DEMONETIZATION:
The government on 8th November announced that INR 500 and INR 1000 notes of Mahatma
Gandhi series will cease to be legal tender effective immediately. The term that describes
this abovementioned process is called demonetization. Demonetization is the process of
withdrawal of a particular form of currency from circulation or stripping a currency unit of its
status as a legal tender.
The reasons provided by the government for demonetization were twofold: a) first it aimed
to curb the circulation of “black money” and counterfeit notes and b) second, the
government aimed to promote a cashless, and more digitalized economy.
Economic Impact: According to the Reserve Bank of India Annual Report for April 2015 to
March 2016, the value of the currency notes at the end of March 2016 was 16.42 trillion
Indian rupees. The 500 rupee and 1,000 rupee currency notes formed 86.4% of the value. In
one stroke, the government removed 86.4% of the currency in circulation by value. In terms
of volume, the currency notes of these two denominations formed 24.4% of a total 90.27
billion piece. This section assesses the economic impact of this abovementioned massive
withdrawal of money from the economy, on growth and inflation and their outlook in the
context of subsequent remonetization.
To understand this, the economy could be bifurcated in three broad segments as following:
1. Agriculture sector;
2. Manufacturing sector, and;
3. Service sector;
1. Agriculture sector;
Agriculture contributes to seventeen per cent of the GDP.31Cash being the primary mode of
transaction in agriculture sector, stress in agriculture was bound to appear because of
demonetization.
Short-Term Impact:
o The short-term impact was mostly negative because of co-operative banks were
barred from exchange-deposit of demonetized currency which formed the major
portion of formal financing in parts like Punjab, Uttar-Pradesh, Odisha and Gujarat.
Sale, transport, marketing and distribution of ready produce to wholesale centers or
mandis, is dominantly cash dependent.
o In the scenario of lack of cash, most of the transaction going on credit basis. The
input dealers (seed, fertilizer and pesticide dealers) are increasing prices by 20-30%
of the normal price as the transactions are on credit basis. In product market also big
traders and commission agents are offering credit to farmers at much higher interest
(reaching 36% for just a month) than in normal conditions. The cash crunch caused
by demonetization affected farmers badly who are not acquainted with cashless
transactions. Prices in consumer markets (Delhi and Mumbai) are higher, but in
villages there were no buyers for farmer’s harvested crop.
Long-term Impact:
o Agricultural sector is still lacking behind in terms of innovation and irrigation. It is
often seen that innocent farmers are exploited by the intermediaries. It is to be seen
in future what Modi’s government has in place for farmers in the future.
o Some of the impacts on presumptions would be:
I. with recovery of black money likely to be in billions, the government can
invest in the agricultural infrastructure.
II. The rates of interest on loans are likely to fall. It will depend on how much
the government does make recovery.
III. Out of the money, the irrigation project can be [Link] government
should try to reach out to the farmers of rural areas also.
o Otherwise, we might see rise in prices of the commodities. So, in a nutshell, the
farmers in rural areas being distantly linked with banking channels will be hit hard.
This will adversely affect the demand and supply of grains, fruits and vegetables and
hence their prices.
2. Manufacturing sector
Demonetization of high-value currency notes in November has begun to hit the
manufacturing sector, according to a private sector survey.35The Nikkei India Manufacturing
Purchasing Managers’ Index (PMI) fell to 49.6 in December, the first time it hit below the 50-
mark in 2016, from 52.3 in November. Having held its ground in November following the
unexpected withdrawal of ₹500 and ₹1,000 bank notes from circulation, India’s
manufacturing industry slid into contraction at the end of 2016.36 Moreover, cash crunch
has resulted in lower purchasing activity in turn leading to lower manufacturing output.
In India’s manufacturing and distribution value chain, there exists various components like
suppliers, raw material, inventory, contract labor, dealers, customers etc. All the mentioned
components are affected individually as well as a whole manufacturing sector. The key
variables such as the logistics and contract labor that are used for loading and unloading is
highly unorganized and was usually paid on a daily basis through hard cash. The dearth of
cash effects these workers adversely and immediately. This in turn led to lower labor
availability.
Make-to-stock sector also had challenges related to consumption of existing goods and
material which in turn created 'bull-whip' effect across the supply chain.
The major decline was seen in the demand of two wheelers than luxury cars/four wheelers
since cash is the primary mode of transaction in the purchase of two wheeler vehicles.
Another segment of automobile industry which is facing effects of demonetization is the
used car industry wherein numerous car dealers have reported sudden decrease in sales. It
is an unorganized industry and therefore, the modes of payments are not exactly regulated.
Business houses are an integral constituent of the country’s economy. While medium and
large scale business is unaffected to such ban, many small-size commercial establishments
are deeply affected by such sudden move by the government. A study by the All India
Manufacturers’ Organization (AIMO), which represents over three lakh small and medium
scale industries, estimated a loss of 35% of temporary jobs in MSMEs across the country
sector and a 50% drop in revenue during the first 34 days of demonetization
3. Service sector
Service sector is also referred to as tertiary sector of the economy, primary and secondary
sector being farming and manufacturing respectively. The service sector produces intangible
goods, more precisely services instead of goods, and according to the U.S. Census Bureau, it
is comprised of various service industries including warehousing and truck transportation
services; information sector services; commodities, securities and other investment services;
professional, technical and scientific services.42 Hence, any economic imbalance in the
above mentioned area will affect the economy as a whole.
o The Nikkei India Services Purchasing Managers' Index (PMI), which tracks services
sector companies on a monthly basis, stood at 46.7 in November, down from 54.5 in
October.43 The Index slipped into contraction territory for the first time since June
2015 and pointed to the sharpest reduction in output for almost three years. A
reading above 50 means the sector is expanding, while a score below this mark
signals contraction. Due to cash crunch in the economy post demonetization,
businesses declined in financial intermediation, hotels & restaurants and renting
activities. The cash shortage resulted in fewer new business operations, which in
turn caused a fall in activity and ended planned expansion in many cases. The drop
in services activity is not surprising since the share of the unorganized sector in
services (around 45% of total, as per 2004-05 data) is much higher than in
manufacturing (around 23%), suggesting larger dependence on cash transactions.
Recent data actually contributes to the expectation of the economists that service sector
recovered that “short-term” of cash crunch by shifting to cashless way of payment which
was the secondary agenda of government for demonetization.