eradicate black money.
The government demonetized 500 and 1000 rupee notes in 2016 to fight corruption and encourage digital transactions.
One important risk connected with demonetization is the potential for economic crises.
When a currency is demonetized, companies and customers may have limited access to cash, resulting in a slowdown of economic activity.
Demonetization's principal objective is to reduce inflation by eliminating excess currency from circulation.
By rendering a particular currency unit illegitimate, the government can reduce the amount of money in circulation, hence reducing inflation.
Another objective of demonetization is to fight black money and corruption.
A currency unit is demonetized when it is withdrawn from circulation and declared to no longer be legal tender.
Often, demonetization is performed to convert the currency unit to a new one or to replace an old or defective one.
