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Impact of demonetization drive, the good, the bad & the ugly

, March 7, 2017, 0 Comments


After growing at a rate of 7% plus continuously for six quarters, India’s GDP growth is set to decelerate in Q3FY17 on account of the NDA government’s demonetization move started on 8th November.

While rendering 500 and 1000 rupee notes illegal with immediate effect, the government sets out multiple goals like curbing the menace of black money, counterfeit currency, terrorism funding and push to cashless economy.

Impact on
Informal sector – The good
Agriculture – The bad
Real Estate – The ugly

Impact on informal sect 

In India, formal and informal sector is highly interdependent through forward and backward linkages. Due to the cash crunch created by demonetization and subsequent restrictions on cash withdrawal from banks, there are disruptions in the supply chain. This is a short term scenario and will fade out soon as cash crunch eases.

The more interesting thing to watch out for is the possible change in the cash based business model of informal sector, which has till now helped it in tax avoidance and minimum documentation. Immediately after demonetization, lot of unaccounted money was routed to informal sector and small businesses, old debts and bills were paid back in cash, necessary credit was extended to vendors and suppliers who could not pay back in cash at the moment and digital payments surged.

As the new notes of 500 and 2000 rupees become increasingly available, many businesses may fall back to earlier way of doing business. To that extent economic impact of demonetization will be short term.

However, if the government is able to raise taxes on excessive cash deposits, there will be erosion in the accumulated wealth. Proper implementation of GST, push to digital payments, ban on transactions above Rs.3 lakhs, positive incentives like reduction in corporate tax rate to 25% for companies with annual turnover of 50 crore and income tax rate of 5% for 2.5 to 5 lakh income, can kick start the process of formalization and consolidation of the informal sector. Big players in formal sector can grab this opportunity for acquisitions as well as increasing market share.

Impact on agriculture

Agriculture is worst hit due to demonetization. Harvest from Kharif season had to be sold at nominal prices due to non-availability of cash with wholesalers who buy crop from farmers. Consumer food price index fell by -0.88% in Nov and -1.84% in Dec (m-o-m).

Impact on real estate sector

The real estate sector has a share of 11% of GDP. This sector is used for parking black money. Share of cash component in real estate dealings varies anywhere between 30-40% in large metros to 70-80% in small towns. The secondary market is worst hit where activity has virtually stopped and all players are in wait and watch mode. The luxury housing segment is expected to take a hit while affordable housing may pick up with genuine buyers with white money being able to enter the market.

The short term impact of demonetization is disruptive, but long term impact depends entirely on follow up action and has the potential to take the Indian economy to a new normal.