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Demonetization

What is Demonetization?

The term Demonetization refers to an act of stripping out neutralizing a currency unit in the circulation of its earlier status as a legal tender. Nations often anticipate positive changes on the liquidity structure of currency and adopt the Demonetization policy in order to counterbalance the current economic condition. Most countries across the globe have used Demonetization at some point in time, to control financial situations like inflation and also to boost the economy of the nation. In November 2016, the Indian government implemented the demonetization policy by banning the high denomination notes of Rs.500 and Rs.1000 in order to curb counterfeit and money laundering.

Effects of Demonetization on Indian Economy

Demonetization had been a sudden move by the Indian Government and it sent a shockwave across the Indian economy. The Prime Minister of India, Narendra Modi, orchestrated this master plan to uproot the problems of corruption, counterfeiting and black money from the Indian economy. This move had reportedly swept off a significant portion of India’s monetary base. The great surgical strike on black money led to the increase of cashless transactions in the country and also untied all knots in tax collection. However, rural households and elder citizens were worst hit due to the sudden monetary reform.  The sudden decision to ban all Rs.500 and Rs.1000 notes overnight had made it to headlines around the globe, attracting both appreciations as well as criticisms.

Demonetized Currency and Small Savings Schemes

Soon after the demonetization, the government of India had notified banks not to accept the discontinued currency notes for depositing in small saving schemes. However, no reasons had been specified by the authority for such a move. Small savings schemes are considered to be one of the most sustainable financial investments that provide better returns at lower risk.  Moreover, cash transactions were the only practical means for people without access to banks to suffice their everyday requirements and for small-scale investments. A considerable section of the society was largely affected by demonetized currency.

Demonetization: Impact on Indian Economy

India is a country where 85% of financial transactions take place in cash. Banning two high denomination banknotes had led to a lot of awkward questions. The service sector in the country depends mostly on cash transactions - they were adversely hit by the waves of Demonetization. The consumption activity of India had also come to a screeching halt.  This drop in economic activity lasted for quite a few months, resulting in a significant fall in GDP from the previous year’s values.

Even as the country faced the most exceptional financial crunch of all times, a few analysts predicted the economic conditions to stabilize within a few quarters. Deutsche Bank and Goldman Sachs expected India to join the list of the fastest-growing economies by next fiscal year. An improved monsoon season in 2017  favored agricultural economy of the nation, which in turn added to the financial recovery as a whole. Economists also predicted that the decision to scrap high-value currency notes would lead to GDP growth by 2%.

Demonetization: Effects on Bullion Market

Demonetization threatened to bring sharp changes in the costs of gold, and it seemed likely to start showing from the first quarter of 2017. The government also announced the exemption limits on gold jewelry as the next enormous move to curb black money. The notification arrived within weeks after the banning of Rs.500 and Rs.1000 notes. The following restrictions were placed on the possession of gold:

  • Indian married women are allowed to keep strictly less than 500 grams of gold in custody.
  • Indian unmarried women are allowed to keep only 250 grams.
  • Men are allowed to keep only 100 grams of gold.
  • The rule did not apply to legitimate gold belongings.

Demonetization: Effects on Real Estate

The real estate, being an unorganized sector, was largely affected when the higher denomination currency notes were declared invalid. However, there wasn't a huge change in the primary real estate market because property buyers make purchases through cheques or loans. The impact of Demonetization was, however, felt in secondary markets, where most of the property dealings take place through cash. The currency reform yielded positive results in the real estate sector as the transparency in dealings increased with time.

Demonetization: Impact on Equity and Mutual Funds

Demonetization had a positive effect on equity funds with more money coming into the organized system of financial transactions. If the cash flow in the entire nation is completely tracked, more people will start investing in equity-linked savings schemes to save on taxes, thus significantly strengthening equities.

Demonetization: Impact on Tax to GDP ratio

In an economic survey conducted in 2016, the tax to GDP ratio of India was discovered to be at 16.6%, which was comparatively low when compared to the emerging markets around the globe. However, as deposits started moving away from the unorganized modes and got simultaneously channelized towards organized deposits in banks, the tax to GDP ratio rose significantly. Analysts have also predicted a significant rise in the percentage of tax collection in the coming years, as all financial transactions are now under the scanner. The Indian populace is hoping that the government may reduce tax rates, owing to the same reasons.

Demonetization: Impact on Jan Dhan Accounts

Before demonetization, the contribution of the Jan Dhan accounts towards organized deposits was quite low in the overall banking domain. However, after Demonetization, these dormant accounts witnessed a steep surge in deposits. The government’s financial inclusion plan gained momentum as a large number of people, especially from rural areas, started opting for bank-based transactions.

Demonetization: Impact on E-wallets

As the currency notes of Rs.500 and Rs.1000 were banned, e-wallet companies such as Paytm, Citrus, PayU, Mobikwik, etc. started witnessing a massive rise in their daily transactions. Demonetization also saw a rise in hirings and several other business functions of these companies. Even the app-based cab companies started promoting cashless transactions.

Demonetization: Impact on Vehicles Market

Purchase of old vehicles considerably declined following the Demonetization move. This somewhat affected the original manufacturers as well, as prospective buyers found it difficult to sell off their old vehicles and purchase new ones.

Demonetization: Impact on Cement and Steel Industry

The cement and steel sectors witnessed a temporary decline in sales. These industries are closely linked to real estate. Closer scrutiny of the situation revealed that there was a considerable impact of Demonetization on the construction industry as the daily wagers were the worst sufferers. Nonetheless, as there was a rise in bank deposits complementing the savings rate, the short-term difficulties were surpassed soon.

Demonetization: Short-term Impact on GDP

The reduced consumer demands due to dulled cash flow triggered a significant decline in GDP figures over a few quarters. Demonetisation had negatively impacted the construction, gold industries, as well as other secondary markets. This reflected in the reduced GDP. However, the situation is steadily coming under control as cash flow is being normalized in these areas of business.

FAQs

  • Why were the higher denomination currency notes demonetized in India?

    This scheme was introduced by the government of India to eradicate black money and counterfeiting. It was reported that a surplus amount of fake currency notes of higher denominations were circulating in the market, which accounted for a rise in crime rate too. The Rs.500 and Rs.1000 notes amounted to about 86% of the monetary base of India. The removal of these currency units brought down several cases of money laundering as well as tax evasion.

  • How are the digital modes of payment to be used?

    One can simply log in to their internet banking account and access many services online. Through internet banking, one can transfer funds, pay bills, shop online, recharge their phone, and do a lot more other transactions. One can also download the bank's mobile banking app to transact online using their smartphone.

  • Did Demonetisation affect the notes issued before 2005?

    Yes, even the currency notes of Rs.500 and Rs.1000 that were issued before 2005 lost their legal tender status following Demonetization.

  • What are the withdrawal limits on Jan Dhan Yojna accounts?

    The withdrawal limits on Jan Dhan Yojna accounts are temporarily set to Rs.10,000 by RBI. If one wishes to withdraw more, then he or she will have to approach the bank and furnish valid reasons for the same.

  • How to deposit cash without a bank account?

    Banks have been directed to facilitate account openings for the unbanked sections. One may visit any bank with the necessary documents to open a new account.

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