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Economics Research Paper

ECONOMICS RESEARCH PAPER

DEMONETISATION AND ITS IMPACT ON INDIAN ECONOMY

RUPAL SHARMA

BA LLB (2016)

SECTION A Introduction

November 8, 2016, marks a monumental economic change in India when the government denominated the notes of Rs. 500 and Rs.1000. Prime Minister Narendra Modi announced that these banknotes would no longer be legal after midnight of 8th November 2016. And the citizens were required to exchange these old notes for new ones by December 31, 2016. The objective was to curb corruption, counterfeit currency, unearth black money and terror funding.

According to RBI report on 31st March 2016, ₹500 and ₹1000 banknotes consist around 86% of total cash circulation having a value of ₹15.44 lakh crore. In this process, 97% of old notes which were around ₹14.97 lakh crore were deposited in banks before 31st December.

This move had a tragic impact on the lives of common people and was followed by a major crash of the Indian economy. My personal experience of conducting a survey regarding the impact of demonetisation on construction workers inspired me to further work on an analysis of this policy.

This paper will discuss the impact of demonetisation on various sectors and tools of macroeconomics including GDP, FDI, etc. It will further analyze the advantages and disadvantages of the demonetisation and literature reviews of various authors.

ORGANIZED SECTOR

During November-December, the monthly housing sale declined by 40% and 49% respectively. Fifty percent of the total sale of the third quarter was from the month of October alone. The monthly housing sales fell about 40% in metropolitan cities.

Demonetisation affected Organised manufacturing adversely as there was a decline in the sale of FMCG (fast moving consumer goods) and automobile industry. Purchasing Managers Index (PMI) faced a contraction in December for the first time in 2016. Consumer durable industry was vastly affected and the manufacturer had to cut down their production due to increasing inventories. There was a decline in consumer demand for the apparels and other end-product of textile industry as the disposable income of the consumer was affected. The winter-wear retailers were severely affected as most of their sales takes place during the period of October- February during which demonetisation was enforced. The overall impact was on the textile value chain.

The two-wheeler auto industry was especially affected in the rural sector. Most of the rural population used cash as a mode of payment which led to the reduction of sales in this industry. The consumer "buying decision" was influenced and resulted in unsold car stock. This stock being forwarded to the next year led to reduction in the selling price of the cars. This impact on automobile industry is a temporary disruption as most of the transactions in this sector occur through bank financing or loans.

The banking sector was most benefited out of this change as major part of the population had to deposit their currency. These deposits in-turn increased the number of accounts in banks and led to an increase in the net interest income and net earnings of the banks. In the beginning, they were not prepared for the outcomes of this change. There was a decline in cash stock as 97% of the currency notes in circulation were declared illegal for any further transactions. The availability of cash was reduced and as a result, a limit was set on cash withdrawals from banks and ATMs which was frowned upon by most citizens.

The Export-Import sector was affected by the currency crunch which led to instability in exports, which lead to uncertainty in internal purchasing power making the Indian economy unstable. They were also hit by the reduction in money supply and overflowing bank deposits.

UNORGANIZED SECTOR

The most affected sector of this move was the unorganized sector which accounts for about 45% of GVA (Gross Value Added) and consists of agricultural laborers, daily wage laborers, etc. which is approximately 90% of the total working population of India. This sector was affected severely as most of their transactions are carried out in the mode of cash and have relatively less awareness about various banking and e-banking methods and are backed with no (or least) social security such as health, education or provident fund benefits. Citizens faced a major problem as the withdrawal limit was low and many workers from the unorganized sector were tricked into exchanging their currency for Rs.300 and Rs. 400.

According to the GVA estimate, the demonetisation impact was to a large extent on construction activities. As per the National Sample Survey conducted by NSSO in 2009-2010, about 4.4 crore workers are employed in the construction activities making it one of largest category of the unorganized sector.

The impact of demonetisation on a daily wage worker presented in this paper is based on a survey conducted by me in the city of Jaipur. 737 casual laborers spread over 20 chowktis were interviewed in the city of Jaipur. The rate of employment was 57.7% before demonetisation fell to 33.8%. The average wage rate before demonetisation was minimum Rs.450 and maximum Rs.488 which declined to minimum Rs.264 and maximum Rs.326. many found it difficult to find work and the ones employed were being paid less and with the old currency. Workers were unable to adapt to this change as it vastly affected their work and income.

Agriculture in India accounts for 50% of the workforce. Farmers, who are regarded as the backbone of our economy were severely affected by demonetisation as all their transactions, output-input channels were pre-dominantly cash-dependent. There was setback due to nationwide cash shortage and a fall in demand for vegetables in wholesale markets. It was difficult for the farmers to purchase inputs like seeds from the market. The limit on withdrawing cash from ATM’s made it almost impossible for the farmers to do so.

MACROECONOMICS

The demand for gold, on the announcement of demonetization, increased as people invested their old notes in gold. Not only consumers but jewelers also benefited by selling gold at best possible competitive prices. Most of the transactions of the gems and jewellery are done in cash. This sudden increase in the demand for gold soon led to a drop in its demand due to shortage of cash in the market. Gold imports dropped down in year 2016 as compared to the previous 10 years data. Factors like weak rural demand, recycling of jewellery of households, destocking of earlier purchases, etc bought down the demand for gold because of increased regulations, for the transparency, of transactions were imposed.

After demonetisation the GDP growth rate declined to 7.1% in 2016-17 from 8.0% in 2015-16. The real growth rate also declined from 6.8% in 2015-16 to 5.7% in 2016-17. Manufacturing sector witnessed the decline in growth from 10.8% in 2015-16 to 7.9% in 2016-17. The most affected of all sectors was the growth of construction sector which witnessed the decline from 6.0% in 2015-16 to 3.7% in 2016-17.The GVA from manufacturing sector has declined from 9.3% in 2015-16 to 7.4% in 2016-17 and also the construction sector witnessed the decline in GVA from 3.9% in 2015-16 to 2.9% in 2016-17.

According to the DS Mukherjee, the impact of present demonetisation will be serious on people who earn and spend their income in cash more than those who earn in non cash but spend in cash. The most hit sector will be the unorganized sector especially the construction as its transaction is generally in cash.

MS Mohammad, in his research observed that the most affected by this move of the government is the common people and the unorganized sector and there is a limited impact on the organized sector.

FDI faced a short term negative impact of the demonetisation as the economy was unstable and therefore was not able to attract foreign investors. It was speculated that there will be an increase in FDI as most of the transactions will be digital now and transparency in transactions will reduce corruption and black money.

Manmohan Singh the former Prime Minister of India remarked that demonetisation has badly disrupted the lives of millions of poor people in India. He argued that this policy had not tackled the problem of black money and might be of great negative impact on the Indian economy.

Demonetisation led to reduction of service tax and excise tax rate in November as compared to the October. Service tax declined to 13% in November and excise tax to 32% in the same month of demonetisation. This shows a negative impact on the indirect taxes due to the compressed demand. According to the Ministry of Finance data, the direct tax collection in the month of November was Rs. 35,000 Cr. which was 30% less to the collection of Rs. 50,000 Cr. in the month of October. Property tax has shown positive result as many local bodies have permitted people to pay their old as well as new property taxes in old notes.

Demonetisation made a part of the currency extinguish from the Indian market. This compelled RBI to print new notes as new currency. RBI claimed that this will increase the government’s liability and to resolve this they suggested introduction of digital methods of payments throughout the Indian economy. RBI also suggested that this new currency can be released in the Indian market only when foreign exchange is converted into rupees.

Banerjee & Chatterjee in their block argued the impact of demonetisation on automobile industry. “The major factor like non cash transactions has considered to be harder hit for the sale of car. The impact results in inventory piling issue, increased fear among the end customer regarding changing government norms for possession of wealth and assets.”

Charan Singh (2016), RBI chair professor, IIM Bangalore argued that demonetisation has mixed implication on Indian economy. According to him it will attract the confidence of foreign investors as they will find India to be serious about corruption through this policy. Secondly, it may lead to reduction in the output from agriculture sector and others due to non availability of cash. Conclusion

The impact of demonetisation has both positive and negative effects. These effects depend upon the long term and short term affect of this policy. The outcome of this policy as argued by government is to curb black money, track the terrorism financing activities and also to stop the dealing in counterfeit notes.

Post-Demonetisation Indain tax department has detected undisclosed income of over Rs. 4,807 Cr. and cash and jewellery of about Rs. 609.03 Cr. This policy has helped in making various state elections clean and transparent as it became difficult to purchase votes due to non availability of cash. The outcome of this policy was not that successful as very less amount of black money was curbed in actuality. This policy had more negative impacts than positive one as it negatively affected the common and poor people in the Indian Economy.

India is still not capable enough to face such a huge policy decision as cash is the most preferred mode of transaction in almost all sectors of the Indian economy. Most of the Indian population is still living in rural area where people are not yet technology friendly and lack access to it. Most of the rural population does not have access to mobile phones and bank accounts. More than half of the population is illiterate and does not know how to use-banking or the use credit and debit cards. Huge population of India is in engaged in unorganized sector. Their survival is dependent on daily wages which lacks any kind of job security so to expecting them to only have a phone but with internet is unrealistic. Their earning is only sufficient enough to provide a roof over their head, thus, they do not have money for savings or a bank account. They find it pointless to open an account since they hardly deposit money in the account because of which the account is soon closed automatically by the banks.

The impact of demonization was also on the housewives who are not mentioned anywhere in the study of demonetisation. Many housewives save small amount of money from the household expenses and hide it from their family members which they call their “JEEVANPUNJEE”. These savings are used at a time when family is short of money and so Demonetisation forced these women to expose their savings. Also, people found it difficult to arrange for money when they needed it for their family medical expenses and marriages, etc. as only a small amount was allowed to be withdrawn from bank.

Demonetisation affected the life of common middle-class man as he had to spend most of his time standing in long crew, in front of banks and ATMs, to withdraw money. Many of them had to take a leave from work in order to withdraw money and sometimes they did not even get a chance for the same because of long crew.

The impact of demonetization would have been a great move if government had made arrangements for availability of new currency before implementing this policy. The non-availability of cash has negatively affected the economy and people have still not recovered from this shock due to shut down of most of the businesses. People need more time and better policy support from the government in order to recover. Government needs to make policy for the rural and poor illiterate people as they are the one who had faced the brunt of this demonetization than anyone else.