Demonetization: An analysis


Demonetization was a bold step by the union government. It affected every walk of life. Demonetisation should be scrutinized to understand the impact. So understanding various macro-economic parameters pertain to demonetisation would help to realise the state of economy in general and goal achievements of demonetisation in particular.


Every policy has a stated goal as well as secondary consequences, some of which are unintended. It is still quite possible that demonetisation will have positive consequences over a longer period—the growth in the direct tax base, the switch in the financial holdings of households from cash to bank deposits, the increased use of digital payments. That is what its supporters are now banking on. The question to be asked is whether the potential long-term benefits will be greater than the short-term costs that the Indian economy had to bear.

Fact sheet

  1. The Annual Report of RBI shows that during the year 2016-’17, Rs 41.5 crores worth of fake currency notes in the form of old Rs 500 and Rs 1,000 notes were detected in the banking system.
  2. This is well above the Rs 27.4 crores of fake currency detected in these denominations in 2015-’16.
  3. The estimate of the total fake currency in the system was Rs 400 crores. It is safe to say that fake currency in Rs 500 and Rs 1,000 denominations was eliminated as those notes can no longer be used anywhere.
  4. However, counterfeits of new Rs 500 and Rs 2,000 notes are already being intercepted, which suggests that the elimination of fake currency is not a lasting benefit and perhaps alternative approaches are required to address this problem.
  5. 98.96% of the Rs15.44 trillion notes invalidated by demonetisation had been deposited with banks.
  6. With limited fiscal and monetary space, any big bang stimulus is unlikely. Inflation is expected to breach 4% mark in January-March 2018. In order to match last fiscal’s growth performance (7.1%), the economy has to grow an average rate of 7.6% in next three-quarters, which presently appears to be difficult.



  1. Increase in tax collection: As a result of demonetization drive, there is a substantial increase in the number of Income Tax Returns (ITRs) filed. The number of Returns filed as on August 5, 2017 registered an increase of 24.7% compared to a growth rate of 9.9% in the previous year.
  2. Curb on Black money: Transactions of more than 3 lakh registered companies are under the radar of suspicion while one lakh companies were struck off the list. The government has already identified more than 37000 shell companies which were engaged in hiding black money and hawala transactions. Around 163 companies which were listed on the exchange platforms were suspended from trading, pending submission of proof documents.
  3. Impact on terrorism and naxalism
    i. As a result of demonetization of SBNs, terrorist and naxalite financing stopped almost entirely.
    ii. No high quality FICN was found / seized by intelligence operations, including at the Indo-Bangladesh Border since demonetization.
    iii.Further, it also adversely affected the hawala operators and dabba trading venues.
  4. Promoted Digital Payment: In 2015-16, the value of transactions for debit and credit cards was ₹1.6 lakh crore and ₹2.4 lakh crore, respectively; in 2016-17, it was ₹3.3 lakh crore for eachAlso, in 2016, the National Electronic Funds Transfer handled 160 crore transactions valued at ₹120 lakh crore, up from around 130 crore transactions worth ₹83 lakh crore in the previous year. Note that the demonetisation impact would only have been registered in the final four to five of 2016-17. The gains in 2017-18 will be even more.


FIGURE: growth slow down

Black money

  1. . It was thought that if cash was squeezed out, the black economy would be eliminated.
  2. But cash is only one component of black wealth: about 1% of it.
  3. It has now been confirmed that 98.8% of demonetised currency has come back to the Reserve Bank of India.
  4. Further, of the ₹16,000 crore that is still out, most of it is accounted for. In brief, not even 0.01% of black money has been extinguished.
  5. Black money is a result of black income generation. This is produced by various means which are not affected by the one-shot squeezing out of cash. Any black cash squeezed out by demonetisation would then quickly get regenerated. So, there is little impact of demonetisation on the black economy, on either wealth or incomes

GDP growth

  1. GDP growth in the first quarter of 2017-18, at 5.7 per cent, compared with 7.9% in the same quarter a year ago, was way lower than consensus estimates by Reuters (6.6%) and Bloomberg (6.5%). Both supply and demand were impacted due to a combination of demonetisation
  2. The big failure of demonetisation is that it was carried out without preparation and caused big losses to the unorganised sector. This has not been factored into the recent data on growth rate, so the loss to the economy would be in lakhs of crores of rupees. Farmers, traders and the youth are all agitating.


  1. Another factor that did not support growth as anticipated is agriculture, particularly in view of the record food grain production in 2016-17.
  2. Agricultural growth declined to 2.3% from 5.2% in January-March 2017 and 2.5% in April-June 2016. In view of record foodgrain production, it appears the shortfall is mainly due to the underperformance of allied sectors, namely dairy, fisheries etc.
  3. The main negative economic consequence of demonetisation has been the disruption of unorganized supply chains that are dependent on cash transactions; it is still not clear how smoothly they were being rebuilt as the economy was remonetized.
  4. RBI annual report shows a rather dramatic spike in the number of suspicious transaction reports filed by banks, financial institutions and intermediaries in 2016-17—it was up from 61,361 in the previous year to a staggering 361,214.

Job Loss

Demonetization decision may have resulted in the loss of roughly 1.5 million jobs, according to survey data put out by the Centre for Monitoring Indian Economy (CMIE). CMIE’s data is based on the result of consecutive waves of household surveys performed from January 2016 to April 2017 .

Monetary policy

  1. The RBI formally became an inflation targeting central bank in 2016 but the liquidity surge in the banking system that came about in the aftermath of demonetisation complicated the conduct of monetary policy.
  2. In addition to the conventional reverse repo auctions (an exercise to remove excess cash from the banking system), the RBI introduced an array of instruments to absorb demonetisation induced liquidity from banks.
  3. Chief among them was the hike in incremental Cash Reserve Ratio – the percentage of cash deposits that banks must keep with the RBI– at 100% on deposits accrued between September 16 and November 11, and the increase in ceiling on the issuance of securities under Market Stabilisation Bonds.
  4. While the increase in incremental Cash Reserve Ratio dented banks’ earnings as banks do not earn interest on the cash reserve parked with the RBI,
  5. The issuance of Market Stabilisation Bonds marked a departure from their traditional role. These bonds are generally issued to mop up the excess supply of rupees arising from the RBI’s intervention to purchase dollars.
  6. While the increase in these bonds represent an increase in quasi-fiscal cost (the interest payments are made by the government and this shows up as fiscal costs instead of appearing as reduced RBI profits) to the government, the repeated auctioning of such bonds (as the RBI report acknowledges) tends to push up the yields which may be contrary to the stance of monetary policy, which may be accommodative or at best neutral in the present low growth and investment regime.
  7. The mopping up of liquidity eroded the RBI’s earnings.
  8. Additionally, its expenditure on printing of currency doubled from last year. Overall, while its income for the year decreased by 23.56%, its expenditure increased by 107.8% resulting in a sharp decline in the RBI’s surplus


  1. Available data points to a lingering impact of demonetisation.
  2. All economic data points are from the organised/corporate sector. The unorganised/informal sector was badly impacted by demonetisation and the present data set has not been able to capture its impact. The annual survey of industries will be able to capture the impact of demonetisation on the unorganised/informal sector, but this will come with a lag. The organised/corporate sector depends on the unorganised/informal sector for provision of intermediate goods and services, which are used in final production. The Central Statistical Office is using only the database of the Ministry of Corporate Affairs. The true picture may emerge only after the annual surveys of industries results are available.
  3. Tax reforms and effective monitoring of suspicious transactions are a better alternative for addressing the issues that the policy-makers sought to fix through demonetisation.

Q.) Demonetisation succeeded in achieving its stated objectives. Critically comment


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