With this so-called demonetization plan, 86% of the currency in circulation was replaced and this resulted in a huge monetary squeeze (Figure 1). The plan was an attempt by the government to wash the stock of counterfeit money out of the economy, which has allegedly been used to fund criminal activities, such as terrorism and drug trafficking.
In addition, the scheme aimed to draw a large part of the black economy into the banked and taxable part of the economy (overall tax revenue to GDP is a meager 11%). Demonetization also targeted to reduce cash in the circulation.
Source Economic Times
Immediate impacted industries- The informal sector which is very cash-dependent and the liquidity squeeze had put a brake on transactions, especially in sectors such as retail, agricultural and commodities. Many entrepreneurs who didn’t have the bank account nor paid the taxes from the agricultural and retail sector ran their daily business solely based on cash transactions. Unorganized sector suffered job losses of 1.5 million (Jan- April 2017) according to CMIE (Center for Monitoring Indian Economy). Rural stress has forced loan waivers of Rs. 88,000 crore. During the demonetization business of these sectors was impacted most as they were not able to pay to the workers, buy the intermediate goods and couldn’t sell goods and service due to cash crunch.
Second, there was crackdown on black money which has been hoarded in the real estate sector. It had resulted in reducing the cash transactions significantly. This was also detrimental for private consumption and housing investment. According to the data from Knight Frank India, sales across the top eight cities were down by 11% year-on-year in the first half of 2017, but they have risen by the same proportion when compared with the July- December 2016.
The demonetization had impacted the various economic sectors. For few it was fruitful and for others not so fruitful. Given below the data for the few sectors impacted by demonetization.
Source: Economics Times
Banks: Within the first month, practically all demonetized currency notes in the country were back in the bank vaults. The sudden flow of cash to public sector banks gave them an instant lifeline clearly visible across the banking system. Lending rates get slashed, the overnight marginal cost of funds-based lending rate (the minimum interest rate below which a bank cannot lend) fell to 7.75% from 8.65%. Meanwhile, three-year loan rates came down to 8.15% from 9.05%.
Financial Technology Startups-Digital wallet and other mobile payment companies were the other beneficiary sector. Due to the cash crunch, many people turned to digital wallets that can be used in conjunction with mobile payment systems, allowing them to pay for purchases with their smart phones.
Among mobile wallet companies, Paytm was the biggest beneficiary. We can gauge the impact of the demonetisation drive on its business by looking at the company’s user base, which has reached 160 million – a fourfold increase since May 2016. Paytm’s traffic rose by 435%, app downloads grew by 200%, and the company saw a 250% rise in overall transaction value.
Hardest Hit Sectors
Rural Area– In rural areas, where access to banking and the internet is quite low was very badly hit. A 2016 Reserve Bank of India (RBI) report on branch authorization policy classified 93% of rural centres in the country as unbanked. Access to the internet is equally patchy, with only 3% of households in underdeveloped rural areas reported access to internet in a 2016 consumer economy survey.
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 demonetisation. By turning farm markets into buyers’ markets, demonetisation may have also contributed to the decline in prices of pulses.
Two wheelers & Four Wheelers- 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.
New investment –proposals worth Rs.1.25 trillion were observed during the quarter ended December 2016. This is low compared to the average Rs.2.36 trillion worth of new investments seen per quarter in the preceding nine quarters of the Modi government.
Source Hindustan Times
Data suggests that demonetisation has hit the pace of announcement of new investment proposals during the quarter ended December 2016. 227 new investment proposals worth Rs.818 billion were announced during this quarter till November 8. In comparison, only 177 investment proposals worth Rs.437 billion were made between November 9 and December 31, 2016.
Thus demonetization had both hits and misses on the Indian economy but still its long journey, as many more goal posts yet needs to be achieved.
Hugo Erken RaboResearch Global Economics & Markets
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