A

PROJECT REPORT
ON

DEMONITIZATION AND ITS IMPACT ON

INDIAN ECONOMY
SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS
FOR THE BACHELOR OF BUSINESS ADMINISTRATION

(BBA) 2015-2018

Under The Guidance of: SUBMITTED BY

DR. Anju Gairola Thapliyal Aashik Ali
H.O.D. Batch:- 2015-18

ADVANCE INSTITUTE OF SCIENCE AND TECHNOLOGY DEHRADUN

HEMWATI NANDAN BAHUGUNA GARHWAL UNIVERSITY
SRINAGAR, UTTARAKHAND
 ACKNOWLEDGEMENT

In the present world of competition there is a race of existence in

which those who are having will to come forward succeed. Project is like a
bridge between theoretical & practical work with the willing. I am joining
the particular project first of all.

I would like to thank the supreme power the almighty God who is
obviously the one who has always guided us to work in the right path of our
life without his grace his project couldn’t become a reality next to him are
my parents and my friends.

I am especially thankful to DR. NAMRATA PRAKASH who gave a

brilliant guidance in the project & guide us for right path of project

AASHIK ALI
 DECLARATION

I hereby declare that, this project title “DEMONITIZATION AND ITS IMPACT ON
INDIAN ECONOMY ” is a genuine & bonafide project prepared by me in partial
fulfillment of Bachelor Degree in Business Administration.

The project work is original & conclusions drawn here are based on the data
collected & analyzed by myself.

To best of my knowledge, this project work has not been submitted by anyone
else in any other institute or university.

Aashik Ali
 INTRODUCTION

The Indian Economy which was billed as the “fastest growing major economy” in the world and
the “only bright spot” among Emerging Markets seems to have slowed down even before the
latest “shock therapy” of “demonetization”. Indeed, the recently released growth figures from the
CSO or the Central Statistical Office considered to be the official department that releases
projected, and actual growth figures (apart from the RBI or the Reserve Bank of India and the
Finance Ministry) hints at a slowdown in the Indian economy even during the quarter before
demonetization happened.

While this is indeed cause for concern with projected growth figures revised downwards from
7.6 % to 7.1% for the financial year ending March 2017, what is cause for greater worry and
even alarm is the view among some economists including the former Prime Minister Dr.
Manmohan Singh (who is a reputed economist in his own right) that the current and ongoing
attempt to flush out black money would shave a good 2% of the GDP or the Gross Domestic
Product.

Indeed, some think tanks and research institutes such as Ambit Research have given even more
dire assessments with their projections of growth figures tending to be in the less than 3% range.
Of course, the consensus view among many economists is that while there would be indeed a
noticeable slowdown in the economy for a “quarter or two”, most of them seem to agree that
growth would indeed bounce back and the Indian economy would regain its momentum as well
as turnaround with a renewed sense of vigour due to higher tax revenues.

Having said that, one must keep in mind the fact that as per the recent estimates by some
economists, nearly 90% of the total cash in circulation has come back into the banking
system and hence, the stated purpose of the Demonetization exercise which was to “extinguish”
black money and enable the RBI to lower its liabilities thereby providing the government with a
huge dividend seems to have been belied. Of course, there are some who now argue that the
Indian Banking System is now “flush with cash” and this has enabled the government to “nudge”
the RBI to cut rates as well as to allow banks to pass on the benefit of ample liquidity to
consumers by lowering lending rates.

However, the flip side of this has been that banks have cut their deposit rates as well which is
natural considering that any cuts to lending rates have to be accompanied by cuts to deposit rates.
This has resulted in a situation where banks with enough deposits seem to be encouraging
spending more than saving and this can indeed create demand in the system since more money
with consumers means more spending thereby leading to an uptick in sales of goods and services
and which has the “multiplier effect” of resulting in more growth.

On the other hand, with more taxes being collected due to higher deposits in banks that can
be taxable as well as increased compliance due to greater scrutiny and oversight by the IT
(Income Tax) Department, the government too might be tempted to announce lower rates for
taxes and other aspects of what are known as fiscal measures. In this context, it is worth
remembering that fiscal stimulus which is by lowering taxes and providing more incentives to
consumers as well as producers by boosting supply can be complemented and supplemented by
the monetary stimulus which is by boosting demand for goods and services by lowering lending
rates thereby putting more money in the hands of consumers.

As economic theory states, both fiscal and monetary stimulus can be implemented in isolation or
taken together and hence, the Demonetization or the DeMo as it is being called might indeed act
as a catalyst for growth. Having said that, one must remember that India is primarily a cash
transaction based economy and hence, removing 86% of the money in circulation is indeed a
“brave” move since there are reports that large sections of the informal economy have come to a
grinding halt.

Moreover, there are also reports of farming sector taking a hit due to lack of cash as well as
sales of automobiles and other capital goods falling even though inventories are building
up. Thus, it remains to be seen as to how the growth figures for the next quarter and the overall
financial year turn out to be. Given that mainstream economists tend to debate and argue both
sides with equal passion and vigour, it is the case that as the cliché goes, the “proof of the
pudding is in the eating” and hence, the actual growth figures have to be watched.

Of course, there are other indicators to keep track of as well in the form of various Indices such
as the PMI or the Purchasing Managers Index which tracks industrial activity as well as the rates
of investment and the credit pickup as well as the Inflation figures. Having said that, one must
also note that given the lack of communication about some of the economic indicators from the
government is indeed worrying given that Demonetization has been billed as the “Biggest
Monetary Experiment” in recent times in the entire world.

The point here is that any such “disruption” must be both communicated and implemented well
and given some of the concerns expressed in this regard by many commentators, one must
indeed look for “straws in the wind” to make sense of the economic impact of Demonetization
on the country.

Digital Payments: What they are, How they Work, and their Benefits and Problems

In recent months, all of us have heard extensively about the “war on cash”, the move to make
India and other countries “cashless economies” and the general trend among policymakers
worldwide to move the economies of the world to a digital and information enabled paradigm.

In this context, it is worth noting that the emphasis laid on digital payments and the digitization
of commerce has implications for individuals, businesspersons, governments, and anyone and
everyone who is a participant in the economy.

Thus, it is important to understand what digital payments and how they work and how they
benefit the economy as well as the associated problems that accrue from using such modes of
transactions and commercial dealings.
Digital Payments are payments that are conducted over the internet and mobile
channels and hence, any payment that is sent online or through mobile computing and internet-
enabled devices can be called such.

This means that for digital payments to take place, the sender of the payment must have a bank
account, an online banking method, a device from which he or she can make the payment, and a
medium of transmission meaning that either he or she should have signed up to a provider or an
intermediary such as a bank or a service provider. We will come to the last part in a bit.

Apart from the sender having such means, the receiver of the payment too must have these ways
to accept payments. This means that there must be a medium of transmission between the sender
and the receiver wherein the former instead of paying the latter in cash and physical format pays
in digital format meaning that the transaction happens over eCommerce or mCommerce modes
of transmission.

Thus, what is important in any digital payment is the “via media” through which the payments
happen which means that the intermediary and the modes of transmission are indeed the keys to
making the transaction or the digital payment successful.

Coming to the intermediary, let us first think about what happens when we pay cash in the
physical format. We first need to withdraw the cash from the bank or get it from someone who is
likewise using cash obtained from the bank.

Thus, without banks and banking channels, there is no way we can access cash or transact for
commercial dealings. Similarly, the digital payments need the intermediary as well and
considering the fact that the payment still involves money though not in physical format and in
digital format means that there must be infrastructure that connects the flow of digital cash
across the payment value chain.
Remember that the payment value chain begins with the sender punching in the details in the
Point of Sale devices at the merchant who in turn, uses the POS to connect to his or her bank
account and thus, remits the money in such accounts. This means that the “digital backbone” is
indeed important.

Now, while in developed countries, almost everyone has a bank account or has access to credit
and debit cards in addition to most merchants having POS machines in their establishments
means that the job of digital payments is infinitely easier than in developing countries where
such infrastructure either does not exist or in basic form.

Thus, for countries such as India to move to the digital payment paradigm means that there is a
massive need and demand to bring in all the players in the payment value chain into the digital
backbone.

Further, when the Indian economy is predominantly cash-based one; this means that there is a
massive effort to transition all the stakeholders in the payment value chain onto the digital
paradigm. Considering that banking channels and access to banking services are mostly in urban
areas, this means that there are huge challenges in migrating all the people into the digital
network.

Moreover, as explained earlier, most merchants lack POS devices, and this is where service
providers such as PayTM and the newly launched BHIM App from the government can do the
trick.

In addition, as most of the country has already been covered under the Aadhar cards, it is easier
for the government to create a digital backbone using such biometric models. Thus, while the
road to a digital economy is indeed challenging, there exist the basic ingredients to smoothen the
journey and all it needs is vision and dedicated effort from all stakeholders including the
willingness of the people to make the journey.
Having said that, one must also caution that while a digital economy sounds like Utopia because
black money, criminal activities, and corruption are supposed to (there is no tangible evidence
from developed countries that they actually do) reduce, there are also pitfalls here since digital
models are susceptible to hacking, identity theft, and cybercrime which raise pertinent questions
about data integrity and data protection.

Moreover, in countries where the law enforcers are yet to come to terms with the digital
paradigm, one must be realistic in expectations about the benefits.

Finally, digital payments are an evolutionary step towards the “business at the speed of
thought” model that pioneers such as Bill Gates have always predicted would be the next step in
our move from physical to digital and hence, despite the challenges and doubts, one must indeed
take steps to move towards it.

Having said that, there is also a case to be made for proceeding gradually instead of the “shock
therapy” and “big bang” method that has been pushed without

Digital Payments: What they are, How they Work, and their Benefits and Problems

In recent months, all of us have heard extensively about the “war on cash”, the move to make
India and other countries “cashless economies” and the general trend among policymakers
worldwide to move the economies of the world to a digital and information enabled paradigm.

In this context, it is worth noting that the emphasis laid on digital payments and the digitization
of commerce has implications for individuals, businesspersons, governments, and anyone and
everyone who is a participant in the economy.

Thus, it is important to understand what digital payments and how they work and how they
benefit the economy as well as the associated problems that accrue from using such modes of
transactions and commercial dealings.
Digital Payments are payments that are conducted over the internet and mobile
channels and hence, any payment that is sent online or through mobile computing and internet-
enabled devices can be called such.

This means that for digital payments to take place, the sender of the payment must have a bank
account, an online banking method, a device from which he or she can make the payment, and a
medium of transmission meaning that either he or she should have signed up to a provider or an
intermediary such as a bank or a service provider. We will come to the last part in a bit.

Apart from the sender having such means, the receiver of the payment too must have these ways
to accept payments. This means that there must be a medium of transmission between the sender
and the receiver wherein the former instead of paying the latter in cash and physical format pays
in digital format meaning that the transaction happens over eCommerce or mCommerce modes
of transmission.

Thus, what is important in any digital payment is the “via media” through which the payments
happen which means that the intermediary and the modes of transmission are indeed the keys to
making the transaction or the digital payment successful.

Coming to the intermediary, let us first think about what happens when we pay cash in the
physical format. We first need to withdraw the cash from the bank or get it from someone who is
likewise using cash obtained from the bank.

Thus, without banks and banking channels, there is no way we can access cash or transact for
commercial dealings. Similarly, the digital payments need the intermediary as well and
considering the fact that the payment still involves money though not in physical format and in
digital format means that there must be infrastructure that connects the flow of digital cash
across the payment value chain.
Remember that the payment value chain begins with the sender punching in the details in the
Point of Sale devices at the merchant who in turn, uses the POS to connect to his or her bank
account and thus, remits the money in such accounts. This means that the “digital backbone” is
indeed important.

Now, while in developed countries, almost everyone has a bank account or has access to credit
and debit cards in addition to most merchants having POS machines in their establishments
means that the job of digital payments is infinitely easier than in developing countries where
such infrastructure either does not exist or in basic form.

Thus, for countries such as India to move to the digital payment paradigm means that there is a
massive need and demand to bring in all the players in the payment value chain into the digital
backbone.

Further, when the Indian economy is predominantly cash-based one; this means that there is a
massive effort to transition all the stakeholders in the payment value chain onto the digital
paradigm. Considering that banking channels and access to banking services are mostly in urban
areas, this means that there are huge challenges in migrating all the people into the digital
network.

Moreover, as explained earlier, most merchants lack POS devices, and this is where service
providers such as PayTM and the newly launched BHIM App from the government can do the
trick.

In addition, as most of the country has already been covered under the Aadhar cards, it is easier
for the government to create a digital backbone using such biometric models. Thus, while the
road to a digital economy is indeed challenging, there exist the basic ingredients to smoothen the
journey and all it needs is vision and dedicated effort from all stakeholders including the
willingness of the people to make the journey.
Having said that, one must also caution that while a digital economy sounds like Utopia because
black money, criminal activities, and corruption are supposed to (there is no tangible evidence
from developed countries that they actually do) reduce, there are also pitfalls here since digital
models are susceptible to hacking, identity theft, and cybercrime which raise pertinent questions
about data integrity and data protection.

Moreover, in countries where the law enforcers are yet to come to terms with the digital
paradigm, one must be realistic in expectations about the benefits.

Finally, digital payments are an evolutionary step towards the “business at the speed of
thought” model that pioneers such as Bill Gates have always predicted would be the next step in
our move from physical to digital and hence, despite the challenges and doubts, one must indeed
take steps to move towards it.

Having said that, there is also a case to be made for proceeding gradually instead of the “shock
therapy” and “big bang” method that has been pushed without adequate preparation.

Chinese Foray into European Economy

The United States has traditionally been China’s biggest trading partner. The two largest
economies in the world have a humungous trade relationship that would put national GDP’s to
shame. For several years this relationship has been valued and cherished by both United States
and China. However, recent events have forced China to make Europe the centerpiece of its
export plans. The United States still leads Europe by a large margin when it comes to volume of
trade with China. However, given Beijing’s relentless efforts, this situation may not sustain for
very long.
Chinese Inroads into Europe

China has made massive inroads into European business both on the trading as well as the
investing front. China now owns half of iconic brands like Pirelli from Italy, Fraser from
England and Volvo from Sweden! That’s information that should have made headlines!
However, somehow Chinese businesses have managed to escape the prying media eyes as the
have increased their investment several folds.

On the trading front as well, the progress has been remarkable. Chinese exports to the
European Union have multiplied in value close to 11 times since 1995. At the same time, they
have also increased their imports a whopping 8 times. Overall, China is exporting more to
Europe than the other way round. A massive trade deficit has already been created, and the
situation is somewhat akin to the US-China relations. The Chinese premier once jokingly
mentioned that every third container that arrives in Germany comes from China. Angela Merkel
also stated that Germany is responsible for over half of European Union’s exports to China!

China and Germany are the two largest manufacturers and exports of the world. Their trade
union is nothing less than formidable and therefore likely to dislodge America as the dominant
economic force in the world.

Why Europe ?

There could be several reasons for the Chinese foray into Europe. Some of them are as follows:

 Europe is a part of the same contiguous landmark as China i.e. Eurasia. This land mass is
home to 5 billion people i.e. over 75% of the world’s population. If properly developed,
this could be the largest market the world has ever seen. China wants to use its
geographical advantage to become the dominant power in the region.
  Politically, United States has been mentioning China as an adversary. The Chinese are
aware that the United States population is looking at alternatives. The narratives spelled
out by both Trump and Hillary seem to be anti-China to varying degrees. The Chinese
therefore know that it is only a matter of time before the trade relation is disrupted and it
would, therefore, be a prudent decision to diversify.
 Also, United States economy is seen as increasingly volatile, even inching towards
bankruptcy. China is forced to buy treasury bills to keep the United States afloat. This is
because if the United States goes bust, so do Chinese businesses! To stop this money
drain and forced bailouts, China could have decided to expand into Europe in a big way.
 Lastly, the European Union is staring at an imminent crisis. With the entire world, except
China in a state of economic collapse, EU would need China to bail them out. This is the
reason they are also very enthusiastic about creating this very cozy relationship with
China. Like United States, they are also running out of people who are willing to buy
their debt at fair market value.

Political Motives

Of late, Chinese and Americans have had a lot of standoffs. This is particularly true in the case of
South Sea where China stakes its territorial claims. China does not want to have to choose
between economics or sovereignty. They want to be a business powerhouse but do not want to
bow down to American imperialism. The quick moves into the American economy would not
have gone unnoticed in Washington. China has relayed its message loud and clear; sovereignty
will not be compromised.

The Silk Route

China also has the advantage of an ancient route that connected it with the Europe. The route is
spread over a contiguous landmass giving China several logistical advantages. China is so
adamant on reviving this ancient route that it has offered to build infrastructure in other countries
at their own cost. The infrastructure would include high-speed roads and railways. China is
confident that it will recover its investment and make a handsome profit by selling massive
incremental quantities of goods via the silk route.

To sum it up, the past may have been all about Sino-American trade but the future is likely to be
based on Sino-European relationships which are at least equally important if not more.
Washington too has started propping up Chinese competitors like India and has made them a
centerpiece of their economic strategy. The warfare to capture the biggest share of the global
political economy has just begun, and it is about to get a lot interesting!

Trump’s Stance on Illegal Immigration

Donald Trump has been a lot in the news lately. He has specifically been in the news because of
his anti-immigration rhetoric. He categorically called Mexicans as anti-social elements and stated
that they have an adverse effect on the American society. He made these statements despite
knowing that Latin Americans form a sizable number within the voting population. This makes
one feel that the white American voters must be feeling severely threatened by Latin Americans,
otherwise, why would they elect what appears to be a racist President!

Several debates were conducted amongst experts, and almost all of them considered Donald
Trump’s decisions to be crazy when considered from a humanitarian perspective. However,
the idea that illegal immigrants were detrimental to the economy was not really rejected by
anybody. Critics were offended that Donald Trump was equating criminal elements of illegal
immigrants with a particular ethnic group. However, there is near consensus that immigrants
contribute to a lion’s share of all criminal activity, particularly towards the Southern border.

In this article, we will list down the negative effects that immigrants have on the economy
of the United States or of any economy in general.
Why Immigration Affects the Lowest Class

Illegal immigration is like inflation to some extent. It hits the lowest rung of the society first and
the hardest. The people that cross over illegally from the border are usually unskilled. This
means that they can only work low-end jobs.

Hence, the low-wage workers suddenly face a lot of competition. Also, since the illegal
immigrants are not subject to minimum wage or taxation laws, they can afford to drop their
wages lower whereas a lawful American citizen would face legal trouble if he were to do so. As
a result, the lower rung of the American society that is already in turmoil is further pushed into
even bigger troubles.

Donald Trump has also targeted high-end technology workers like the ones using the H1B
too! However, these immigrants enter the country via lawful means and they don’t actually
contribute to any crime as such. They may be taking away relatively fewer middle-class jobs, but
the true menace is actually faced by the people of lowest social strata.

How Immigration Affects the State

Illegal immigration has a huge effect on the state. The entire spectrum of cause and effects is
complex and therefore beyond the scope of this article. However, we will touch a few important
points.

 Increased Law Enforcement Spending: States like Texas, New Mexico, and Arizona
have higher crime rates than their counterparts Washington and California. This is
because the southern border of the United States is porous. This means that criminal
elements can move in and out of the United States very easily. This has created a law
enforcement nightmare in these states. Cities like Laredo, Texas have suffered heavily
because of their sister cities in Mexico. Nuevo Laredo in Mexico is the murder capital of
 the world. To prevent the spillover of this drug crime into America, the government has
to increase their spending drastically. If a wall can indeed keep these anti-social elements
out, building a wall maybe a cheaper and more effective alternative.
 Increased Entitlement Payments: As discussed earlier in this article, increased
immigration hits the lowest strata of the society first. This means that a large number of
people in lower-end jobs are unemployed. Hence, the state has to pay entitlement
payments like social security and Medicare to them. Also, this increased unemployment
further perpetuates the cycle of crime. Hence, the state loses a significant portion of its
funds to problems that can be resolved, if the immigration issue is fixed.

Who Will do Our Jobs Argument ?

There is a lobby of people who believe that the low-end jobs done by illegal immigrants can only
be done by them. The logic is that no American would want such menial jobs. Hence, the
immigrants are contributing to society by doing the work that Americans did not want to do
anyways. Therefore, if illegal immigration is curbed, it might affect the American society
somehow, since these jobs will not be done!

Nothing could be farther from the truth. There are several other countries which are developed
like the United States. In those countries, a large number of these menial jobs are automated.
This frees up the work force which can then be used for more productive purposes. The
technology for automating menial jobs is already developed and is cheap to use. The functioning
of the United States will not in any way, be affected by excluding illegal immigrants. To the
contrary, the economy is likely to get many benefits.

Verification Process

Donald Trump’s immigration policy may not be as crazy as it sounds. There are several
economic advantages to getting rid of the immigrants. More importantly, America will send a
message that the only way to stay on their shores is to come via a rigorous immigration process.
This will weed out the anti-social elements. At the same time, the hard working people that want
to add value to the American society will still be welcome on its shores!

Why India Demonetized 2 Currency Notes

By David Ashworth | Nov 22, 2016 12:49 pm EDT

Indian government’s surprise

In an address to the nation on November 8, India’s prime minister, Narendra Modi, declared that
the two highest denomination currency notes—the 500 rupee note and the 1,000 rupee note—
won’t remain legal tender. The notes were demonetized at midnight on November 8. The move
aimed to curb black money in the financial system. Black money is one of the factors holding
back the economy.

The demonetization was a surprise. Since the announcement, the media discussed the pros and
cons for consumers and the banking system (HDB) (IBN).
Lion’s share put out of circulation
According to the RBI’s (Reserve Bank of India) Annual Report for April 2015 to March 2016,
the value of the currency notes at the end of March 2016 was 16.42 trillion Indian rupees. The
500 rupee and 1,000 rupee currency notes formed 86.4% of the value. In one stroke, the
government removed 86.4% of the currency in circulation by value. In terms of volume, the
currency notes of these two denominations formed 24.4% of a total 90.27 billion pieces.

Also, RBI data showed that as of March 2016, 632,926 currency notes were counterfeit—known
as an FICN (Fake Indian Currency Note). As a proportion of NIC (Notes in Circulation), the
1,000 rupee and 500 rupee notes were the highest. Nullifying these FICNs was also part of the
demonetization move.
In this series
In this series, we’ll look at the possible impact of the demonetization on the Indian economy.
We’ll discuss what it could mean for inflation, monetary policy, and financial markets (INDA)
(PIN) (EPI). The series should help you assess what could transpire with your Indian investments
in the short to medium term.
Let’s start by looking at the broad impact that the demonetization had on the Indian economy.

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PART 2

Aftershock: Impact of Demonetization on India and Investments PART 2 OF 6

How Could Demonetization Impact the Indian Economy?

By David Ashworth | Nov 22, 2016 12:49 pm EDT

Demonetization will hit the economy

The demonetization of the 500 rupee note and the 1,000 rupee note—the two highest currency
denominations available in India—will likely hit the economy hard in the short term. The
surprise move is expected to grind the consumption activity in the Indian economy to a virtual
halt. The service sector, which dominates economic activity and involves a sizable chunk of cash
transactions, will likely be hit the hardest.
India’s economic growth
Growth in the Indian economy remained solid in the quarter from April to June 2016 (the latest
available). In India, a financial year begins in April and ends in March of the following year. The
previously mentioned quarter is the first quarter of fiscal 2016–2017. During that period, the
GDP (gross domestic product) rose 7.1%, while the GVA (gross value added) rose 7.3%. The
relationship between the GDP and GVA is:

GDP = GVA + taxes on products – subsidies on products

The base year for calculating the GVA is 2011–2012.

The fall in economic activity due to demonetization could last from two to three quarters. As a
result, GDP and GVA growth in the quarters from September to December 2016 and January to
March 2017 could be significantly lower than previous years. Some bounce back should be seen
in the first quarter of fiscal 2017–2018. In the medium term, the Indian economy can grow
considerably after curbing the debilitation caused by counterfeit money and an increase in
economic activity.

A fall in discretionary consumption will hurt companies operating in this space (TTM) (VEDL).
However, a rise in tax flow and lower interest rates, are expected to help the Indian economy
(PIN) (EPI) (INDA) grow stronger.
In the next part, we’ll discuss how demonetization could impact inflation in India.

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PART 3

Aftershock: Impact of Demonetization on India and Investments PART 3 OF 6

Will Demonetization Impact India’s Inflation?

By David Ashworth | Nov 22, 2016 12:49 pm EDT

Measures of inflation in India

The RBI (Reserve Bank of India) considers the CPI (consumer price index) as its primary gauge
of measuring inflation. Prior to the RBI adopting the CPI in India (PIN) (FINGX), another
measure of inflation—the WPI (wholesale price index)—was the key gauge of inflation and it’s
still considered for reference. To learn more about these measures of inflation, read India’s
different inflation measures—WPI versus CPI.
The RBI has CPI growth targets to adhere to while deciding its monetary policy stance. By
January 2016, it was supposed to keep inflation below a target of 6%, which it was able to do. Its
next target is to keep inflation at or below the 5% mark by March 2017.
Impact of demonetization
The demonetization that has been in effect since November 9 is expected to have a negative
impact on inflation. Consumer spending activity fell to a near halt. Consumers are refraining
from making any purchases except essential items from the consumer staples, healthcare, and
energy segments. Activity in the real estate sector, which includes a lot of cash and
undocumented transactions, slowed down significantly, Metropolitan and Tier 1 cities
reported up to a 30% fall in house prices.

Food item inflation, measured by changes in the Consumer Food Price Index, accounts for
47.3% of the overall CPI. Due to 86.4% of the value of the currency notes in circulation going
out of the financial system and re-monetization being slow, the supply and demand of food items
fell. It will exert more downward pressure on inflation.

Investors in India-focused funds (EPI) (WAINX) should continue to monitor CPI inflation. It
will determine future rate cuts by the RBI. A change in the repo rate will impact interest rate–
sensitive sectors and industries like financials (HDB) (IBN) and automobiles (TTM), among
other sectors like the tech (WIT) (INFY) sector.
In the next part, we’ll discuss how demonetization could impact India’s monetary policy

The Demonetization

Event Update

The move by the government to demonetize Rs.500 and Rs.1000 notes by replacing them with
new Rs.500 and Rs.2000 notes has taken the country with surprise. The move by the government
is to tackle the menace of black money, corruption, terror funding and fake currency. From a
market perspective, we think that this is a very welcome move by the government and which has
taken the black money hoarders with surprise. The total value of old Rs.500 and Rs.1000 notes in
the circulation is to the tune of Rs.14.2 trillion, which is about 85% of the total value of currency
in circulation. This means that the total cash has to now pass though the formal banking channels
to get legitimacy.

The World Bank in July, 2010 estimated the size of the shadow economy for India at 20.7% of
the Gross Domestic Product (GDP) in 1999 and rising to 23.2% in 2007. Assuming that this
figure has not risen since then (quite unlikely though) and that the cash component of the shadow
economy is also proportional (it could be higher), the estimated unaccounted value of the
currency could be to the tune of Rs.3.3 trillion. Now, post the announcement of demonetization
by the government this money would have to either account for by paying the relevant tax and
penalties or would get extinguished. There are higher chances of larger proportion of this
unaccounted currency getting extinguished as the tax rate and subsequent legal issues could be
prohibitively high for such money.

The positive macro benefits of this move by the government

This move by the government is likely to have long term benefits for the economy. The
extinguishing of the major proportion of unaccounted currency would reduce from the liabilities
of the government and would add to its finances. This can have very strong implication as the
government would get money to spend without borrowing from the market. This would mean
that while interest rates can be low, the government spending on large infrastructure (we assume
that the government would use large proportion for infra spending) projects would kick start
capex cycle and push economic growth higher in the medium term. The move is also likely to
have a habit changing impact in the Indian populous and there could be increased belief of
keeping cash in the banks rather than stashed at home and use formal banking channels for their
spending needs. With a large part of the cash moving through the banking channels, the banking
sector is likely to be flush with funds in the near term and this would help them reduce cost of
funds for such period. Also with more money being kept in the banking channel, some of these
low cost deposits may be sticky and improve the medium to long term Current Account and
Savings Account (CASA) ratio of the banks. Another element of the demonetization would be
reduction in cash transactions in real estate. This is likely to reduce to real estate prices and make
it affordable to some extent. This may be visible more in the rural belt, where many non-farming
entities purchase fertile farmland, not for farming but for money parking purpose.

The demonetisation and consequent reduction in shadow economy would bring the demand for
such farm lands down. This move is likely to lead to better tax compliance, raise the Tax to GDP
ratio and improved tax collection. This could lead to lower borrowing and better fiscal
management. Also with lower cash transactions in the near term, inflation may see downtrend in
the near term. Also with higher tax to GDP ratio, the government may also get enough headroom
to reduce the income tax rates, which can lead to higher disposable income with people and can
improve consumption demand in the medium to long term.
 However there could be near term challenges

In the immediate term, the reduced ability of the unorganized sector to deal in cash would impact
the demand. Consumption items which had large element of cash dealing involved may see
lower demand. Real estate and allied sectors may see near term to medium term negative impact.
This HDFC Bank Investment Advisory Group may also lead to corporate earnings getting
impacted in Q3FY17, as a large part of the old currency gets extinguished and takes time for
fresh money to come into circulation.

We will see some of the impacts of demonetization on the following:

 Equities
 Debt
 Various Asset classes
(Gold, Bonds, Real Estate)
 Overall Economic Impact
(Immediate and over the time)

EQUITIES

The day after the demonetisation move was announced and Trump won the USpresidency, the
BSE Sensex opened with a massive loss of 1,300 points, butrecovered later. It rallied on 10
November and reported net gains for these twodays of trading, only to tank 700 points the next
day. Should you be worried?“The global unfolding of these two events and the market jitters
created by thempresents a value buying opportunity,” says Dhananjay Sinha, Head,
InstitutionalResearch, Emkay Global. However, the impact of these events is not over
andinvestors shouldn’t ignore them. “The ripple effects of demonetisation cannot beunderstated.
There are major industries in India that thrive on a paralleleconomy funded by black money,”
says Ritesh Jain, CIO, Tata Mutual Fund.Though the government is exchanging old notes with
the new ones, it will stillsqueeze the currency circulation in the shortterm. “There may be a
negativeimpact on the GDP in the Oct– Dec quarter, as consumption shock getstransmitted into
the system. Some rupee appreciation in the forex markets isalso expected as notes in circulation
will decrease,” says Anis Chakravarty,Lead Economist, Deloitte India. If the RBI and the
government don’t step in toease the liquidity situation, our exportoriented sectors may suffer.

Let’s take a closer look at specific sectors, starting with real estate. It is best toavoid realty stocks
as the sector will be among the worst affected by thedemonetisation move. The housing finance
sector, consequentially, will also beunder pressure. “Housing finance companies are likely to
witness some stresson loans given to real estate developers who are likely to face a liquidity
crunchin the short term.

Since most of the cash in circulation now will be converted to bank deposits,banks will be the
biggest beneficiaries of the demonetisation move. “We expectbanks to benefit because of more
deposits, especially lowcost deposits,” saysRao. Though all banks will benefit from this,
investors should focus on bankssuch as HDFC, ICICI that are strong on technology and can
leverage theongoing changes to their advantage.

DEBT

With the rupee remaining relatively stable, the debt market has reacted positively to both
Trump’s victory and the demonetization move.“Bond prices may remain elevated as the flight to
safety would continue,” says Sharma. This is because of the deflationary impact of
demonetization. “We arelikely to see some decline in inflationary pressures as demand comes
down inthe short term,” says Anis Chakravarty, Lead Economist, Deloitte India. “This will also
keep prices in check as the ability to hoard commodities and otherassets will be greatly reduced,”
says Murthy Nagarajan, Head, Fixed Income,Quantum Mutual Fund. Improvement in
government finances due to shift of theblack economy to white—increased tax compliance and
better revenues forgovernment— is another positive aspect. The debt market has also
startedexpecting further rate cuts, which, again, is good news for debt investors. “Withthe
household inflation expectations coming down, the possibility of rate cuts isincreasing,” says
Chakravarty. Experts expect a 5075 basis points rate cut inthe next 69 months.

Various Asset Class

a.Bond prices will rise as interest rates drop.

b.Real Estate is expected to fall by around 20 -25 % and stabilize thereafter.

c.Effect onGold is a bit uncertain, and may be neutral/ negative. Lower black money will
depress demand, but at the same time Gold is a hedge against uncertainty and those still wanting
to park black money may prefer to put it into Gold instead of cash.
d.Equity is expected to benefit the most due to three reasons. One, there will be a gradual shift
from physical assets (real estate/ Gold) to financial assets. Two, the organised sector (corporates,
especially listed ones) will benefit due to less cash transactions. Lastly, lower inflation and
interest rates will benefit listed corporates through lower borrowing costs, thereby increasing
their profitability and valuations.

Thus Asset Allocation and re balancing thereof will now play an even more important role,
making proper financial planning imperative.
 Overall Economic Impact

a. GDP growth is expected to be negative for around 6 months. However subsequent 2 years
will see sharp “hockey stick” revival in growth.

b. Inflation is expected to fall sharply with fall in Real Estate prices and transaction costs
thereof.

c.Government Deficit will see a huge windfall in the next 2 years.

d. Currency is expected to strengthen as inflation drops and economy gets a boost.

e. Banking System will get a boost, as around Rs 7-8 lakh crores base money (new legal money)
will enter the system, which will further create around 3-4 times more money due to re-
circulation.

f. Real Estate and Jewellery sectors, though battered initially will stabilize in the next 6
months.

Immediate impact: is expected to be negative all round:

 In the short term it will be a logistical nightmare to manage the cash replacement in banks
and smooth functioning of the banking system

 Slowdown in consumer spending due to limited cash availability

 Severe liquidity issues in cash based sectors like Real Estate and Jewellery

 GDP will decline in the next 2 quarters due to reduction in overall spending
 Other Impacts

 Effect on parallel economy The removal of these 500 and 1000 notes and replacement of the
same with new 500 and 2000 Rupee Notes is expected to - remove black money from the
economy as they will be blocked since the owners will not be in a position to deposit the
same in the banks, - Temporarily stall the circulation of large volume of counterfeit currency
and - curb the funding for anti-social elements like smuggling, terrorism, espionage, etc.

 Effect on Money Supply With the older 500 and 1000 Rupees notes being scrapped, until the
new 500 and 2000 Rupees notes get widely circulated in the market, money supply is
expected to reduce in the short run. To the extent that black money (which is not counterfeit)
does not re-enter the system, reserve money and hence money supply will decrease
permanently. However gradually as the new notes get circulated in the market and the
mismatch gets corrected, money supply will pick up.

 Effect on various economic entities with cash transaction lowering in the short run, until
the new notes are spread widely into circulation, certain sections of the society could face
short term disruptions in facilitation of their transactions. These sections are:  Agriculture
and related sector  Small traders  SME  Services Sector  Households  Political Parties 
Professionals like doctor, carpenter, utility service providers, etc.  Retail outlets

 Effect on Online Transactions and alternative modes of payment: With cash transactions
facing a reduction, alternative forms of payment will see a surge in demand. Digital
transaction systems, E wallets and apps, online transactions using E banking, usage of Plastic
money (Debit and Credit Cards), etc. will definitely see substantial increase in demand. This
should eventually lead to strengthening of such systems and the infrastructure required.
 Views

From an equity market perspective, this move would be positive for sectors like Banking and
Infrastructure in the medium to long term. This could be negative for sectors like Consumer
Durables, Luxury items, Gems and Jewellery, Real Estate and allied sectors, in the near to
medium term. This move can lead to improved tax compliance, better fiscal balance, lower
inflation, lower corruption, complete elimination of fake currency and another stepping stone for
sustained economic growth in the longer term.

 In spite of the initial hiccups and disruptions in the system, eventually this change will be
well assimilated and will prove positive for the economy in the long run.
 Black money hoarders will definitely lose out, eventually boosting the formal economy in the
long run.
 Short term fall in real estate prices might benefit middle class citizens.
 This move by the Government along with the implementation of the GST will eventually
make the system more accountable and efficient.
 REVIEW OF LITERATURE

Demonetization in 1946 and 1978: Stories from the past

Prior to last week’s announcement by Prime Minister Narendra Modi that high denomination
notes would stop being legal tender from 9th November, there were two similar instances in
India.

The first instance was in 1946 and the second in 1978 when an ordinance was promulgated to
phase out notes with denomination of Rs 1,000, Rs 5,000 and Rs 10,000.

The media in terms of numbers was limited in 1946 and 1978 when compared to 2016. But given
the importance of the decisions, it did trigger coverage.

Newspaper and magazine archives of the 1946 decision do not seem to be available online.
Therefore, I relied on Reserve Bank of India commissioned history of India’s central bank to get
an idea of how a stakeholder perceived the decision.

The following extract of RBI’s history volume is sourced from “Mostly Economics,” a blog on
economic developments in India.

According to RBI’s relevant volume:

“Sir Chintaman Deshmukh (governor) felt that we may not get even as much as Rs. 10 crores
as additional tax revenue from tax evasion and that the contemplated measure, if designed
to achieve such a purpose, has no precedent or parallel anywhere. If value is going to be paid
for value (no matter whether such value is in lower denomination notes), it is not going
to obliterate black markets. His advice is that we should think very seriously if for the object
in view (as he deduces from the declaration form) whether this is an opportune time to proceed
with the scheme. Provided Government are satisfied on the points of (i) sparing harassment to
the unoffending holders and (ii) a worthwhile minimum of results in the shape of extra
tax revenue, he does not wish to object to the scheme as drafted, if Government wish to
proceed with it notwithstanding the administrative difficulties involved.”

It was not the first time an RBI governor was skeptical of government’s move to strip currency of
legal tender characteristic at short notice.

In 1978, when Janata government proclaimed an ordinance, some of the media coverage of the
development was available online.

A Times of India report (sourced in-house) published on 17th January 1978 said:
“A press note issued tonight said that the ordinance had been promulgated because there was
reason to think that high-denomination notes were facilitating the illegal transfer of money for
financing transactions which are harmful to the national economy or which are for illegal
purposes. There has been concern in recent months over the behaviour of agricultural prices
particularly of edible oils. In spite of a bumper harvest agricultural prices are ruling much
higher than after the poor harvest of 1976- 77. Massive imports of edible oil have failed to bring
down prices and the mustard oil price control order has failed miserably to give the consumer
his requirements at the specified rate. There has been a feeling that a considerable amount of
black money has gone to finance hoarding and speculation. The demonetisation of high
denomination currency notes will hit black money hard.”

An analysis of the move was written by Jay Dubashi in one of India Today’s February
editions. Dubashi reported that the ordinance had a ripple effect on other markets such as gold
and diamond where prices slumped by 5 to 10% within a week. In addition, the old notes were
going at 70% discount in Bombay’s Zaveri Bazar.

In his report, Dubashi wrote:

“Politics apart, the demonetization is unlikely to curb black money in circulation, for the simple
reason that no one really knows how much black money there is in circulation and, even more
important, whether black money can really be defined in precise terms in all its shades.”
I.G Patel was governor of RBI when the ordinance was promulgated in 1978. He was not happy
about the government move.

COUNTRIES WHO TRIED DEMONITIZATION IN THE PAST

With the ban of Rs.500 and Rs.1000 currency and introduction of new notes, India is coping
with demonetisation. The measure isn’t new, however, as several other countries have
embraced it in the past. Some met the purposes, whereas some failed miserably.
Here are eight countries that tried demonetisation before India...
.
1. Nigeria
During the government of Muhammadu Buhari in 1984, Nigeria introduced new
currency and banned the old notes. However, the debt -ridden and inflation hit
country did not take the change well and the economy collapsed.
2. Ghana
In 1982, Ghana ditched their 50 cedis note to tackle tax evasion and empty excess
liquidity. This made the people of the country support the black market and they
started investing in physical assets which obviously made the economy weak.
3. Pakistan
From December 2016, Pakistan will phase out the old notes as it will bring in new
designs. Pakistan legally issued the tender a year and a half back, and therefore, the
citizens had time to exchange the old notes and get newly designed notes.
4. Zimbabwe
Zimbabwe used to have $100,000,000,000,000 note. Yes, a one hundred trillion dollar
note! The Zimbabwean economy went for a toss when President Robert Mugabe issued
edicts to ban inflation through laughable value notes. After demonetisation, the value
of trillion dollars dropped to $0.5 dollar and were also put up on eBay.
POSTIVE AND NEGATIVE OUTCOME FOR DEMONITIZATION IN DIFFERENT
SECTOR

The impact of the government’s move to eliminate current high-value currency notes on FMCG
(fast moving consumer goods) companies can be seen in two parts. One is on the distribution
channel as small retailers—who make up the bulk of sales—mostly deal in cash. While
consumers will recover relatively quickly as the new currency notes become available, trade
channels may take a few weeks as their transactions will be of higher value. If their purchases
decline, that will affect sales growth reported by companies.

The second impact is at the consumer level if the move causes a liquidity crunch. Consumer
staples may not see a sizeable impact, though some down-trading to lower value packs may be
seen.

Discretionary consumption may see some impact as consumers with a liquidity crunch may
become choosy on where they spend.

The current quarter may, therefore, show some impact of this development on sales growth of
companies. This comes even as some pockets of revival in growth are becoming visible. If the
rural economy revives as expected, then the headwinds from the government’s move will be
easier to manage. Even otherwise, it does not appear as if FMCG companies will face any lasting
impact because of this decision. Even then, the BSE FMCG index was down by 2.1% on
Wednesday.

The fast-moving consumer goods (FMCG) sector is expected to fully recover from the hit taken
post-demonetization by the end of this fiscal, MD, Godrej Consumer Products Ltd
(GCPL), Vivek Gambhir said on Wednesday.
“We are pleasantly surprised by how things are recovering. Our expectation is that in 4-6 weeks
the FMCG industry should get back to full normalcy. By end of fourth quarter there will be full
recovery,” Gambhir said in an interview with BTVi.
As lot of us saw that post the announcement of demonetization, few weeks after November 8
were very bad. But pace of normalcy was positive in December. Things are trending in right
direction,” he added.

In December the company postponed spending, but intends to increase it in Q4 to back all its
products, Gambhir said.

“The biggest slowdown has been in the rural sector. On back of good monsoon, there was hope
of rural demand picking up, which got derailed due to demonetization. But our hope is that it will
soon pick up,” he added.

As a positive effect of demonetization, there is a move towards formal economy and organised
national players, Gambhir said.

“Regional players, who are not organised, will find it increasingly challenged. And with Goods
and Services Tax (GST) it will become more difficult for them to evade indirect tax,” he added.

Generally across the board, when consumers are constrained for cash, it affects the demand. “But
pick-up in demand starts positive impact. Our hope is that we will see benefits sooner,” Gambhir
said.

He said that though the modern trade has done well post-demonetization but it cannot
compensate for the wholesaler channel that thrives on cash.
South and west India have been more resilient, but impact is more on eastern India, that is
wholesale-driven and driven by cash, he said.

“But for wholesale as well the expectation is that things should return to normal in 4-6 weeks.
For us 40 per cent dependency is on the wholesalers,” he added.

On GST, he said that though the April 1, 2017, deadline seems difficult at this stage, hopes are
there that it will get passed by September 16 next year.

EFFECT OF DEMONITIZATION IN FMCG SECTOR

Aimed at curbing black money, demonetization has taken a toll on India’s FMCG sector. After a
good monsoon this year, traders believed that the winter would be better than ever. However
Modi’s decision to demonetize old notes of higher denomination has dipped the sales by 1-1.5%
or Rs 3,840 crore in November, as compared to October.

"While 1¬1.5% net impact of demonetisation does not look huge, considering the size of the
FMCG industry at Rs 2.56 lakh crore, this is a large drop in terms of absolute value," said
Nielsen.

Data revealed also shows that retailers across the country are stocking less goods that earlier.

Purchase of personal care items such as toilet soaps, toothpaste and shampoo has seen the
steepest decline by retailers. The fall in off-take is driven by urban India (-3.1% Nov vs Oct),
while rural India has managed to stay flat at 0.4% mainly due to smaller packs, smaller currency
transactions and a flourishing barter system. However chemists were relieved of this because
they were allowed to take old notes and grew better in rural India
 How demonetization will impact top six sectors of economy
In a historic move, the Modi government decided to cancel the legal tender of Rs 500 and Rs
1000 notes in a bid to curb and eliminate black money and counterfeiting, which is also likely to
impact various sectors of the economy.
In a historic move, the Modi government decided to cancel the legal tender of Rs 500 and Rs
1000 notes in a bid to curb and eliminate black money and counterfeiting, which is also likely to
impact various sectors of the economy. There are short-term implications for cash-intensive
sectors such as real estate, construction, and consumption. However, in the medium term,
benefits through higher government spending, better transmission, greater financial inclusion and
movement of household savings from physical to financial would be beneficial for boosting
potential growth, says a recent research report by YES Securities.
Here we are taking a look at how demonetization will impact the top six sectors of the nation’s
economy:
Agri and related sectors:
The sector typically sees high cash transactions and therefore near-term impact could be seen till
liquidity is infused in the rural areas. As farmers face a temporary shortage of cash in hand, it
could lead to a delay in payment which in turn would hurt the related companies in the short
term. As liquidity eases and cashless transactions gain acceptance, the fundamentals would be
driven by the longer term drivers of normal monsoons and positive traction in acreage.
Autos & Auto Ancillaries:
Two Wheelers: Clampdown on cash transactions and temporary cash crunch could hurt
purchases particularly in the economy segment of the two wheeler space where the percentage of
cash transactions have been high. However, as companies learn to work around it, demand may
pick up by overall growth in consumption on the rural as well as the urban side.
Passenger Vehicles: The seasonal slowdown seen during November and December months could
get more pronounced as consumers delay purchases due to temporary liquidity crunch and
expectations of rate cuts. However, as most passenger vehicles are financed through loans, the
blip would be temporary and demand may recover on the back of growth in demand in rural and
urban areas as well as trickle down benefit of the 7th Pay Commission Payouts.
Commercial Vehicles: Slackness in the economy on account of demonetization could have a
negative impact on the commercial vehicle volumes which have been under pressure in recent
times. However, this slowdown may be short lived and demand may pick up, led by pre-buying
in response to the changes in emission norms as well as a pickup in overall economic activity.
Consumption-related sectors like consumer durables, FMCG, etc.
The outlook is near-term negative as cash sales account for a significant chunk of sales for
companies in these sectors. As customers and companies migrate to the cashless platforms,
demand should come back making demonetization near term neutral. In the long term, demand
may shift from the unorganized players to the organized players.
Real Estate:
Land parcels are usually paid for in cash. With restrictions on cash transactions, land prices
would fall, extent of which would depend on the concentration of players in the subject market.
Cities/Areas where speculative buying (or buying for investment) is high could see demand
come under pressure.
As smaller/unorganized players get affected, demand for real estate may decline.
Developers could see cash crunch.
Long term: As prices correct, the market could see an expansion in terms of demand as
affordability increases. Increase in transparency, lower incidence of speculation should would
lead to an entry of genuine buyers which could help drive long-term growth in the sector.
Building Materials, Metals, Cement, etc.
These sectors could see a slowdown in near-term demand due to their high dependence on real
estate. Slowdown would be more pronounced for unorganized players wherein cash transactions
are higher.
Over time as demand for real estate improves, we would see growth come back for these sectors
as well. Organized players would also see an expansion in market share on the back of the shift
in demand from the unorganized to organized.
BFSI:
Banks: A rise in deposit base will allow banks to lower the blended cost of funds as higher
CASA deposits help to replace the high cost of borrowing and lower overall cost of funds. The
new regime of MCLR will immediately take into account the lower cost and will thereby lead to
a decline in lending rates and improved transmission.
Digital wallet providers and payment banks would benefit from increased focus on cash less
transactions both in terms of volumes as well as in terms of value.
NBFCs: In the short term there would be a negative impact on NBFCs that make disbursements
in cash and/or do most of their collections in cash. These include gold financing companies,
microfinance institutions, etc. However, as these companies migrate to the cashless business
models, the pain would ease off.
NBFC lending against property (LAP): This is the segment that could face severe pressure in the
near to medium term as fall in property prices combined with longer time for liquidating
property could put add pressure on the financers in this segment.
 RESEARCH METHODOLOGY

The survey technique is intended to secure one or more items of information from a
sample of respondents who are representatives of a larger group. The information is recorded on
a form known as questionnaire. As data are gathered by asking questions from persons who are
believed to have desired information, the method is known as questionnaire technique.

REASONS FOR WIDE USE OF THIS METHOD:

 It can secure both quantitative and qualitative information directly from the respondents.
 It is the only method of directly measuring attitudes and motivations.
 It is quite flexible in terms of the types of data to be saaembled, the method of collection
or the timing of research.

Meaning of Research

According to D. Slessinger and M. Stephenson in the Encyclopedia of social sciences

define research as “the manipulation of things, concepts or symbols for the purpose of
generalizing to extend, correct or verify knowledge, whether that knowledge aids in construction
of theory or in the practice of an art”.

TYPES OF RESEARCH

1. Exploratory Research,
2. Descriptive Research.

Exploratory Research:

Exploratory research studies are also termed as formulate research studies. The main
purpose of such studies in that of formulating a problem for more precise investigation or of
developing the working hypothesis forms an operational point of view.
 DATA ANALYSIS

How demonetisation affected the Indian economy, in 10 charts

A year ago, Prime Minister Narendra Modi announced the scrapping of high-value banknotes
which amounted to 86% of currency in circulation. The demonetisation of currency notes was
supposed to be an attack on black money, on counterfeit notes, and projected as part of a broader
push to promote digitization and non-cash payments. A year later, progress on all these counts
appears to be very modest, and should make us question whether this exercise was needed at all
to fulfil its stated aims.

The costs imposed by the currency-scrapping exercise were, however, quite severe, at least in the
short term, disrupting ordinary life across the country for several weeks. The hardest-hit were
those in rural areas, where access to banking and the internet are quite low. A 2016 Reserve
Bank of India (RBI) report on branch authorization policy classified 93% of rural centres in the
country as unbanked, with the population dependent on roving banking correspondents and on
distant urban or semi-urban branches. Access to the internet is equally patchy, with only 3% of
households in underdeveloped rural areas reporting access to internet in a 2016 consumer
economy survey.
Click here for enlarge

Economic costs

The rural and informal economy suffered disproportionately because most transactions are cash-
based. The liquidity squeeze led to a pile-up at wholesale markets, leading to a sharp decline in
the Wholesale Price Index (WPI) of perishables such as fruits and vegetables in the immediate
aftermath of demonetisation. By turning farm markets into buyers’ markets, demonetisation may
have also contributed to the decline in prices of pulses. Rural consumer sentiment too took a hit,
with domestic sales of two-wheelers plunging sharply. Car sales also declined but the decline
was less severe than in the case of two-wheelers.

The slowdown in the economy, which started before demonetisation, also seems to have been
exacerbated by demonetisation. New project announcements declined sharply in the wake of
demonetisation, a Centre for Monitoring Indian Economy (CMIE) analysis showed, hurting the
capex cycle.

Contrary to what some economists predicted, the dividend from RBI to the government was
lower because of demonetisation. RBI’s domestic earnings declined as it had to pay interest of
Rs17,426 crore after it mopped up excess liquidity in the banking system following
demonetisation. The previous year, the central bank had earned interest of Rs506 crore in its
liquidity management operations. RBI’s printing costs also went up because of the move.

Uncertain benefits

The one big promise of demonetisation was a rapid expansion in the tax base but the actual
results have been quite modest. According to the finance ministry’s estimates published in the
latest Economic Survey, the tax base expansion attributable to demonetisation was Rs10,600
crore, lower than what RBI spent on interest expenses, and equivalent to only 0.1% of India’s
gross domestic product (GDP). The full effect on tax collections “will materialize gradually” as
reported income of new taxpayers grows, said the survey. How far such gains materialize
remains to be seen.
Another stated aim of demonetisation was to detect and eliminate counterfeit notes. The growth
in detected counterfeit notes after demonetisation has not been unusually large, shows RBI data,
even as counterfeits of the freshly issued notes have already emerged in the system.

Demonetisation did provide a boost to non-cash payments in the short term but that effect may
be waning, with the cash-to-GDP ratio back to double-digits. There seems to have been some
impact on the stock of black money (rather than the flow), given that the construction sector
has been hit hard. But this may also have led to large-scale job losses. The proportion of high-
value notes (Rs500 and above)—often viewed as conduits of black money—has also been rising
as new notes have entered the system. At the end of fiscal year 2017 (FY17), the proportion of
high-value notes stood at 74%, considerably lower than that in FY16. But this figure may rise
significantly by the end of FY18.

Money supply growth may decline by 3%

The average growth of money supply in the economy may slip to 9 per cent from 12 per cent in
the near term, if 25-30 per cent of unaccounted currency does not flow back into the banking
system post demonetisation move, Dun & Bradstreet said in a report.
On the “basis of the result of the demonetisation that took place in 1978; if 25-30 per cent of
unaccounted undeclared money does not come back in the system that is Rs 3.5 trillion to Rs 4.3
trillion, it will impact growth in money supply by about 3 per cent,” the report said.
“Considering the average growth of money supply for last three years which is around 12 per
cent, growth in money supply might moderate to an estimated 9 per cent in near term,” it added.
However, it noted that in the case the RBI decides to print the entire 86 per cent of the high
denomination notes, money supply will pick up with the new notes being gradually circulated
over a period of time.
On the evening of November 8, the government announced that Rs 500 and Rs 1,000 notes
would no longer be legal tender, as part of its move to eradicate black money.
As per D&B, while demonetisation would cause short term pain across the board, it is largely
anticipated to have far reaching impact on the Indian economy in the mid to long term.
“In sync with the Digital India initiative, these measures would accelerate the move towards a
cashless economy. Along with GST, this measure would improve tax compliance and fiscal
balance of the government,” the report said.
Noting that the move sends out a positive signal to global investors, D&B said it may help India
climb the rank of various indices published by international agencies such as the corruption
perceptions index.
The efforts taken by the government to eradicate black money over the past two and a half years
include formation of a special investigation team, law passed in 2015 on disclosure of foreign
bank accounts, levy of strict rules to curtail benami transactions in 2016, and scheme to declare
black money in 2016.

Will demonetization adversely impact GDP growth?

New Delhi: The government’s move to suck out 86% value of money in circulation by
demonetizing Rs.500 and Rs.1,000 currency notes will adversely impact India’s economic
growth, at least in the short run, fear some economists. Some others, however, maintain that the
demonetization move, taken to weed out black money and counterfeit notes in circulation, will
have little effect on the economy.

Former chief statistician of India Pronab Sen said with 86% of value of money in circulation, the
economy will have to make do with only 14% of money in circulation at least for two weeks,
until when there are restrictions on withdrawing money.

The government has announced that withdrawal through ATMs will be limited to Rs.2,000 per
day up to 18 November and Rs.4,000 per day thereafter. Cash withdrawal from one’s bank
account is also limited to Rs.10,000 per day and Rs.20,000 per week till 24 November.

Scrapping Rs500, Rs1,000 currency notes was in the works in secret for 6 months

Sen said this will impact a large number of cash transactions which will have a multiplier effect
on the economy. “If I am not going to able to sell, I am not going to buy from my supplier which
will kickstart a chain reaction. So even if the first round impact of lower money circulation may
not have a large impact, the chain effect will be large,” he added.

Sen said it is the informal sector accounting for around 40% of the economy which will be
impacted the most, especially in rural India. “This is likely to reduce GDP growth by one
percentage point this year (2016-17),” Sen warned.

GDP growth in the first quarter (April-June) slowed down to 7.1% from 7.5% during the same
quarter a year ago and the slowdown is attributed to increase in subsidy payments by 53% which
resulted in lower growth in indirect taxes. The government expects the GDP to grow at 8% in
2016-17 on the back of a bumper farm production due to normal monsoon.

Sen said the situation could have been better handled by giving a longer period of time to phase
out high-value currency notes instead of making them invalid overnight. “The impact in rural
India will be much more due to the sheer logistical difficulty for banks to reach out to depositors.
It will also impact urban poor who depend on daily wages,” he added.

N.R. Bhanumurthy, professor at the National Institute of Public Finance and Policy, said a
decline in money supply will directly impact growth in the short run using the quantity theory of
money.“If all the money sucked out of the economy does not come back which is likely due to
the existence of black money, then it will directly impact growth in the short run. The extent of
its impact on growth will depend on the size of unaccounted money in the economy,” he added.

Also read: Demonetization to give major push to e-wallets, payments through UPI

Current chief statistician of India T.C.A. Ananth, however, said the disruption due to
demonetization in the economy is unlikely to be significant. “The rural economy has changed a
lot compared to what it is used to be 30-40 years ago. It is only a transitory phenomenon of
shifting from one currency to the other and is unlikely to have any significant impact on the
economy,” he added.

Finance minister Arun Jaitley, responding to a question at a press conference on Wednesday,

ruled out any short-term impact of demonetization on growth, holding that it will rather benefit
growth in the long run because “all this will impact the size of the GDP itself because more
transaction that were happening outside the (formal) economy will get into the economy itself”.

However, both Sen and Bhanumurthy said demonetization will bring down inflation in the
economy, though for different reasons.

Sen said lower money supply will lead to a deflationary situation with too little money chasing
too many goods. Bhanumurthy, on the other hand, said demonetization will play a positive role
in curbing inflation in the medium term due to lower money supply as unaccounted money used
in sectors like real estate and higher education will be taken out of the system

Will demonetization slow down India's growth?

1.The prime motivation for this move was “black money”. Yes. People holding black money are
scared and devastated with what are they even supposed to do with what is ‘potentially zero’
value now. This leads them with two options : Either they can declare it or they can’t.

If they don't want to declare it, they will either resort to measure involves distributing this
money. This may reduce the money under circulation as they may also have to pull out
unaccounted wealth. Less money under circulation will lead to deflation. Now any sane
person would probably end up doing charity or something of that sort.

If they want to convert it to white money, they will end up paying more tax and government will
have more money under radar and as a result the government will have more money in hand and
hence can do something good of it which will help in the long run.

2. Inflation Reduction. This demonetization also strike directly on the fake currency racket.
This move will decrease the fake currency under circulation. Suppose I have Rs.1000Rs fake and
I want to buy certain thing and its cost is Rs.500. It wont matter to me if I pay Rs.500 or Rs.1000
for it. So fake money in a way boosted inflation. Absence of it might lead to deflation. Deflation
will increase the value of the currency and pave for the nation’s growth.

3.Terrorism. Fake money was also a reason for terrorism as PM pointed out fake money being
used buying weapons by the terrorist. This will help terrorism to a certain extent.
4.Curbing Corruption. Elections are mostly funded by black money. Reduction in black money
will lead to less rigged election .Ergo there will be fair election and suitable candidates will win.
Fair election will therefore help nation progress won’t it?

How DEMONITIZATION WILL EFFECT INFLATION

Inflation can be classified on the basis of demand and supply. There are two points to be
considered. One is demand for and supply of money or demand pull and the second is demand
for and supply of goods and services or cost push.

Let us examine first demand for and supply of money. It is said that about ₹14000 crores of
money were in circulation in the denomination of ₹500/₹1000. Now these notes are withdrawn
from circulation and will be deposited in all banks and RBI latest by 31st March 2017.

Govt will also release new notes to the market. So it is to be ascertained how much currency
supply is reduced follwing demonetisation of old currency and introduction of new notes.

Assuming demand for money remains the same and supply of money reduced, prices will come
down as people cannot demand goods and services in the absence of money. There may be
increase in e-commerce, but given the fact that 50% of people donot have bank accounts it is
unlikely that demand for cash will fall.

So prices of goods and services will fall in the absence of demand. So it is expected there will be
less inflation during next six months. As it is during busy season following harvest the
inflationary pressure is low.
The second aspect relates to demand for and supply of goods and services. It is expected that
there will be good harvest this year following a good monsoon. So supply of goods will increase.

However there may be less demand following reduction in money supply due to demonetisation.
Thus infaltionary pressure will continue to be low following demonetisation of currency.

What is the relation between demonetization and inflation?

Inflation in simple terms is the sustained increase in price levels of goods and services in an
economy over a given period of time. Inflation therefore is defined as a rate (e.g. 10%) rather
than as a quantity (Rs 100 or so). The rate indicates the percentage increase in the price of a good
or service over its earlier price point on a given date in the past. The antonym of Inflation is
Deflation (a general reduction in price of a good or service over a period of time). The rate of
Inflation itself may also increase (causing uncontrolled hyper-inflation), decrease (disinflation)
or remain constant.

What is the Cause of Inflation?

Economists study Inflation from various angles using many theories, all of which can be said to
apply equally well, since price of a good or service can rise due to various reasons such as:-

Demand-pull. A sudden increase in demand for an item. This could be due to a spurt in use of
an item due to informed choices, increase in activities requiring the use of the item, seasonal
preferences, perceived drop in prices etc…

Cost-push. A sudden decrease in supply of an item. This could be due to reduced production,
reduced demand, break in supply chain, natural disaster, loss of stock, recall of stock, hoarding
etc…

Built-in Price Increase. Increase in production cost of an item due to increase in factor (land,
labour, capital & management) and raw material cost.

But the most widely acknowledged cause of inflation is an increase in the quantity of money in
the economy, which essentially means that for a given level of output, there is more money
chasing the goods and services than was earlier available.
When economists & policy makers refer to Inflation, they relate it to Cost Price Index (CPI),
which is the overall cost of a ‘basket’ of essential (wage goods), semi-essential & allied (white
goods) commodities. On the other hand Inflation varies from individual sector to sector
depending upon the market forces at play. So while the agriculture sector may be facing
inflation, the services/ manufacturing sector may be facing a deflation although eventually cross
term effects will cause the inflation to average out across all the sectors when related to CPI.

Imagine there are two persons (A & B) in an economy each earning Rs 1,00,000/. there is a third
person C who sells houses. Considering the average demand for house in the economy is one per
person, A & B would be willing to pay a suitable price to buy a two bedroom house after
allowing for other expenses such as food, beverages, entertainment, education, travel, health &
of-course taxes to the government at 30% of emoluments which is Rs 30,000/-. per month. Let us
say that the house costs Rs 20,00,000/- and A & B plan to take a loan of Rs 10,00,000/- to buy
the house & pay an appropriate EMI on housing loan of about Rs 10,000/- per month which suits
their budget. This is an equitable condition.

Now, if there is a person D who earns Rs 1,30,000/- per month but declares only Rs 30,000/-
(which may be an exempt limit), thereby not paying any tax to the government. D will therefore
have a surplus of Rs 30,000/- per month & over the years accumulate a significant amount of
illegal money, which he cannot disclose to anyone. This money is black money. Since D cannot
disclose the money, it goes without saying that in today’s financial system he cannot deposit this
money in a bank because then it will come up for scrutiny by the tax authorities who track all
bank accounts using the PAN Number. Thus D stashes away the money in cash. But as the cash
piles up he needs to dispose it. He may use some amount on ordinarily untracked transactions
such as regular eating out, entertainment, travelling, holidays, buying consumer & luxury goods,
but these can only absorb that much cash (remember, he needs to keep a low profile too).

Meanwhile, the stash is increasing & in its present form is in any case useless to D and the
economy as a whole. So what does D do? He goes to C to buy a house on a bulk purchase &
offers to pay 25% by cheque & the balance 75% in cash to dispose off his cash in bulk. C
realises that D has illegal money & sees a business opportunity to make more money & offers
the house to D at a cost of Rs 40,00,000/- while agreeing to his terms of accepting Rs 10,00,000/-
by cheque & Rs 30,00,000/- in cash.

There will be other people like D who may have hoarded illegal cash either through tax evasion
or corruption which they cannot bring into the system. If many such people approach C or
similar builders to sell houses on part white money, part black money basis, one can imagine
how the cost of housing will be bid up. In a bid to convert their black money into white assets,
such people tend to buy up property & gold in excess of their need thereby creating an artificial
demand pull.

C has two options with the money. He may either declare the receipt of the total money on the
transaction & pays tax on it in which case the money gets back to being white & in circulation or
he may not declare it in which case he will continue to hoard it & try similar disposal on other
assets such as gold, consumer durables & even housing (this is usually the case). Either way, the
market price of housing has increased, leaving ordinary people like A & B unable to afford the
same. This is a classic case of inflation caused due to excess money in few hands in the
market. Real Estate costs in India are highly bloated due to this reason. This will also create a
culture of illegally procuring various services thereby denying them to others. For e.g. people
with black money can manage seats for their wards in colleges paying capitation fees, in turn
increasing the costs for ordinary public or even denying them the opportunity.

This still leaves a large amount of unused cash lying stashed, as black money generates black
money (for e.g., such people may rent their houses earning money that they will again not
declare). Slowly & slowly, the money is sucked out of one end of the market & hoarded at the
other end, in turn leading to a cash crunch on one end & cash surplus on the other. This
invariably affects the whole economy as costs of goods & services keep increasing on the one
hand due to excess cash & unchecked over-consumerism, creating wide gaps between the
haves & have nots.

Demonetisation.

Demonetisation, in one stroke made these stashed money redundant, forcing such hoarders of
black money to either deposit it in the banks themselves or through agents & risk tracking by the
IT authorities or just destroy it. Even allowing for all the dirty tricks that such people will
invariably try, a large part of this stashed money will just lapse & be destroyed.

Every currency is a promissory note on behalf of the government to pay the bearer a sum
equivalent to the denomination of the note. It is thus a liability of the government which will get
wiped out once the note is destroyed or not tendered.

Imagine, you purchased a car from someone & wrote a promissory note (like a cheque) in his
favour as payment of the cost of the car, which he is expected to encash at the bank. What if that
person tears away the cheque? Won’t you be relieved of your liability? You will therefore
effectively have a surplus in your hand because you have got the car as fair value for your
promissory note which however has not been encashed. Similarly, a currency note is a
promissory note that can be encashed at any place in the country.

It is said that the government had about 1570 crores of Rs 500/- notes (ie Rs 7.85 lakh crores) &
about 530 crore of Rs 1,000/- notes (ie Rs 5.30 lakh crores) total Rs 13.15 lakh crores) in
circulation in the economy. On 31 Dec 16 or latest by 31 Mar 17, when the time for depositing
old currency back will lapse, the government will take stock of all the money that has been
deposited in old notes. Any note not reverted back to the system will become a waived liability -
in effect, a surplus in the hands of the government that it can use for various welfare &
developmental activity.

The above will entail the following:-

Firstly, Rs 13.15 lakh crore rupees will be straightaway sucked out of the market.

Even taking the most conservative estimate cited by critics of demonetisation of the black
money held in cash within the economy ie 6% of the total cash, it still amounts to Rs 78,900
crores (I believe it is much more than that, but my guess is as good as anybody else’s).

After allowing for about 25% leakages in the system leading to reconversion of black money
through various subterfuges adopted by the hoarders & abetted by the common man (did you
notice the serpentine queues outside banks that suddenly shrunk when the government started
marking people with indelible ink. These were ‘Aam Garib Admi’ queuing up to exchange the
‘Amir’s’ black money. Comic irony or poetic justice), we may still estimate that about 75% ie
Rs 59,175 crores will either be recovered or destroyed.

The government has already stated that about Rs 21,000 crores have been deposited in Jan
Dhan Accounts that did not even have a single paise till now. This shows the extent of
connivance of the ‘Aam Garib Aadmi’ with the ‘Corrupt Amir’. There are statements that these
unaccounted for money will be charged tax at 60% ie about 12,600 crores in tax revenue.

Figures with respect to non-Jan Dhan Accounts are not yet available. Of the balance Rs 38,175
(ie 59,175 - 21,000), let us say about Rs 25,000 crores is destroyed which I expect will happen,
then the whole amount is surplus to the treasury.

The government may levy a similar 60% on the balance Rs 13,175 crores (38,175 -
25,000) which will again amount to about Rs 7,905 crores in additional revenue.

The balance of Rs 12.56 lakh crores (13.15 - 0.59) will be replaced over the next few months.
Since the entire money so replaced will be through banks, a majority of it will remain within the
financial system. In any case citizens are temporarily allowed only Rs 24,000/- per week till 31
Dec 16. In the meantime, more & more people are graduating to cashless system of transaction &
may in the future withdraw less & less money from the banks. Personally I expect at least
about 25 - 30% of the replaced cash, ie about Rs 3.14 to 3.77 lakh crores will move into the
financial system.

I do not expect the government to replace the lost/ destroyed currency (ie about Rs 25,000
crore) in the immediate future for two reasons:-

It will take time.

The banks are already facing very high liquidity due to the sudden influx of cash & till there is
commensurate outflow of cash from the banks, there is no point in pumping in more cash into
the market from the RBI.

It is prudent for the RBI to wait & watch the outcome of the Demonetisation on the economy
before replacing the lost/ destroyed cash.
To sum it up:-

The Indian Economy had a turnover of money of approximately Rs 15.22 lakh crores, of which
about 86.4% ie Rs 13.15 lakh crores was cash based.

This cash economy will shrink to Rs 8.85 lakhs (ie 12.56 - (0.25 destroyed + 3.46 entering
banking system).

Apart from the regular revenue collections of the year, the government will collect an additional
revenue of approx Rs 20,505 crores in direct taxes alone, which is a straight 2.74% increase in
direct taxes over & above the last fiscal’s collection of Rs 7.48 lakh crores. This is not allowing
for the prospective revenue accretion on account of many new citizens who will come under the
tax scanner.

The government has already collected, in the words of our PM himself, a further about Rs 1.25
lakh crores in direct taxes through a combination of tax raids & the Income Disclosure
Scheme.

Taken together the cash economy will further shrink to about Rs 7.40 lakh crores (ie Rs 8.85 -
(1.25 +0.20) along with a monumental accretion of about 19.39% in direct taxes collected.

I have not even taken into account the huge amounts collected by State Governments, by way of
clearance of long pending Tax dues & Utility Bills that were cleared by people almost overnight
in order to get rid of their black money. The figures in this respect are still awaited, but an early
figure revealed in papers was that about Rs 914 crores were collected in Mumbai city alone as on
21 Nov 16. Extrapolate this to the nation as a whole. This will further shrink the cash economy.

Further, a significant component of Fake Indian Currency Notes (FICN) in the market has
been completely nullified by Demonetisation, in effect reducing the cash economy even more.

Expected Outcomes

Even after allowing for reduced production on account of the temporary cash crunch we may
project that the amount of goods & services in the economy will grow by an average of at least
6% in a conservative estimate, even as the cash available has reduced by about 40%. In effect
there will be much less cash chasing the goods & services, which will definitely have an
impact of lowering the prices. One can already start to see the early effects, as Pulses which
had touched Rs 200/- per kilogram has come down to Rs 80 - 90/- per kilogram. Vegetables
are also much cheaper.
 CONCLUSION

Demonetization process is like a two faces of a coin because one side it will benefit the nation
and other side it's going to create some temporary and long term problems, we ll discuss each
side of coin one by one :

 Benefits for the nation.

1. Possible to stop counterfeit currency using for the terrorism activity.
2. Black money : by demonestation of higher currency suddenly it will take out illegally
stored money from the holders.
3. Transparency: moving towards digital economy may bring the transparency in the
system.
4. Easy monitoring: digital payment easy to monitor cash flow.
5. Less chance of avoiding the taxes.
6. Transparency in the system will bring more invest from the foreign countries.
 Drawbacks
1. Losses to small vendors trade because of cash crunch( violation of article 19 of the
Indian constitution)
2. Many people died because some hospitals not accepted old money and rejected treat
them.
3. Repeatedly changes in the rules and misleading to the people
4. Many people do not have bank accounts in rural areas and hilly areas.
5. Lots of daily basis labours removed from the work
6. Violation of article 14( between holders and non-holders)
 BIBLIOGRAPHY

Text Books

Indian economy: Albert J. Dells Bittas

Indian Economy: David L. Loudon

Principles of Marketing: Philip Kotler

Marketing Management: Philip Kotler