09 Nov 2016 20:48 IST

Demonetisation and its aftermath

People queue up outside an ATM to withdraw 100 rupees notes | PTI   -  PTI

What does the move to withdraw ₹500 and ₹1,000 notes mean for you?

By now, after listening to the news of demonetisation of ₹500 and ₹1,000 notes, you would have frantically searched for ₹100 notes, eagerly waiting for Thursday to get those now-illegal notes exchanged.

While this affects you immediately, what more can you expect — at the micro and macro level — in the aftermath of the withdrawal of these bank notes from circulation?

Let’s us examine the issue.

History of demonetisation

Demonetisation, which means withdrawal of legally acceptable currency from circulation, is not new in the world or in India. The last demonetisation was done in January 1978, when ₹1,000, ₹5,000 and ₹10,000 notes were scrapped by the Janata Government led by Prime Minster Morarji Desai.

Demonetisation is generally advised by economists as a tool to curb black money, weed out fake notes, and prevent cross-border funding that can create political instability in a country or sponsor terrorism. India now faces all these challenges, which explains the current drive.

The impact

However, a peep into the history of previous demonetisations shows that the present move could have far-reaching consequences, and be very different from the experience of 1978, given that not many common people regularly used high-value notes for exchange earlier.

It is no wonder, then, that the move has triggered panic amongst people, not to mention the inconvenience they are facing, considering the huge volume of these notes that were in circulation.

As of March 2016, the value of banknotes in circulation was ₹1,641,500 lakh crore, an increase of 14.9 per cent over the previous year. In value terms, ₹500 and ₹1,000 notes together accounted for 86.4 per cent of the total value of notes in circulation.

During 2015-16, according to the RBI’s 2015-16 annual report, the demand for banknotes and coins remained high, notwithstanding the growing shift towards non-cash modes of transactions.

Road ahead

Apart from exchanging notes, which all of us have to do, there are many other consequences.

~ Despite criticism, demonetisation is bound to rein in black money in an effective way, as those who hoard money have only two choices — either to account for it or to destroy the notes.

~ At a micro-level, liquidity or money circulation in the economy will be adversely impacted, as the parallel economy or black money is estimated to be equal to India’s Gross Domestic Product (GDP). In an economy, all money is the same, irrespective of it being white or black. As long as it has purchasing power, it will impact aggregate demand. Aggregate demand, in turn, creates more production and employment, which leads to wages and creates demand again, and the cycle continues.

So, assuming that black money is driving spending in Indian economy in key sectors like real estate to a significant extent, squeezing it out of the economy might adversely impact aggregate demand. Real estate prices are expected to fall. Sale of consumer goods, electronics and automobiles too might get impacted.

~ There will be a massive jump in non-cash transactions and e-commerce may get a boost. However, it remains to be seen how production and consumption at the macro level will be impacted in the near term as well as long term.

Even though demonetisation might arrest the use of black money in the short term, how can the hoarding of ₹2,000 notes be prevented? Will it lead to a fresh cycle of parallel economy in the years to come?

Only time will reveal the answers to these questions.

The Hindu BusinessLine's experts examine the challenges ahead in effectively introducing the new currency and how it may impact the demand for gold. Everyone's talking about the nexus between the real estate sector and black money. What happens with the introduction of the new currency? Watch to know more.