TOPIC- IMPACT OF DEMONETIZATION ON THE

ECONOMY OF INDIA

SUBMITTED BY,
TANAY BOTHRA
BBA LLB
SEMESTER II
ECONOMICS II
DIVISION-F
ROLL NO- F008

SUBMITTED TO,
DR. PARINAAZ MEHTA

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Table of Contents
Introduction.........................................................................................................3
Research Objectives........................................................................................3
Variables..............................................................................................................3
Gross Domestic Product (GDP).....................................................................3
GDP Growth Rate...........................................................................................4
Inflation............................................................................................................5
Gross Fixed Capital Formation (GFCF).......................................................5
Real Interest Rate............................................................................................6
Currency in Circulation..................................................................................6
Data Analysis.......................................................................................................7
Gross Domestic Product (in U.S Dollars)......................................................7
Growth Rate of GDP (in percentage)............................................................8
Gross Fixed Capital Formation (GCFC)......................................................9
Currency in Circulation................................................................................10
Rate of Inflation.............................................................................................11
Real Interest Rates........................................................................................12
Data Analysis by Correlation..........................................................................13
Correlation 1: Between GDP and Currency in Circulation......................13
Correlation 2: Between GDP Growth rate and Gross Fixed Capital
Formation.......................................................................................................14
Correlation 3: Between Rate of Inflation and Real Interest Rate............15
Appendix............................................................................................................15
Appendix A....................................................................................................15
Appendix B.....................................................................................................16
Conclusion.........................................................................................................17
Findings..........................................................................................................17
References..........................................................................................................19
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Introduction
This paper will make an attempt to study the impact of demonetization on the Indian
economy in different facets, to simplify the research analysis we will also be comparing the
data of previous years to understand if there is any correlation or not which will help us study
the impact of demonetization in a much more efficient manner. The demonetization of Rs
500 and Rs 1000 currency notes announced on November 8, 2016 was easily the most
controversial economic policy decision taken in India in two decades.
In his first televised address to the nation, Mr. Modi, the honorable prime minister of India
said people holding notes of Rs. 500 and Rs. 1000 can deposit the same in their bank and post
office accounts from November 10, 2016 till December 30, 2016. The main objective of this
move was to tackle with black money, corruption and fake currency. All though these were
the objectives, the repercussions of this move were so impactful and it helped us understand
the gravity and nature of it in the coming years.

Research Objectives
 To understand the impact of demonetization on the GDP of the country
 To study if there is any correlation between the GDP and the Currency in Circulation
in pre-demonetization era and the post demonetization era
 To study the correlation between GDP growth rate and Gross Fixed Capital Formation
 To study the correlation between Inflation and Real Interest rates in the pre-
demonetization era and the post-demonetization era
 To study the impact of impact of demonetization on all the variables which have been
utilized to carry out the research and analysis

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Variables
Gross Domestic Product (GDP)
Gross domestic product (GDP) is the total monetary or market value of all the finished goods
and services produced within a country’s borders in a specific time period. As a broad
measure of overall domestic production, it functions as a comprehensive scorecard of a given
country’s economic health. Though GDP is typically calculated on an annual basis, it is
sometimes calculated on a quarterly basis as well. In the U.S., for example, the government
releases an annualized GDP estimate for each fiscal quarter and also for the calendar year.
The individual data sets included in this report are given in real terms, so the data is adjusted
for price changes and is, therefore, net of inflation. It is normally calculated by using data
ascertained through surveys of retailers, manufacturers, and builders, and by looking at trade
flows. In this part of data analysis we will be calculating the GDP of India from the year
2012-2020 to understand the impact by comparing the pre-demonetization era and the post
demonetization era. We have also calculated and gathered the data for GDP in terms of US
dollars. It is very important for us to understand the role of GDP in this study and as to how
will it help us in studying the impact of demonetization of the country. One of the main
reasons as to why GDP is being used as a variable in this particular study to correlate it with
the cash circulation in the pre-demonetization era and the post demonetization era, as we
continue with the study we will understand what cash circulation means and in what terms
will we studying it. To calculate the GDP of a country for a financial year, we have taken the
average of the four fiscal quarters in a year.

GDP Growth Rate

The GDP growth rate compares the year-over-year (or quarterly) change in a country’s
economic output to measure how fast an economy is growing. Usually expressed as a
percentage rate, this measure is popular for economic policy-makers because GDP growth is
thought to be closely connected to key policy targets such as inflation and unemployment
rates. If GDP growth rates accelerate, it may be a signal that the economy is “overheating”
and the central bank may seek to raise interest rates. Conversely, central banks see a
shrinking (or negative) GDP growth rate (i.e., a recession) as a signal that rates should be
lowered and that stimulus may be necessary. The reason why GDP growth rate is very
important to our study is because it will help us correlate with the Gross Fixed Capital
Formation. As we go ahead with the study we will understand the meaning of this term and as
to how will it help us in correlation with GDP growth rate. For this variable also we have

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collected the data from the financial year 2012 to 2020 in terms of percentage. GDP growth
rate is also a very important indicator to understand the growth or improvement of the
economy.

Inflation
While it is easy to measure the price changes of individual products over time, human needs
extend much beyond one or two such products. Individuals need a big and diversified set of
products as well as a host of services for living a comfortable life. They include commodities
like food grains, metal and fuel, utilities like electricity and transportation, and services like
healthcare, entertainment, and labour. Inflation aims to measure the overall impact of price
changes for a diversified set of products and services, and allows for a single value
representation of the increase in the price level of goods and services in an economy over a
period of time. As a currency loses value, prices rise and it buys fewer goods and services.
This loss of purchasing power impacts the general cost of living for the common public
which ultimately leads to a deceleration in economic growth. The consensus view among
economists is that sustained inflation occurs when a nation's money supply growth outpaces
economic growth. An increase in the supply of money is the root of inflation, though this can
play out through different mechanisms in the economy. Money supply can be increased by
the monetary authorities either by printing and giving away more money to the individuals,
by legally devaluing (reducing the value of) the legal tender currency, more (most
commonly) by loaning new money into existence as reserve account credits through the
banking system by purchasing government bonds from banks on the secondary market. Like
other variables we have collected data for the rate of inflation in India from 2012 to 2020. We
will be using inflation to correlate with the real interest rate in country to understand it’s
impact on the same. The reason why inflation is a very important concept in our research is
because how it deals with circulation of notes and as to how circulation of notes was banned
to a certain extent with demonetization, so it is very important for us to carry out the study in
that aspect.

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Gross Fixed Capital Formation (GFCF)
Gross fixed capital formation is essentially net investment. It is a component of the
Expenditure method of calculating GDP. To be more precise Gross fixed capital formation
measures the net increase in fixed capital. Gross fixed capital formation includes spending on
land improvements (fences, ditches, drains, and so on); plant, machinery, and equipment
purchases; the construction of roads, railways, private residential dwellings, and commercial
and industrial buildings. Disposal of fixed assets is taken away from the total.
Generally speaking, developing countries often devote a higher % of GDP to investment.
Countries with rapid rates of economic growth are heavily investing in more fixed assets to
enable rapid economic growth. We will make an attempt to correlate this variable with the
GDP Growth rate of the country to understand if there is any correlation between them and if
this relation was impacted by demonetization.

Real Interest Rate

A real interest rate is an interest rate that has been adjusted to remove the effects of inflation
to reflect the real cost of funds to the borrower and the real yield to the lender or to an
investor. The real interest rate reflects the rate of time-preference for current goods over
future goods. the real interest rate reflects the degree to which an individual prefers current
goods over future goods. A borrower who is eager to enjoy the present use of funds shows a
stronger time-preference for current goods over future goods and is willing to pay a higher
interest rate for loaned funds. Similarly a lender who strongly prefers to put off consumption
to the future shows a lower time-preference and will be willing to loan funds at a lower rate.
Adjusting for inflation can help reveal the rate of time-preference among market participants.
While the nominal interest rate is the interest rate actually paid on a loan or investment, the
real interest rate is a reflection of the change in purchasing power derived from an investment
or given up by the borrower. The nominal interest rate is generally the one advertised by the
institution backing the loan or investment. Adjusting the nominal interest rate to compensate
for the effects of inflation helps to identify the shift in purchasing power of a given level of
capital over time.

Currency in Circulation
Currency in circulation refers to the amount of cash–in the form of paper notes or coins–
within a country that is physically used to conduct transactions between consumers and

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businesses. Currency in circulation is all of the money that has been issued by a country's
monetary authority, minus cash that has been removed from the system. Currency in
circulation represents part of the overall money supply, with a portion of the overall supply
being stored in checking and savings accounts. Currency in circulation can also be thought of
as currency in hand because it is the money used throughout a country's economy to buy
goods and services. Monetary authorities of central government pay attention to the amount
of physical currency in circulation because it represents one of the most liquid asset classes.
Currency in circulation is less important to central banks’ monetary policy relative to other
types of money (for example bank reserves) because the quantity of currency is relatively less
flexible. Currency in circulation is very important for us to study in this chapter as it will help
us understand the impact banning of 500 and 1000 rupees notes had on circulation of
currency. For the purposes of this project will only be gathering data of the notes in
circulation as they were main subject of demonetization. For this variable also we will be
collecting data from 2012 to 2020. The value of all the currency in circulation will be
compared with the GDP of the country of the to understand if there is any correlation
between the increase in value of currency with increase in the value of the GDP of the
country. This will also help us understand the impact of demonetization in a much better way.

Year Gross Domestic Product (in crores) Data Analysis

Gross Domestic

    Product (in U.S

Dollars)
2012 1,83,000

2013 1,86,000

2014 2,04,000

2015 2,10,000

2016 2,29,000

2017 2,65,000

2018 2,71,000

7 2019 2,87,000

2020 2,95,000
The above data represents the GDP of India from 2012 to 2020, we can notice every year the
GDP has kept on increasing but not at the same rate, we will go on and further analyse the
GDP growth rate of India as well from 2012- 2018. With the above observations we
understand that the GDP on a whole has kept on increasing from 2012 to 2018, further on we
will understand if this amount is positively correlated or negatively correlated to the currency
that is present in the economy and which is available for circulation.

Growth Rate of GDP (in percentage)

Year GDP Growth ( in percentage)

201
5.50%
2
201
6.40%
3
201
7.40%
4
201
8%
5
201
8.30%
6
201
7%
7
201
6.10%
8
201
4.20%
9
202
7.97%
0

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The figures above represent the growth of GDP over the years (from 2012 to 2018), we can
notice that the growth has taken a dip after demonetization as the 2017 was first fiscal year
since 2012 which recorded a slump in the growth of GDP of the country. We can also notice
that this trend goes on for the next two years until 2020. One can assume that the reason why
GDP recorded a growth was because of normalisation and efficient circulation of the new
currencies that were introduced, this may be a indicator which suggests that demonetization
might help the economy of the country and it’s GDP on a long term. The Indian economy is a
cash-driven economy and demonetisation has largely affected its growth. The GDP growth
rate of 8.01% in 2015-2016 fell to 7.11% in 2016-2017 after demonetisation. This was
largely due to less availability of cash in cash-intensive industries like manufacturing and
construction. It has also adversely impacted the primary function of banks to issue loans and
has put pressure on them as current account holders demand large sums of cash.

It has impacted the manufacturing sector which is wary about investing in inventories. This is
evident from the weakening IIP and PMI numbers as well as the GDP number falling to just
5.7% in the first quarter ended June 2017. Thirdly, there has been some initial impact on
sectors like two wheelers and entry level cars which represent rural demand. However, that
has picked up in the months the remonetisation process started. The good news is that while
the disruptive impact of demonetization has been disruptive, the long term benefits are likely
to outweigh these costs.

Gross Fixed Capital Formation (GCFC)

Year Gross Fixed Capital Formation

2012 33.40%

2013 31.30%

2014 33.30%

2015 34%

2016 33.30%

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 2017 28%

2018 28.60%

2019 29.30%

2020 28.10%

From the data above we can imply after the year 2017, there the percentage of investment has
decreased right down to 28 percent, even after the circulation of the notes coming back to
normalcy, this is one of the impacts of demonetization in terms of investment which the
economy is still facing, it was first time since 2012 than the GCFC was reduced by 4 percent,
as we go on with the research we try to understand if there is any correlation between the
growth rate of GDP and the GCFC of the country’s economy.

Currency in Circulation

Year Cash Circulation

Pieces ( in million) Value( in billion)

2012 69,384 10,528

2013 73,517 11,648

2014 77,330 12,829

2015 83,579 14,480

2016 90,266 16,640

2017 1,00,293 13,350

2018 1,02,395 18,290

2019 1,08,759 21,370

2020 1,15,976 23,700

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This is one of the most surprising elements of the study, as we understand that
demonetization banned the circulation of Rs.500 and Rs.1000 notes, but the currency in
circulation in the country throughout the last 8 years has seen only an upward trend, the
expected Year Inflation Rate impact in an economy where
demonetization is carried is
2012 9.31%
expected to be huge in terms of
2013 10.91%
circulation of currency, but
there was 2014 5.80% no such impact and that is why
we 2015 5% cannot validate the fact that
after demonetization in an economy
2016 4.94%
the currency in circulation
2017 2% decreases. In fact the
2018 4.86% circulation in currency saw its
biggest jump after demonetization.
2019 7.66%
The reason for this might be
2020 6.20%
understood better once we
look at the rate of inflation.

Rate of Inflation

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As we notice in the above table, the rate of inflation goes down drastically in the years after
demonetisation occurred and caught up again in 2019 and 2020, while there are many factors
that might have affected inflation in 2020 such as the COVID-19 pandemic which led to a
nationwide lockdown, there are other reasons due to which the rate of inflation in 2017 was
so low and inflation was so high. Currency squeeze due
to demonetisation along with seasonal factors pushed food inflation significantly down but
has not had much impact on inflation excluding food and fuel. An important consequence
of demonetisation has been the sharp increase in the use of digital transactions.

Real Interest Rates

Year Real Interest Rate

2012 2.47%
2013 3.87%
2014 6.70%
2015 7.56%
2016 6.22%
2017 5.52%
2018 4.69%
2019 6.37%
2020 3.51%

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As we can see from the above data that the interest rates which were on a rise since 2012, saw
a dump in 2016 which is the year when demonetization was announced, there are many
aspects through which demonetization impacted the real interest rate, those factors can also
be visible in the statistics. With an abundant increase in deposits, deposit rates get slashed. This
shouldn’t come as a big surprise to customers—it’s simple demand-supply economics. As the
supply (deposits) increase, prices (deposit rate) fall. And that’s what has happened. Most banks
have announced a cut. ICICI Bank and HDFC Bank cut deposit rates by as much as 0.25%. This
cut is likely to continue too. “All rates will fall,” said SBI Chairman, Arundhati Bhattacharya in a
recent report, indicating that deposit rates, as well as lending rates, could decrease further. The
demonetization has led to a cash crunch in the system. People have limited access to 100-rupee
notes. Even those who did receive 2,000-rupee notes are unwilling to spend it because of issues
with getting loose change. This means, demand for goods and services is likely to fall in the
short-term. This is potentially disinflationary. After all, as demand falls, prices fall too. This
could give the RBI room to cut key lending rates in the near future. Lower demand because of the
demonetization could exert a downward pressure on inflation in the near term. Similarly,
categories such as food, housing and transport that have a higher cash component could witness a
dip in prices. However, the government’s tax revenue is likely to increase. This could translate
into higher investments and expenditure by the government. This could push up employment and
incomes, and thus demand, in the long run. Hence, the impact on inflation—and thus interest
rates—is expected to be neutral in the medium to long run, according to a CRISIL report.

Data Analysis by Correlation

Correlation 1: Between GDP and Currency in Circulation

Year GDP Currency in Circulation

Value Pieces
2012 1,83,000 10,528 69,382
2013 1,86,000 11,648 73,517
2014 2,04,000 12,829 77,330
2015 2,10,000 14,480 83,579

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 2016 2,29,000 16,640 90,266
2017 2,65,000 13,350 1,00,293
2018 2,71,000 18,290 1,02,395
2019 2,87,000 21,370 1,08,759
2020 2,95,000 23,700 1,15,976

Correlation- 0.877328104948648

Here we observe that is a positive and strong correlation between GDP and the currency in
circulation, the reason for this is pretty basic. While a country's GDP is not a perfect
representation of economic productivity and health, in general, a higher level of GDP is more
desirable than a lower level. A country's GDP provides information about the size of its
economy and the GDP growth rate is one of the best indicators of economic growth over
time. The GDP per capita measurement also has a close correlation with the trend in living
standards over time.

In general, when the GDP growth rate shows rising economic productivity, the value of
money in circulation increases. This is because each unit of currency can subsequently be
exchanged for more valuable goods and services. Economic growth tends to have a natural
deflationary effect, even if the supply of money does not shrink. Some evidence of this
phenomenon can be observed in the technology sector, where innovations and technological
advancements are growing faster than inflation; currently, the prices of televisions, cell
phones, and computers tend to be falling.

Correlation 2: Between GDP Growth rate and Gross Fixed Capital Formation
Year GDP Growth Gross Fixed Capital Formation
2012 5.5 33.4
2013 6.4 31.3
2014 7.4 30.1
2015 8 34.4
2016 8.3 33.3
2017 7 28.1

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 2018 6.1 28.6
2019 4.2 29.3
2020 7.97 28.1

Correlation- 0.422352634415136

Here we observe that the correlation between GDP Growth and Gross Fixed Capital
Formation is not strong with correlation only being 0.422352634415136.
We understand that even during the period after demonetisation where the economy was
coming back on its feet in terms of growth in GDP, it was not the same with Gross Capital
Formation. In the years 2012-2020 especially between 2017-2020 the correlation between
Gross Fixed Capital Formation and Growth of GDP was not really strong which indicates that
the government had not done a great job in terms formation of capital post demonetization.

Correlation 3: Between Rate of Inflation and Real Interest Rate

Year Inflation Rate Real Interest Rate

2012 9.31 2.474
2013 10.91 3.866
2104 5.8 6.695
2015 4.9 7.556
2016 4.94 6.223
2017 2.49 5.522
2018 4.86 4.685
2019 7.66 6.369
2020 6.2 3.51

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 Correlation- -0.380046321554726

We observe that between 2012-2020 there was a weak negative correlation between the
Inflation rate and the Real Interest Rate which helps us conclude that there is no strong
correlation or dependency between two variables. The relation these two variables share is in
terms of formula where we find the real interest rate by subtracting the inflation from the
nominal interest rate.

Appendix
Appendix A
Economic Costs of Demonetization-
The rural and informal economy suffered disproportionately because most transactions are
cash-based. The liquidity squeeze led to a pile-up at wholesale markets, leading to a sharp
decline in the Wholesale Price Index (WPI) of perishables such as fruits and vegetables in the
immediate aftermath of demonetization. By turning farm markets into buyers’ markets,
demonetization may have also contributed to the decline in prices of pulses. Rural consumer
sentiment too took a hit, with domestic sales of two-wheelers plunging sharply. Car sales also
declined but the decline was less severe than in the case of two-wheelers. The slowdown in
the economy, which started before demonetization, also seems to have been exacerbated by
demonetization. New project announcements declined sharply in the wake of demonetization,
a Centre for Monitoring Indian Economy (CMIE) analysis showed, hurting the capex cycle.
Contrary to what some economists predicted, the dividend from RBI to the government was
lower because of demonetization. RBI’s domestic earnings declined as it had to pay interest
of Rs17,426 crore after it mopped up excess liquidity in the banking system following
demonetization. The previous year, the central bank had earned interest of Rs506 crore in its
liquidity management operations. RBI’s printing costs also went up because of the move.

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Appendix B
Uncertain Benefits-
The one big promise of demonetization was a rapid expansion in the tax base but the actual
results have been quite modest. According to the finance ministry’s estimates published in the
latest Economic Survey, the tax base expansion attributable to demonetization was Rs10,600
crore, lower than what RBI spent on interest expenses, and equivalent to only 0.1% of India’s
gross domestic product (GDP). The full effect on tax collections “will materialize gradually"
as reported income of new taxpayers grows, said the survey. How far such gains materialize
remains to be seen. Another stated aim of demonetization was to detect and eliminate
counterfeit notes. The growth in detected counterfeit notes after demonetization has not been
unusually large, shows RBI data, even as counterfeits of the freshly issued notes have already
emerged in the system. Demonetization did provide a boost to non-cash payments in the short
term but that effect may be waning, with the cash-to-GDP ratio back to double-digits. There
seems to have been some impact on the stock of black money (rather than the flow), given
that the construction sector has been hit hard. But this may also have led to large-scale job
losses. The proportion of high-value notes (Rs500 and above)—often viewed as conduits of
black money—has also been rising as new notes have entered the system. At the end of fiscal

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year 2017 (FY17), the proportion of high-value notes stood at 74%, considerably lower than
that in FY16.

Conclusion
Findings
To study the impact of the demonetization on the economy is very difficult because of the
timeline, over the last 5 years the BJP government has carried a lot of radical economic
schemes and policies that have the potential of having a great impact on the economy of the
country, therefore analyzing the data and implicating the result on particular factor becomes
very difficult, in the last 2 years we have also been hit by a pandemic which has had severe
economic impacts worldwide including in India, which makes it very possible that some of
the data might be the result of the pandemic. Although the data that has been chosen to
conduct this study is highly related to the economic condition of the country after
demonetization and is highly responsible for it. Although there are many variables which we
found to have a strong correlation over the last years, we also studied these tables in a
separate manner to understand the main objective of the paper: What kind of Impact did
Demonetization have on the Indian Economy?

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