The Economic Impact of Demonetisation

India’s Gamble with Demonetisation

 

Courtesy: Business Insider

On the evening of November 8, 2016, Prime Minster Narendra Modi made an announcement that all Rs 500 and Rs 1000 currency notes (almost 80 percent of notes in circulation) would be cancelled with effect from the midnight claiming that this would be a strike on corruption.

Almost four months on, the country has gone through a lot of turmoil with long lines at banks, moneyless ATMs and tales of individual suffering. The Reserve Bank of India (RBI) and the government have stopped providing data on old currency notes. Demonetisation is now a pick of any of the following among fighting corruption, attacking terrorism financing, defeating inflation and creating a cashless society. It is interesting that Modi’s political popularity has barely been affected by this with Indians accepting the inconveniences for the claimed overall well-being. 

 

Economic Data

While it is too early to understand if demonetisation will achieve what it set out to do, it is interesting to understand how economic parameters are affected by the move. 

The Central Statistical Office (CSO) released data on February 28 stating that the Indian economy grew at a slower 7 percent in October-December 2016, down from 7.4 percent in the previous quarter. This estimate is surprising because of reduction in consumer goods sales in rural areas and muted investment activity because of the liquidity crunch. There is data that factory output contracted by 0.4 percent during December, against 5.7 percent growth in November. It is unclear how well this data has been captured by the CSO. 

Last week, the International Monetary Fund (IMF), said that India’s economic growth is expected to be 6.6 percent in 2016-17, against its earlier estimate of 7.6 percent in view of the disrupted supply chains and fall in demand for goods. 

   

Opinions

Economists realise that there is no precedent to follow for this cash ban and their models may not adequately capture the impact on the unorganised sector in India. Nobel laureate, Dr Amartya Sen has criticised this exercise and feels that with more than 25 percent illiteracy, with poor electrical, communication and digital infrastructure, a digital India is a pipe dream. Former Prime Minister Dr Manmohan Singh feels that India’s GDP for 2016-17 will come down by at least 2%. Other economists like Lawrence Summers, Kaushik Basu think that this was an ill-conceived move and bad economics.

However, economists Mr Bibek Deb Roy, member of NITI Ayog, Mr Arvind Nirmani and Mr Surjit Bhalla feel that this is a positive strike against black money and a good move. 

In conclusion, demonetisation has polarised some of the sharpest economist minds in the country and the world. There are those in support, and there are those who have either criticised its execution or the need for the decision itself. The long term impact is unclear to all and it is likely to take years before the economists and history can understand the true implications of this unprecedented move.