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Impact of Demonetization

, November 14, 2016, 0 Comments

demonetization-black-money-marketexpress-inA week back government came with the sudden announcement that Rs 1000 and Rs 500 notes will cease to be legal tender. The government also provided various alternatives for the public to convert their defunct currency notes into spendable cash. By the end of 13-11-2016 it is said that about 3 lakh crore of white money had been deposited by the public in the bank accounts. The money supply holdings of banks have thus gone up by a huge amount. Increased money supply with banks is potentially inflationary and this coupled with a shortage of commodities coming into the market can lead to price rise in the short run. As against this reduced purchasing power with the public resulting from sterilization of cash holdings can have a disinflationary impact.

The impact of demonetization on economic activity is going to be negative in the short run. The small businesses do not have sufficient cash holdings with which to carry out production activity.

They also do not have cash holdings with which to pay the day labourers they employ. The traders do not have cash to pay the farmers or SMEs for the goods supplied by them. Productive economic activity has thus come to a standstill and this will reflect on the growth rate of the economy during the short run which will be subdued.

Demonetization has resulted in great inconvenience to the public seeking to exchange their defunct currency note for fresh cash. They have to stand in long queues for long hours day after day. The problem doesn’t disappear in one day. Almost a week has passed since demonetization was announced and still the long queues before commercial bank offices and ATMs continue. The public is inconvenienced because they don’t have the cash with which to buy daily necessities. Households where some members are admitted in hospitals have to face great inconvenience because they are unable to pay hospital bills and make payment for medicines required. Families where a ceremony like marriage is due have immense difficulty as many of them find it difficult to pay their bills online.

The people in rural areas and the farmers are also facing a great deal of hardship. Many of them do not have bank accounts or own a debit/credit card. The concept of internet banking is far removed for them. These people may be induced to rise in revolt. Already the case of looting of a fair price shop by the public in Madhya Pradesh has been reported. It goes to the credit of the peace loving nature of the Indian public that major incidence of social unrest have not been reported so far.

If the demonetization measure introduced by the government has to be successful it should result in immobilization of a large amount of black economy. The large volume of cash deposited by the public during the last few days in banks is actually white money. They can only have an inflationary impact by increasing money supply. The real success for the government will come when people fail to deposit their holdings of black money in banks. The extent to which this happens will determine the success of the scheme.

The demonetization scheme is meant to deal with black money maintained in the form of cash. In addition to cash a great deal of black money is converted into gold and jewellery, real estate including land, share holdings and so on. The present demonetization scheme does not have an impact on black money held in those forms which do not constitute cash holdings. It will clean up the system only to the extent black money is held in the form of cash.

The demonetization scheme introduced by the government is a well-intentioned one. But poor implementation and poor planning has caused a great deal of inconvenience to the public. There is also no guarantee that the problem of black money will go away forever. It is possible that after a passage of time the people will revert to their old bad habits and the black money problem will reappear in society. Moreover the present scheme only covers the cash component. To the extent that other forms of black money holdings are more important its contribution to cleaning up of the system is limited.