A Year After Demonetization-India's Story Is Still Being Written

On November 08, 2016, Prime Minister Narendra Modi announced on national television that the Indian government had decided to ban the two largest denomination currency notes of INR 500 & INR 1,000 with immediate effect. This decision cut across lines of social or economic status, and it affected each and every Indian.

Demonetization was and it still remains one of the boldest policy decisions ever taken by any Indian Government since independence. This is because India is predominantly a cash-driven economy with a very large parallel or black economy, and even today a vast majority of Indian's are not part of the formal financial or banking system. Most individuals in India would get paid in cash, which they would store at home instead of depositing it in a bank account. As a result of this tendency, demonetization was followed by several weeks of chaos and confusion, people spent hours waiting in lines outside banks and ATMs to withdraw new or valid lower denomination currency notes. Adding fuel to the fire was the fact that a substantial chunk of currency notes in circulation (approximately 85%) were denominated in INR 500 and INR 1000, which implied that only 15% of all currency notes could be used, the rest was practically useless.

The media and newspapers erupted with multiple debates covering all possible implications of this decision, while most of India's general public soon realised that the decision was here to stay and they started looking for ways and means to cope and move on. The overall opinion was divided and it continues to remain so, with a few sections in favour and a few not in favour. November 08, 2017, marked the first anniversary of demonetization and if you want know more about the reasons for demonetization, it impacts, and the way forward, then continue reading further.

Why did the Indian Government Demonetize High Value Currency Notes?

1. Shift towards digital transactions: India is predominantly a cash driven economy, and the demonetisation drive was seen as a way to catalyse the shift towards digital financial transactions. At that time a lot people who had debit/credit cards but were not using them, started making card based payments on a day to day basis. While initially the focus was on going completely cashless, it was later changed to less-cash instead.

2. Curbing Black Money: India is very popular for its 'Jugaad' or by any means approach, and not surprisingly, post demonetisation, holders of black money, tried hard to 'convert their black money in to white' using various illegal means. The total value of the invalidated INR 500 and INR 1,000 currency notes at the time of demonetisation was around INR 15.44 Lakh Crores. However, post 10 months of demonetization, the Reserve Bank of India (RBI) reported that approximately 99% of these notes had found their way back into the formal banking system. This meant that almost all currency notes returned by way of unaccounted deposits made in several different accounts. The Income Tax authorities are still investigating these transactions.

3. Increase in Deposit Base: According to the RBI, INR 2.8-4.3 Lakh Crore deposits were made into the banking system due to demonetization. While these deposits continue to be scrutinized, there is no doubt that the overall deposit base increased and a far larger number of people have started using the formal banking for saving or holding their money.

4. Financial Inclusion (Jan Dhan Yojna): Over 3 Crore new bank accounts were created post demonetisation, one-fifth of which came from the state of Uttar Pradesh alone. It is interesting to note that some states eventually recorded a drop in PMJDY accounts eventually. The accounts required that the average balance should not cross more than INR 50,000 at any point in time and the annual turnover in the account should be below INR 1 Lakh. Withdrawals should not be more than INR 10,000 a month.

5. Positive Impact on Stock Markets: Demonetisation led to an indirect gain in the stock markets as well as the period post-November saw an increase in the flow of domestic savings into mutual funds. Incidentally, the assets under management (AUM) of the mutual fund industry broke several past records.

Effect on GDP: Demonetisation had an impact on the country's growth as well, India recorded only a 5.7% GDP growth during April-June quarter - one of the lowest in recent years, this was mainly due to an abrupt withdrawal of almost 86% of all currency in circulation. On the whole however, it is believed that the move would result in positive long term impact, as it would help in ushering a new era of greater transparency and accountability.

Impact of Demonetization

Demonetization made many promises, and it was and continues to be a very radical and bold move deployed by one of the fastest growing large economies of the world for achieving multiple objectives at once. A few of these objectives were, shift to a digital financial transactions, eradication of black money, countering terrorism, and fight corruption among others.

1. Significant shift towards cashless economy: India's journey towards a cashless future received a huge jumpstart due to demonetization. As per some industry veterans, payment processing volumes grew over three times post demonetisation, and they continue to grow at a healthy rate of around 20% on a month-on-month basis. According to the Payments Council of India, the growth rate of the digital payments industry, which was earlier in the range of 20-50%, has accelerated post demonetisation to around 40-70%. Digital wallets have broadened people’s views and the whole country is now trying to identify new possibilities.

2. Stabilization of Real Estate Prices: One of the worst affected sectors by demonetisation is real estate, which has been a haven for holders of black money since a very long time. The prices in this sector for most asset classes have either reduced or stagnated. With all deals mainly happening between end users, as they are the only ones who are still buying. Investors and speculators have largely left the market, thereby cleaning up the system and gradually shifting towards all-white transactions, which little or nil direct cash involvement.

3. Reduced Interest Rates: With more people becoming a part of the formal banking system, a rate cut on interest rates was expected, and eventually almost all banks cut rates on deposits and borrowings. Flush with funds, the State Bank of India, was the first to cut its home loan rates to 8.65% from 8.9% and also it also offered a waiver on processing fee for a few months. Other Banks, NBFCs and Financial Institutions, soon followed suit.

4. Increase in Formal Investments: Post demonetisation, black money or money from unreported sources could not be invested easily, as a result there was a rush to somehow show or declare these incomes and invest them in various formal investment channels.

5. Higher Tax Collections: Almost all businesses, whether small, medium, or large came under scrutiny post demonetisation. Income Tax Authorities became very alert and were on the lookout for any wrongdoing. As a result, the tax collections increased by several fold and individuals and businesses started reported far more accurate results.

Greater Public Awareness: The whole exercise made India sit up and take notice of every step being taken to better its economy. It made citizens aware of various malpractices and also introduced them to a new more efficient way of conducting financial transactions.

Long Term Implications

One year after the radical move, and several discussions and debates later, let's look at a few long term implications of demonetisation.

1. Economic Boost: Higher participation by the general public in India's formal financial system will lead to a much-needed boost to our countries economy, as a larger share of funds can be tracked and their impact can be measured.

2. Reduced Significance of Parallel/ Black Economy: Some industries like real estate and construction that were plagued with black money saw a complete turnaround in their functioning. With buyers more aware, reduced speculation and higher white or non-cash transactions. The industry has hit a plateau of sorts, we expect real estate prices to reduce further and make home ownership more affordable. Such effects have resonated in almost all industries as we as a nation are gradually shifting towards a more transparent and tax compliant future.

3. Digitized Processes & Transactions: As a result of demonetisation, several Indians learned to trust and use digital wallets. The various discounts and incentives on offer further helped matters during the initial phase of the journey, the success rate of these processes is now well established and they will continue to gain even more traction in future.

4. Tax Compliance: The nation is now shifting towards higher tax compliance, and this open up several new avenues for growth and development. The nation as a whole would hugely benefit from this, as the government can use this money to drive growth, development, and various welfare schemes for the benefit of all Indians.

In the long term, demonetisation appears to be a positive driver of economic growth, higher tax compliance and a far more integrated economy which is stable and more resilient in times of uncertainty. All of these points resonate well with our long term objectives of becoming a global power.