“ECONOMIC EFFECTS OF DEMONETISATION ”

Submitted by:

Samar Pratap Singh, B.A. L.L.B (Hons.)(1368)

Submitted to:

Dr. Shivani Mohan,

Assistant Professor of Economics

This final draft is submitted for the partial fulfilment of the

(B.A. L.L.B) course in Economics — II.

20th April 2017

Chanakya National Law University, Patna

 ECONOMIC E FFECTS O F DEMONETISATION

Table of Contents

DECLARATION BY THE CANDIDATE ............................................................................................... 3

ACKNOWLEDGEMENT......................................................................................................................... 4

I. ECONOMIC EFFECTS OF DEMONETISATION:“A HELICOPTER HOOVER” ........................... 5

AIMS AND OBJECTIVE ..................................................................................................................... 6

HYPOTHESIS....................................................................................................................................... 6

RESEARCH QUESTIONS: .................................................................................................................. 6

LIMITATIONS ..................................................................................................................................... 7

RESEARCH METHODOLOGY .......................................................................................................... 7

II. IMPACT AND OBJECTIVE OF DEMONETISATION: .................................................................... 8

BACKGROUND ................................................................................................................................... 8

BENEFITS .......................................................................................................................................... 11

LONG TERM BENEFITS: ................................................................................................................. 13

III. CRITICAL ANALYSIS ................................................................................................................... 20

IV. CONCLUSION AND SUGGESTION ............................................................................................ 25

BIBLIOGRAPHY ................................................................................................................................... 27

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 ECONOMIC E FFECTS O F DEMONETISATION

DECLARATION BY THE CANDIDATE

I, hereby, declare that the work reported in the L.L.B (Hons.) Project Report titled “ECONOMIC

EFFECTS OF DEMONETISATION” s ubmitted at CHANAKYA NATIONAL LAW UNIVERSITY,

PATNA is an authentic record of my work carried out under the supervision of Dr. Shivani Mohan,
Assistant Professor of Economics. I have not submitted this work elsewhere for any other degree or
diploma. I am fully responsible for the contents of my Project Report.

(Signature of the Candidate)

Samar Pratap Singh (1368)

B.A. L.L.B., 2nd year
CNLU, Patna

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 ECONOMIC E FFECTS O F DEMONETISATION

ACKNOWLEDGEMENT

I would like to show my gratitude towards my guide, Dr. Shivani Mohan, Assistant Professor of
Economics under whose guidance, I structured my project.
I owe the present accomplishment of my project to everyone, who helped me immensely with materials
throughout the project and without whom I couldn’t have completed it in the present way.
I would also like to extend my gratitude to my friends and all those unseen hands that helped me out at
every stage of my project.

THANK YOU,

SAMAR PRATAP SINGH

2nd year, SEMESTER -4th
CNLU, PATNA

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 ECONOMIC E FFECTS O F DEMONETISATION

I. ECONOMIC EFFECTS OF DEMONETISATION:“A HELICOPTER HOOVER”

On November 8, 2016, the government announced a historic measure, with profound implications for the
economy. The two largest denomination notes, Rs 500 and Rs 1000, were “demonetized” with immediate
effect, ceasing to be legal tender except for a few specified purposes. At one fell stroke, 86 percent of the
cash in circulation was thereby rendered invalid. These notes were to be deposited in the banks by
December 30, 2016, while restrictions were placed on cash withdrawals. In other words, restrictions were
placed on the convertibility of domestic money and bank deposits.1
The aim of the action was fourfold: to curb corruption; counterfeiting; the use of high denomination notes
for terrorist activities; and especially the accumulation of “black money”, generated by income that has
not been declared to the tax authorities. It followed a series of earlier efforts to curb such illicit activities,
including the creation of the Special Investigative Team (SIT) in the 2014 budget; the Black Money and
Imposition of Tax Act 2015; Benami Transactions Act 2016; the information exchange agreement with
Switzerland; changes in the tax treaties with Mauritius, Cyprus and Singapore; and the Income Disclosure
Scheme.2 Demonetisation was aimed at signalling a regime change, emphasizing the government’s
determination to penalize illicit activities and the associated wealth. In effect, the tax on all illicit
activities, as well as legal activities that were not disclosed to the tax authorities, was sought to be
permanently and punitively increased. India’s demonetisation is unprecedented in international economic
history, in that it combined secrecy and suddenness amidst normal economic and political conditions. All
other sudden demonetisations have occurred in the context of hyperinflation, wars, political upheavals, or
other extreme circumstances. But the Indian economy had been growing at the fastest clip in the world on
the back of stable macroeconomics and an impressive set of reforms. In such normal circumstances,
demonetisations—such as the one announced recently in Europe— tend to be phased in gradually.3

India’s action is not unprecedented in its own economic history: there were two previous instances of
demonetisation, in 1946 and 1978, the latter not having any significant effect on cash.4 But the recent
action had large, albeit temporary, currency consequences. In the wake of the Global Financial Crisis
(GFC), advanced economies have used monetary policy to stimulate growth, stretching its use to domains
heretofore considered heretical such as negative interest rate policies and “helicopter drops” of money. In

1
Notification; S.O. 3407(E); [F.No.10/03/2016-Cy.I];Ministry Of Finance (Department of Economic Affairs) New Delhi, the
8th November, 2016.
2
Economic survey, published by Government of India Ministry of Finance Department of Economic Affairs Economic
Division January, 2017.
3
In 1970, a Committee headed by former Chief Justice K.N. Wanchoo, in its interim report, recommended
demonetisation of the 10, 100, and higher denomination notes to combat the scourge of black money. These
denominations accounted for 86.6 percent of the then money stock.
4
Ibid.
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 ECONOMIC E FFECTS O F DEMONETISATION

fact, India has given a whole new expression to unconventional monetary policy, with the difference that
whereas advanced economies have focused on expanding the money supply, India’s demonetisation has
reduced it. This policy could be considered a “reverse helicopter drop”, or perhaps more accurately a
“helicopter hoover”. The public debate on demonetisation has raised three sets of questions. First, broader
aspects of management, as reflected in the design and implementation of the initiative. Second, its
economic impact in the short and medium run. And, third, its implications for the broader vision
underlying the future conduct of economic policy. This project focuses on the second question. A
cautionary word is in order. India’s demonetisation is unprecedented, representing a structural break from
the past. This means that forecasting its impact is hazardous. The discussion that follows, especially the
attempts at quantification, must consequently be seen as tentative and far from definitive. History’s
verdict, when it arrives through the “foggy ruins of time,” could surprise today’s prognostications.

Aims and objective

The aim of the researcher is to:

1. Know the impact of the demonetisation on black money and fake currency notes.
2. Analyse the effect of demonetisation on the growth of economy.
3. Ascertain the perfect steps needed for the creation of digitalised and clean economy.

Hypothesis

1. That the impact of demonetisation on the black money and fake currency is short lived.
2. That the impact of demonetisation derailed the growth of economy.
3. That the demonetisation and financial inclusion programmes will make clean and digitalised
economy.

Research questions:

1. Whether the impact of demonetisation will wash away the black money and fake currency
forever?
2. What type of impact this demonetisation over the economy?
3. What is the role of demonetisation for checking the corruption and enhancing transparency in
transaction?

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Limitations

Since, it is being a recent step by the government. The information regarding it is available only with
government websites or newspapers. The unavailability of the literature or commentary in book form is a
concern for the researcher. The researcher has a limited time to prepare this project report. Having less
time, it is very difficult to make it more comprehensive. The researcher for gathering the information and
reviews have to go through various videos and documentary. This was a horrible experience when it took
hours for the video to buffer and play on YouTube.

Research methodology

The researcher has chosen to do doctrinal type of research. While doing this project, he consulted various
government notifications, schemes, news reports and case study of various cities. The researcher, after
reading the materials available, prepared a comparative chart. This helped in understanding the problems
existing and brings out the solution for the problem existing in India.

The researcher went through various documentaries and Finance minister’s speech videos in order to
understand the method of the government in making India cashless and digitalised. This made the
researcher to better understand the flaws and problem with the method. It also helped to point out the
effectiveness of the method.

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II. IMPACT AND OBJECTIVE OF DEMONETISATION:

There are two dimensions in which the cash can be understood: its origin and its nature. In terms of
function the cash can be used as a medium of exchange. (For transactions) or as a store of value like
other forms of wealth such as gold and real estate. In terms of nature, cash can be illicit or cannot be
illicit. There are certain factors which influence the way for demonetisation. Those are:—

Background

First, India’s currency to GDP ratio has evolved in two broad phases. It declined fairly steadily for the
first decade and a half after Independence, falling from around 12 percent in 1952-53 to about 9 percent
in 1967-68. Thereafter, the ratio appears to have responded to the growth of the economy. It began its
upward trend in the late 1970s when growth increased, and then accelerated further during the growth
boom of the 2000s. This ratio declined during the period of high inflation in the late 2000s and early
2010s but it rebounded after 2014-15 to 12 percent when inflation declined again. The value of high
denomination notes (INR 500 and INR 1000) relative to GDP has also increased in line with rising living
standards. Second, India’s economy is relatively cash-dependent, even taking account of the fact that it is
a relatively poor country.5 The cash holdings were not being used for legitimate transactions, but perhaps
for other activities such as corruption. This presumption is especially strong because across the globe
there is a link between cash and nefarious activities: the higher the amount of cash in circulation, the
greater the amount of corruption, as measured by Transparency International. In this sense, attempts to
reduce the cash in an economy could have important long-term benefits in terms of reducing levels of
corruption. Yet India is “off the line”, meaning that its cash in circulation is relatively high for its level of
corruption. This suggests two possibilities. Perhaps India’s level of corruption (or other related
pathologies) is much worse than the index shows, so that the orange dot should really be placed to the
right. Or cash is being used for other, presumably legitimate purposes. But even if high levels of cash are
needed this doesn’t mean high denominations are needed. It is usually the case that high value notes are
associated with corruption because they are easier to store and carry, compared to smaller denominations
or other stores of value such as gold (Sands, 2016; Henry, 1980; Summers, 2016; Rogoff, 2016). How
high were India’s high denomination notes in terms of their use for transactions relative to store of value?
Figures 5-6 shed some light. In particular, it is useful to look at the size of the notes relative to nominal
per capita income. The higher a note is relative to income, the less likely it is to be used purely for
transactions purposes. In India’s case, the denomination/ income ratio has fallen sharply over the past

5
Economic survey 2016-17 at pg 55.
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 ECONOMIC E FFECTS O F DEMONETISATION

quarter century because incomes have been growing rapidly relative to the prevailing highest
denomination notes (Figure 5). This suggests that the high denomination notes have become increasingly
useful for transactions over time.

This impression is confirmed by cross country data, which show that the Rs 1,000 note was in the middle
of the pack compared to other currencies, especially those of its peer group of lower middle-income
economies (Figure 6). Perhaps the most conclusive evidence on the extent to which Rs 500 and Rs 1000
notes are used for transactions comes from data on “soil rates,” that is the rate at which notes are
considered to be too damaged to use and have been returned to the central bank. RBI data show that in
India low denomination notes have a soil rate of 33 percent per year. In contrast, the soil rate for the Rs
500 note is 22 percent, and the Rs 1000 just 11 percent. One way to estimate black money is to assume
that all these notes should soil at the same rate, if they were really being used for transactions. This would
yield an estimate of money that is not used for transactions at Rs. 7.3 lakh crores. But this assumption
would be extreme since the lower soil rates for the high denomination notes could arise if they are used in
the same way, but just less frequently because there are fewer high value transactions. There is a way,
albeit not perfect, to differentiate between these two hypotheses, by comparing Indian data to soil rates in
other countries. In principle, if a rupee-denomination note and a foreign denomination note fulfill a
similar transaction function, then their soil rates should be similar (all else equal). If the Indian soil rate is
instead lower, this suggests that a fraction of the notes are not being used for transactions, but rather for
storing black money. 3.23 Using relative soil rates for the US $50 and $20 notes and applying them to
comparable Indian high denomination notes, yields an estimate of the amount not used for transactions,
and hence potentially black, of about Rs. 3 lakh crore. This is substantial, as it represents about 2 percent
of GDP.

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Table: Impact of demonetisation6
Sector Impact
Effect through end-December
Money/interest rates Cash declined sharply
Bank deposits increased sharply
RBI’s balance sheet largely
unchanged: return of currency
reduced the central bank’s cash
liabilities but increased its deposit
liabilities to commercial banks
Interest rates on deposits, loans, and
government securities declined;
implicit rate
on cash increased
Financial System Increased
Savings
Corruption
(underlying illicit
activities)
Unaccounted Unaccounted income/black
income/black money (underlying activity
money (underlying may or may not be illicit)
activity
may or may not be illicit)
Private Wealth Private sector wealth declined, since
some high denomination notes were
not returned and real estate prices fell
Public Sector Wealth No effect.
Formalization/ Digital transactions amongst new
digitalisation users (RuPay/ AEPS) increased
sharply; existing users’ transactions
increased in line with historical trend
Real estate Prices declined, as wealth fell while
cash shortages impeded transactions
6
Economic survey, published by Government of India Ministry of Finance Department of Economic Affairs Economic
Division January, 2017.
10
Likely longer-term effect
Cash will recover but settle at a
lower
Deposits will decline, but probably
settle at a slightly higher level
RBI’s balance sheet will shrink,
after the deadline for redeeming
outstanding notes
Loan rates could fall further, if
much
of the deposit increase proves
durable
Increase, to the extent that the cash
deposit ratio falls permanently
Could decline, if incentives for
compliance improve
Formalization should reduce the
flow of unaccounted income
Wealth could fall further, if real
estate prices continue to decline
Government/RBI’s wealth will
increase when unreturned cash is
extinguished, reducing liabilities
Some return to cash as supply
normalises, but the now-launched
digital revolution will continue
Prices could fall further as investing
undeclared income in real estate
becomes more difficult; but tax
component could rise, especially if
 ECONOMIC E FFECTS O F DEMONETISATION

GST imposed on real estate

Broader economy Job losses, decline in farm incomes, Should gradually stabilize as the
social disruption, especially in cash- economy is remonetised
intensive sectors

GDP Growth slowed, as demonetisation Could be beneficial in the long

reduced demand (cash, private run if formalization increases and
wealth), supply (reduced liquidity corruption falls
and working capital, and disrupted
supply chains), and increased
uncertainty
Cash-intensive sectors (agriculture, Informal output could decline but
real estate, jewellery) were affected recorded GDP would increase as the
more economy becomes more formalized
Recorded GDP will understate
impact on informal sector because
informal manufacturing is estimated
using formal sector indicators (Index
of Industrial Production).
But over time as the economy
becomes more formalized the
underestimation will decline.
Recorded GDP will also be
overstated because banking sector
value added is based (inter alia) on
deposits which have surged
temporarily
Tax collection Income taxes rose because of Indirect and corporate taxes could
increased disclosure decline, to the extent growth slows
Payments to local bodies and Over long run, taxes should increase
discoms as formalization expands and
increased because demonetised notes compliance improves
remained legal tender for tax
payments/ clearances of arrears
Uncertainty/ Uncertainty increased, as firms and Credibility will be strengthened if
Credibility households were unsure of the demonetisation is accompanied by
economic impact and implications complementary measures. Early and
for future policy full remonetisation essential. Tax
Investment decisions and durable arbitrariness and harassment could
goods purchases postponed attenuate credibility

Benefits :7
1. Tax on black money:

Perhaps the most important way to view demonetisation is as a tax administration measure, one designed
to tax holdings of black money. Of course, demonetisation of large denomination notes is not exactly the
same as demonetisation of black money. Some cash holdings were perfectly “white”, the fruit of income
upon which taxes had either been paid or had not been applicable in the first place (agricultural income,
for example). Accordingly, the scheme included a screening mechanism, aimed separating “white”

7
Ibid at pg 61.
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income from “black”. Cash holdings arising from income that had been declared could readily be
deposited at banks and ultimately exchanged for new notes. But those with black money faced three
difficult choices. They could:

• declare their unaccounted wealth and pay taxes at a penalty rate;

• continue to hide it, not converting their old notes and thereby suffering a tax rate of 100 percent; or

• launder their black money, paying a cost for converting the money into white.

Anecdotal evidence suggests there was, indeed, active laundering. One laundering mechanism seems to
have been to “re-time” the accrual of income, by constructing receipts that made it seem as if the black
money had just been earned in the period immediately before November 8th, 2016. Such schemes might
have allowed black money to have been deposited in bank accounts -- but only if the income was reported
and taxes paid on it. In this way, demonetisation would have brought black money into the tax net. Other
schemes would have required black money holders to pay a percentage to private intermediaries as a price
for converting it into white. For example, some holders reportedly paid individuals to queue up at banks
to exchange or deposit money for them. It was also widely reported that Jan Dhan accounts witnessed a
surge in deposits during the 50-day window between November 8 and December 30 – though the amount
of this increase was relatively small, around Rs 42,000 crore.8 In all these cases, black money holders still
suffered a substantial loss, in taxes or “conversion fees”. Moreover, bank accounts are still being screened
for suspicious transactions, which mean that those who engaged in laundering run the risk of punitive
taxes and prosecution, in addition to the fees or taxes already paid. Meanwhile, some amount of
unreturned high denomination notes. The December 30, 2016 Ordinance has declared the unreturned
notes as no longer constituting legal tender. When the grace period expires, the RBI could declare that
these unreturned notes are no longer valid in any way, either as legal tender or as assets that can be
exchanged for new currency. When this occurs, the associated liability will be extinguished, and the
RBI’s net worth will increase. In this sense, demonetisation has effected a transfer of wealth from holders
of illicit black money to the public sector, which can then be redeployed in various productive ways – to
retire government debt, recapitalize banks, or even redistribute back to the private sector. More to the
point, the amount of unreturned high denomination notes is not the proper measure of the amount of black
money that has been “taxed” away from holders of illicit wealth. In addition, one needs to add the taxes
collected on money declared under disclosure scheme (Pradhan Mantri Garib Kalyan Yojana, PMGKY),
as well as the “taxes” paid to intermediaries who laundered money.8

8
Ibid at pg 63.
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b. Tax compliance

Demonetisation can also be interpreted as a regime shift on the part of the government. It is a
demonstration of the state’s resolve to crack down on black money, showing that tax evasion will no
longer be tolerated or accepted as an inevitable part of life. Since this action has commanded support
amongst the population, demonetisation shows that black money will no longer be tolerated by the wider
public, either. These two sanctions – financial penalty and social condemnation – could have a powerful
and long-lasting effect on behavior, especially if they were combined with other incentive-compatible
measures, described in Section X. In this case, evaders might decide in the years to come that it would be
better to pay a moderate regular tax, rather than risk having to pay a sudden penal tax. Corruption and
compliance could be permanently affected. Demonetisation could also aid tax administration in another
way, by shifting transactions out of the cash economy and into the formal payments system. With large
denominations eliminated, households and firms have begun to shift from cash to electronic payment
technologies. As a result, the tax-GDP ratio, as well as the size of the formal economy, could be
permanently higher.9

c. Tax on informal savings

Beyond reducing tax evasion, demonetisation could have other far reaching effects. For example, it will
channel savings into the formal financial system. Without doubt, much of the cash that has been deposited
in the banking system will be taken out again, as the cash withdrawal limits are eased and the note supply
improves. But some of the new deposits will surely remain in the banks, where they will provide a base
for banks to provide more loans, at lower interest rates. In the longer-term, if demonetisation is
successful, it will reduce the equilibrium cash-GDP and cash-deposits ratio in the economy. This will
increase financial savings which could have a positive impact on long run growth.10

Long term benefits:

By definition, it is too early to quantify the direction and magnitude of long term changes. It will take
several years to see the impact of demonetisation on illicit transactions, on black money, and on financial
savings. But there are some signs pointing to change.

a. Digitalisation

One intermediate objective of demonetisation is to create a less-cash or cash-lite economy, as this is key
to channelling more saving channelled through the formal financial system and improving tax

9
Ibid at pg 65.
10
Ibid.
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compliance. Currently, India is far away from this objective: the Watal Committee has recently estimated
that cash accounts for about 78 percent of all consumer payments.11 According to Price water house
Coopers (2015) India has a very high predominance of consumer transactions carried out in cash relative
to other countries (accounting for 68 percent of total transactions by value and 98 percent by volume;
Figure below).

Figure. Consumer Transactions Carried Out in Cash (%, 2015) 12

And there are many reasons for this situation. Cash has many advantages: it is convenient, accepted
everywhere, and its use is costless for ordinary people, though not of course for society at large. Cash
transactions are also anonymous, helping to preserve privacy, which is a virtue as long as the transactions
are not illicit or designed to evade taxation. In contrast, digital transactions face significant impediments.
They require special equipment, cell phones for customers and Point-Of-Sale (POS) machines for
merchants, which will only work if there is internet connectivity. They are also costly to users, since e-
payment firms need to recoup their costs by imposing charges on customers, merchants, or both. At the
same time, these disadvantages are counterbalanced by two cardinal virtues. Digital transactions help
bring people into the modern “wired” era. And they bring people into the formal economy, thereby
increasing financial saving, reducing tax evasion, and levelling the playing field between tax-compliant
and tax-evading firms (and individuals).

11
Available at; <http://www.finmin.nic.in/reports/watal_report271216.pdf> Accessed on 25-04-2017 at 8:00 PM.
12
Source: PricewaterhouseCoopers 2015.
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Digitalisation can broadly impact three sections of society: the poor, who are largely outside the digital
economy; the less affluent, who are becoming part of the digital economy having acquired Jan Dhan
accounts and RuPay cards; and the affluent, who are fully digitally integrated via credit cards. One simple
measure that illustrates the size of these three categories is cell phone ownership. There are approximately
350 million people without cell phones (the digitally excluded); 350 million with regular “feature”
phones, and 250 million with smart phones.

In the wake of the demonetisation, the government has taken a number of steps to facilitate and
incentivize the move to a digital economy. These include:

• Launch of the BHIM (Bharat Interface For Money) app for smart phones. This is based on the new
Unified Payments Interface (UPI) which has created inter-operability of digital transactions. As of
January 10, there had been 10 million downloads, and over 1 million transactions had been conducted.
The 250 million digital-haves can use their smart phone to make simple and quick payments.13

• Launch of BHIM USSD 2.0, a product that allows the 350 million feature phone users to take
advantage of the UPI.

• Launch of Aadhaar Merchant Pay, aimed at the 350 million who do not have phones. This enables
anyone with just an Aadhaar number and a bank account to make a merchant payment using his biometric
identification. Aadhar Merchant Pay will soon be integrated into BHIM and the necessary POS devices
will soon be rolled out.

Reductions in fees (Merchant Discount Rate) paid on digital transactions and transactions that use the
UPI. There have also been relaxations of limits on the use of payment wallets. Tax benefits have also
been provided for to incentivize digital transactions. Encouraging the adoption of POS devices beyond the
current 1.5 million, through tariff reductions. So far, facilities such as RuPay and payment wallets still
make up only a tiny proportion of digital transactions, much less overall financial transaction. For
example, RBI survey data indicates that during December 2016 digital wallets accounted for just Rs 95
billion in transactions and UPI only Rs 7 billion, compared to Rs 314 billion for debit (excluding RuPay
and ATM transactions) and Rs 270 billion for credit cards. Still, they are growing rapidly. The impact on
the digitally excluded category can be gleaned via transactions in the Aadhaar-Enabled Payments System
(AEPS). We find that total AEPS transactions have been steadily rising before November 8, 2016 but
have accelerated thereafter (Figure below).

13
It has used standard interoperable UPI QR codes for merchants.
15
 ECONOMIC E FFECTS O F DEMONETISATION

Figure . Digital Transactions (Rs crores) of Digitally Excluded14

The impact on the middle category of digitally connected can be gleaned via Rupay transactions. Here
data from the National Payments Corporation of India (NPCI) show that RuPay-based electronic
transactions increased by about Rs. 13,000 crore in case of POS transactions and about Rs. 2,000 crore in
e-commerce, an increase of over 300-400 percent

The impact on the digital-haves can be discerned from credit card and debit card transactions excluding
for RuPay cards and ATMs that were affected by cash shortages. There appears to have been a sharp
increase of about 21 percent after November 8, 2016 and it remains to be seen whether this will be
sustained even as remonetisation accelerates.

Unique Payment Interface (UPI) transactions have also soared but from negligible initial levels. As
people have started to use such e-payment systems, they have discovered that it is more convenient to
conduct financial activities electronically. And they are finding that such transactions are feasible in many
more places, because demonetisation is creating network effects: as first movers embrace e-payments,
others find it worthwhile joining them; and as more households participate, more firms are participating
as well. That said, the security features of these e-payment systems will need to inspire trust, to ensure
this trend continues.

b. Real estate

Demonetisation could have particularly profound impact on the real estate sector. In the past, much of the
black money accumulated was ultimately used to evade taxes on property sales. To the extent that black
money is reduced and financial transactions increasingly take place through electronic means, this type of

14
Source: NPCI; Note: AEPS – Aadhaar Enabled Payment System.
16
 ECONOMIC E FFECTS O F DEMONETISATION

tax evasion will also diminish. While too early to assess whether there will be permanent effects, Figure
(here) shows that the weighted average price of real estate in eight major cities, which was already on a
declining trend fell further after November 8, 2016. An equilibrium reduction in real estate prices is
desirable as it will lead to affordable housing for the middle class, and facilitate labour mobility across
India currently impeded by high and unaffordable rents.

Figure . Real Estate Prices15

Short-term impact

Notwithstanding its long-term potential, demonetisation will impose short term costs on the economy.
Assessing the extent of these costs remains difficult, as sectoral data has only recently begun to filter in.
Moreover, the overall economy is so large and diverse that extrapolating from a few indicators is an
exceptionally hazardous venture. And above all demonetisation represents a large structural shock so that
underlying behavioral parameters of the past will be imperfect indicators of future behavior and hence
outcomes. Nevertheless, an analytical framework to assess the situation remains indispensable. We first
quantify the cash impact, which then serves as the basis for estimating the GDP impact.16

a. Impact on cash/money

To estimate the impact on GDP, it is first necessary to establish the impact of demonetisation on the
supply of cash. Even to estimate the impact that has already occurred is not easy because the effective
level of cash in circulation during November 9-December 30, 2016 depended on the extent to which: a)
old notes were still being used for transactions; b) the new Rs 2000 notes were actually liquid, in the
sense that individuals and firms could actually use them for transactions; c) cash, old or new, was not
returned. To calculate the effective cash in circulation, we need further assumptions on (a)-(b) above.

15
Source: Knight Frank and Survey calculations.
16
Economic survey 2016-2017 at pg 66.
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• On (a), it was assumed that 75 percent of outstanding Rs 500 and Rs 1000 rupee denominations
continued to serve de facto as legal tender.

• On (b), it was assumed that only 75 percent of the Rs 2000 notes were liquid in November, improving
to 85 percent in December and 100 percent from January onwards, as new Rs 500 notes came
increasingly into circulation.17 Projecting beyond end-December is much more straightforward, since the
old notes are no longer circulating. Instead, the critical variable is the pace at which new notes and their
denominations can be supplied (“remonetisation”). All these assumptions and inputs lead to estimates of
effective currency in circulation between November 8, 2016 and the end of April, 2017. These estimates
are expressed in absolute terms as well as a percentage of likely transactions demand. The latter is based
on underlying nominal GDP growth as well as an assumed increase in the extent of digitalization and
equilibrium reduction in the cash-deposits ratio, which will reduce the transactions demand for cash going
forward. Since the transactions demand is an estimate, we show the confidence bands around our central
estimates. The resulting figures for effective currency in circulation are markedly different from market
perception based headline numbers. These headline numbers suggest that the currency decline after
November 8, 2016 amounted to 62 percent by end-November,2016 narrowing to 41 percent by end-
December, 2016. Our comparable numbers are 25 percent and 35 percent, respectively. In other words,
the true extent of the cash reduction was much smaller than commonly perceived, and the true peak of the
monetary – as opposed to the psychological – shock occurred in December, rather than November.

Impact on GDP

It is first important to understand the analytics of the demonetisation shock in the short run.
Demonetisation is potentially:18

• an aggregate demand shock, because it reduces the supply of money and affects private wealth
(especially of those holding unaccounted money and owning real estate);
• an aggregate supply shock to the extent that cash is a necessary input for economic activity (for
example, if agricultural producers require cash to pay labour);
• and an uncertainty shock because economic agents face imponderables related to the impact and
duration of the liquidity shock as well as further policy responses (causing consumers to defer or
reduce discretionary consumption and firms to reconsider investment plans).
Anecdotal and other survey data abound on the impact of demonetisation. But we are interested in a
macro-assessment and hence focus on five broad indicators:

17
Economic survey 2016-2017 at pg. 67.
18
Ibid at pg 69.
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 ECONOMIC E FFECTS O F DEMONETISATION

• Agricultural (rabi) sowing;

• Indirect tax revenue, as a broad gauge of production and sales;
• Auto sales generally, as a measure of discretionary consumer spending, and two-wheelers in
particular as it is the best available indicator of rural and demand of the less affluent;
• Real estate prices; and
• Real credit growth

Contrary to early fears, as of January 15, 2016 aggregate sowing of the two major rabi crops—wheat and
pulses (gram)-- exceeded last year’s planting by 7 percent and 15 percent, respectively (Figure below).
Whether this will lead to a commensurate increase in production will depend on the extent to which
farmers’ access to inputs—seeds, fertiliser, credit, and labour—was impeded by demonetisation.

Figure . Rabi Sowing for Wheat and Gram (in mn ha)

Figure: Growth in Indirect Taxes (YoY monthly & cumulative, %)

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 ECONOMIC E FFECTS O F DEMONETISATION

III. CRITICAL ANALYSIS

The last chapter of this project is almost replica of the economic survey of 2016-2017 released by the
Ministry of finance, govt. of India. There whatever benefit and impact of demonetisation has been shown
is positive and logical too. The researcher after reading the report was too much impressed with the
panacea which the government brought for all the economic problem of the country. The picture showed
in the economic survey is too gloomy that one can easily be mesmerised.

But in the economic survey itself there are few things which compel one to think otherwise, if the report
is observed minutely. First of all, annexure one of the chapter 3 of the survey.

In this annexure there are various countries listed along with the reason for demonetisation and the impact
of it afterwards. There we can see that the demonetisation were done in countries where Excess liquidity
and Inflation, Fight hyperinflation, Fight organized crime and address money overhang, Fiscal and
banking Crisis like situations prevailed. No country or a few countries might have done demonetisation
when its economy was growing at its full pace and was among one of the fastest growing economy. Yes,
demonetisation helps in curbing inflation and counterfeiting currency which ultimately revives dying
economy. But in practical world 90% of demonetisation drives by various government failed. It was
risky. The most pertinent question to be asked is: 19
 whether it was a fit situation to introduce demonetisation?
Even if we are satisfied that it was a fit time for this demonetisation but the question here is:
 Is the post-demonetisation picture is same as that which the government is showing to the people?
It is because in the last two demonetisation drives in India the success was a farfetched dream. India’s
action is not unprecedented in its own economic history: there were two previous instances of
demonetisation, in 1946 and 1978, the latter not having any significant effect on cash. That was the
period when Indian economy was catching pace. The situation might have changed but “Has it
changed that much?”20
Second thing is that the prominent argument behind demonetisation was that the higher denomination
currency notes can be easily hoarded and transported. So, demonetisation will curb the same. But what
government has done is just opposite. The introduction of Rs.2000 notes has made it even easier to keep
and hoard black money than earlier.

19
Annexure 1; Chapter 3 of Economic survey report of 2016-2017.
20
Economic survey report 2016-2017, pg. 54.
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 ECONOMIC E FFECTS O F DEMONETISATION

Moreover, Minister Of State In The Ministry Of Finance (Shri Arjun Ram Meghwal) Answering
Unstarred Question No. 535 On 7th February, 2017
 Whether as a result of demonetisation the country's economy has become almost free from parallel
economy run by fake currency and black money, if so, the details thereof;
He admitted that Post demonetization, during the period 9th November 2016 to 10th January 2017,
more than 1100 searches and surveys were conducted and more than 5100 notices were issued by the
Income Tax Department for verification of suspicious high value cash deposits. These actions led to
seizure of valuables of more than Rs. 610 crore which includes cash of Rs. 513 crore. Seizure of cash
in new currency notes was about Rs 110 crore.21
It means the black money has been converted easily into new notes. In such a short duration, the
culprits managed to change their notes. It shows some flaw in the management and hence, it was not
full proof. It can also be verified by the restlessness and childlike behaviour of RBI during that period.
The RBI website shows upsurge in the notifications in that period. Earlier in one day at maximum 5-6
notifications use to be issued but in that period on an average 10 notifications were released.

The prime objective of this drive is to make digitalised India and for making it this demonetisation drive
was seen as a key step. There were many programmes run to encourage people to do cashless
transactions.
But do we have capability to go cashless. It can be seen by the answer by the ministers in Rajya Sabha.
 whether Government has any proposal to introduce/promote cashless transaction in Agriculture
sector business in the country, if so, the details thereof;

In agriculture sector, Till date, 143 POS machines have already been installed at 27 ICAR institutes, 20
KVKs and 18 State Agricultural Universities (SAUs). Under National Agriculture Market (eNAM)
scheme, electronic payment gateway is available for transactions by various stakeholders. DARE/ICAR
has also not proposed any transaction fee waiver on cashless transactions.
Here, question arises that mere installation of 143 POS is sufficient to make a sector cashless where 70%
of whole population is dependant. On the other hand, the poor farmers have been burdened with an extra
charge for transaction.22
 whether Government proposes to equip all ration shops across the country with devices for
cashless transactions;

21
Rajya sabha questions; Available at <http://164.100.47.5/qsearch/qsearch.aspx> Accessed on 25-04-2017 at 8:25 pm.
22
Ibid.
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 ECONOMIC E FFECTS O F DEMONETISATION

 if so, the details thereof along with the target fixed therefor;
 the total number of ration shops in the country and how many out of them are making cashless
transactions, at present;
 whether Government has held any consultation with State Governments in this regard; and
 if so, the details thereof and the expenditure likely to be incurred in equipping the ration shops
with devices for cashless transactions?

The answer by the hon’ble minister was surprising how such a comic answer can be given.
(a): To increase transparency and improve targeting and to modernise and automate TPDS operations, the
Department in association with States/UTs is implementing the installation of electronic Point of Sale
(ePoS) devices for the biometric authentication and distribution of the subsidised food grains to eligible
beneficiaries. Since these devices are able to perform Aadhaar based biometric authentication of
beneficiaries, these devices can be leveraged to enable Aadhaar based digital/cashless transactions at
FPSs with the help of additional software application integration.

(b): Department has prepared a detailed roadmap and an action plan along with Statewise targets to
implement the various modes of cashless transactions. However, complete roll out of the strategy for
cashless mechanism depends on readiness of the States/UTs, availability of adequate infrastructure, status
of financial inclusion, level of Aadhaar seeding, awareness level of beneficiaries and telecom coverage
etc. Accordingly, all States/UTs Governments have been advised to adopt a phase wise approach, starting
with Metropolitan Cities, Municipal Corporations, Municipalities, District Headquarters and other urban
areas where the conditions allow for an effective implementation and then eventually expanding it to semi
urban and rural areas.

(c): Presently there are 5.26 lakh Fair Price Shops in 34 States/UTs (excluding Chandigarh and
Puducherry which have implemented Direct Cash Transfers scheme). Out of these 49,319 Fair Price
Shops have been implementing cashless/digital transactions.

(d): Department has regularly been consulting the State Governments with regards to the implementation
of digital/cashless payments in PDS. The department has also organised a National Conference on ‘PDS
reforms and Cashless/Less cash Environment’ with Hon’ble State Food Ministers and Food Secretaries of
all States/UTs on 19.01.2017 at New Delhi.

(e): Department had issued guidelines and specification of Point of Sale (PoS) devices /Mobile Terminal
in November, 2014 for procuring these devices. In this specification, biometric scanner was also
prescribed for authenticating the PDS beneficiaries using finger print and Aadhaar number. So, no
22
 ECONOMIC E FFECTS O F DEMONETISATION

additional cost will be incurred on hardware devices for supporting the digital payment through Aadhaar
enabled payment system (AePS) but States/UTs have to upgrade the software on the same ePoS device to
enable the cashless transactions. In addition to AePS, the States have also been made aware of other
modes of cashless transactions through USSD, UPI, BHIM, e-wallet, etc.23

Starting from the first answer, the minister in question (a) & (b) answered very nicely but he forgot that
still our 40% of population is under BPL in which maximum are dependent on fair price shop. Can a
reasonable man think that a person who does not have enough money to eat will have data to do online
payment with an additional transaction charge.
Literacy is a big problem with that group of people. A person who doesn’t know how to sign, how can he
do digital transaction which is very difficult even for highly qualified people of old age?

Coming to next answer, the answer to (b) is more irresponsible. One can imagine the time it will take t
make the dream come true of our hon’ble minister. For that period, those people will starve. Despite
having money they cannot spend. Hard earned money of daily wage earners who don’t have bank
accounts is of no value today in old notes. In this drive the bad people managed to get their notes changed
but the daily wage earner had to choose between the two —either earn for today and eat food or go and
stand in queue for days to save hard earned money.

Among 5.26 lakh fair price shops only 49,319 Fair Price Shops have been implementing cashless/digital
transactions. So, it comes even below 10% of the total shops. It is nothing but a mockery.

23
Ibid.
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 ECONOMIC E FFECTS O F DEMONETISATION

*Chapter 3 of Economic survey report of 2016-2017.

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 ECONOMIC E FFECTS O F DEMONETISATION

IV. CONCLUSION AND SUGGESTION

“Demonetisation will cause the economy to run into great difficulties in the future. Declaring the old
Rs500 notes legal again might minimise the damage majorly,” said Kaushik Basu, former chief
economist, World Bank. Basu was delivering a lecture at the Indian Institute of Technology-Bombay
(IIT-B) on Friday as part of the N R Kamath Chair Colloquium.24

Despite several warnings and historical thumps down, the economy is shown progressing. It is not bad but
raises some pertinent question on several points.

According to the data released by the CSO, the GDP growth rate is affected by mere 0.26% to 0.5 % in
the 3rd quarter and still managed 7% growth. The private final consumption expenditure grew by
11.2%.25

The question is still remained unanswered since, nowhere in the world such an unprecedented course is
shown by the economy. How can a credit and cash starved nation clocked a growth of 7% and
consumption growth by 11.2%?

There can be two reasons:

1. The impact of demonetisation cannot be felt in such a short duration.

2. The methodology employed in calculating the growth rate is flawed.

There are few suggestions which need to be thought upon to make the dream of digitalisation and cashless
economy a reality.

1. The government should make it mandatory to go for demonetisation in every fixed no. of years. Say,
after every 5 or 10 years all the currency in circulation will be changed.

2. The adhaar should be linked with the bank account, which needs to be mandatory, and by just sweep of
thumb on the POS device the transaction is done. For a country where digital literacy is very less this is a
fit option.

3. The network of connectivity and data charges should be lowered.

24
Shreya Bhandary,“Notes ban will hurt economy: former chief economist of World Bank”, HT,Mumbai; Pub. On. Dec 10,
2016
Accessed from http://www.hindustantimes.com/mumbai-news/notes-ban-will-hurt-economy-former-chief-economist-of-
world-bank/story-7bdhaMayfFXh30p1hLICuJ.html. Accessed on.-26-04-2017; 04:27.
25
Press Note on Second Advance Estimates of National Income 2016-17 and Quarterly Estimates of Gross Domestic Product
for The Third Quarter (Q3) Of 2016-17; published by Central Statistics Office;Ministry Of Statistics & Programme
Implementation;Government Of India on Feb, 28 2017.
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 ECONOMIC E FFECTS O F DEMONETISATION

4. The transaction charge should be waived off.

5. All the ration shop or fair priced shop and ration card should be linked with adhaar card.

6. PMJDY accounts should be scrutinised and miss use of the account should be stopped.

7. The shops should be registered and while registration POS should be distributed.

8. The network of banking should be expanded with customer friendly terms and conditions.
9. The village panchayat should take responsibility to install the POS devices at every agricultural outlet.
10. The circle rates of the land and the market rate should be made same. So, real estate will not be a good
investment for the tax evaders. The registration of land should be made digitalised.

Automatically, all the objectives of demonetisation and clean and digitalised economy will be fulfilled.
The corruption will be at its minimum. All the three questions of my project have been answered. The
first question is answered in negative. The black money can be washed away only by moral
transformation. It can be minimised by regular demonetisation only.

The second question has been answered as affirmatively. The long term effect on the economy is
beneficial provided that the effect is persisting. It needs the suggestions to be implemented upon.

The third question has also been answered. The demonetisation and cashless transaction increases
accountability and transparency in the economy provided that maximum of the people comes under
banking network.

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BIBLIOGRAPHY

 Report :
 Economic Survey 2016-17; Published by Finance ministry; Govt. of India.
 Press Note on Second Advance Estimates of National Income 2016-17 and Quarterly Estimates of
Gross Domestic Product for The Third Quarter (Q3) Of 2016-17; Published by Central Statistics
Office;Ministry Of Statistics & Programme Implementation;Government Of India.
 Government Of India; Ministry Of Agriculture And Farmers Welfare; Rajya Sabha Questions.

 Websites:
 Finance ministry; Govt. of India
Available at <http://finmin.nic.in/>
 Ministry of Statistics & Programme Implementation; Govt. of India

Available at< http://www.mospi.gov.in/central-statistics-office-cso-0 >

 Parliament of India; Rajya Sabha

Available at <http://164.100.47.5/qsearch/qsearch.aspx>

 Reserve Bank of India

Available at< https://www.rbi.org.in/ >
 Hindustan times

Available at< http://www.hindustantimes.com>

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