On November 8, 2016, the Government of India banned ₹500 and ₹1,000 notes. Yes, there were many socio-economic consequences as a result of this move, but why did the Modi government take such a bold step? According to the Finance Ministry, currency notes of other denominations had seen a 40 per cent growth in circulation from 2011 to 2016, as against a 76 per cent and 109 per cent rise in circulation of the ₹500 and ₹1000 notes, respectively. These two denominations constituted 86 per cent of the total cash in the economy.
According to the Government, there were three major reasons for the move. The first was to tackle black money in the economy; second was to lower the cash in circulation, which is directly related to corruption in our country, and the third was to eliminate fake currency and dodgy funds that have been used by terror groups to fund terrorism in India.
Changing goal posts
The premise of demonetisation kept changing as days passed. Initially, it was central to curb black money, then to curb terrorist funding via fake currency and later, when the digital payment gateways started growing, the focus shifted to electronic payments.
Individuals with black money were penalised. If they had a pile of black money it was now impossible to get the notes exchanged due to strict exchange rules and limits. But some, who converted their black money into other assets, were not affected. Those who did this remain unaffected as the whole process only talks about cash; no measure has been taken to bring back the money that was hastily invested in gold, real estate, and the like. Of all the money that is unaccounted for, cash constitutes only 4 per cent. A large part of India’s population still does not have bank accounts, and they were severely affected; especially after people did not exchange their notes well before the deadline. After an extremely tough initial few days for the general public, things eventually began going back to normal and back on track for the common man in the next few months.
Liquidity and growth
Short-term implications of the move were positive since there didn’t seem to be any major terror activities, and a lot of money seemed to have entered the system and this led to an inflow of liquid funds into banks; but later, there was a currency crunch. So, in the short-term, liquidity was hit for the next six months, at the very least. This led to a slowdown in consumption, production, employment, growth and tax revenue. However, as the consumption stabilised, everything began falling into place. Banks reduced interest rates to boost consumption, but this didn’t go on for long as it come with the risk of inflation. Since they were sitting on a pile of cash, investing that in the market coupled with deficit spending by the government could help the the economy achieve impressive growth numbers. Among the long-term impactwas reduced growth rate, since consumption had gone down. The government, however, said that most (99 per cent) of the black money circled back into the system and was now ‘legal’ (white) money.
How some sectors were affected
The real estate was impacted since the number of buyers came down, and low demand brought down the prices in the short term. However, this subsequently helped improve the sector’s prospects. The sector also dragged down the cement and ceramic sectors with it.
Gold and commodities witnessed a momentary price surge, then a fall in the short run, but these are likely to stabilize in the long term. As soon as the announcement was made, the price of gold went up — that was a momentary effect. A couple of weeks later, the price of gold fell because people had limited cash and invested it in items that were necessary. However, people prefer jewellery to cash, so in the long run, gold prices are likely to rise again.
Banks and financial services benefited in the short term due to heavy transaction volumes and large deposits. Tourism and entertainment went down since they transacted mostly in cash. Consumer durables sector saw a slump in sales as individuals postponed purchases.
At what cost
There were a lot of questions regarding demonetisation.
Many economists, including Amartya Sen, disagreed with the move. Questions such aswhat was the purpose of such a bold step? Cash accounted only for 4 per cent of the total black money; what about the other 96 per cent (invested in other assets) against which no strong moves had been taken?
It is clear that demonetisation did not do much to bring back the black money, but it could also be that it helped stop it for some time. It has not yet been proven that a cashless economy would result in a corruption-free India. Kenya and Nigeria have mostly been cashless, but they are among the most corrupt countries.
According to the Centre For Monitoring Indian Economy, the cost of demonetisation was estimated at ₹1.28 trillion. Was the exercise worth it?
(The authors are students of IIM Trichy)