Effects of Demonetization in India

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Impact on Informal Economy

In our cash-based economy where close to 83 percent of transactions takes place in cash, a cash deficit is bound to have a paralyzing effect on economic activity levels in the short term. The informal sector accounts for more than 40 percent of India’s GDP and provides employment to close to 80 percent of the labor force. The developed countries have large portion of their population working in the formal sector and developing countries want their formal sector to go larger. But the sudden push may create job losses on a large scale.

The shrinkage of the informal sector is likely to result in a short-term adverse effect as the informal sector is no longer able to employ the numbers that it did. Even though the productivity of informal sector is low millions of people are depended on it for their livelihood. However, as the informal sector shrinks, the formal organized sector is likely to gain market share. Research is showing that in next two years the share of the formal economy in India could expand from 60 percent to 80 percent.

Impact on formal and informal financial institutions

As soon as the decision was announced the work load on banks increased multi-fold. Queues in banks are not dwindling after one month and their ability to keep ATM’s running is coming are coming under huge scrutiny. This has greatly affected other banking services such as loan clearances, opening of bank and Demat accounts, check collection, credit card processing, etc. With cash transactions facing a reduction online payments will see a surge in demand. We can expect a large amount of cash in circulation to be brought within the purview of the formal banking system by way of deposits which will reduce the deposit rates and loan rates.

The informal financial sector comprising moneylenders and other institutions such as nidhis, hundis, chit funds, etc. The transactional costs of these institutions are low but the repayment is high. They will have a very hard time exchanging its stock of currency (some of which may well be black money), and may indeed suffer a permanent erosion in its lending capacity. These institutions are regarded as vile by majority of but many people’s livelihood depends on the capital provided by this sector because the formal financial sector has yet failed to reach them. This will have adverse effect on the livelihoods of people depending on the informal financial sector.

Sectoral Impact of demonetization

While sectors in the unorganized economy are likely to be affected, technology and financial services are expected to gain. The commodities and agricultural sector, including the market for consumer durables and non-durables is expected to face reduction in demand. In the short to medium-term, large purchases will likely be made online purchases rather than traditional retail outlets. This will adversely impact the retail sector.

The real estate sector is already suffering from reduction in demand as prices remain high and the unsold housing units are piling up will further face downfall as the transaction are made in cash partially or fully. There is an expectation that there will be a revaluation of current real estate transactions across the board. The luxury goods market is also likely to get affected as this move represents an erosion of real wealth to many people black money or otherwise. Luxury cars, SUVs, gems, jewelry, gold and high-end branded products which are high price goods are also purchased by cash and hence will get negatively impacted

On the positive side, customers will acquire their requirements through online transactions such as net banking and paytm wallets. Businesses in the fin-tech sector, including payment banks, mobile wallets, electronic transfer providers, etc. are therefore expected to see gains.

Positively impacted

- Debit and credit Cards payment

- Mobile wallets such as paytm

- Online retail industry

- Net and payment banks

- e-marketplace

Negatively impacted

- Agriculture

- Luxury goods

- Real Estate

- Commodities

- Traditional Retail

- Consumer durables

- Consumer non-durables

Challenges in Implementation

To meet the objectives, it has set the govt requires massive efforts in the successful implementation of the demonetization. The biggest hurdle is to mint new currency to replace the old one. It is seen that this policy was done in secrecy and therefore was not known to even the top official of govt and RBI. The RBI didn’t therefore print lower denomination notes to offset some amount of cash crunch that has followed.

It has been calculated that 2200 crore notes of rs 500 and rs 2000 have become invalid. However, the current printing capacity of RBI currency presses is only 300 crores per month. Hence it would require 7 months to fully replace the old notes with new ones if all the notes are exchanged. The logistics part of bringing the notes from presses to currency chests to bank vault will be tested to the limit as printing and distributing notes. Here the 2000 rs note would allow to build the monetary value at a faster rate. The printing of currency notes on such a large scale and such short period is something that the Currency presses and distribution have never done before. Hence there will be a huge strain on govt machinery to get it done.

Secondly as the Banks were uninformed prior to taking the decision the 2.2 lac ATM’s in the country were not calibrated for the new series and size of 500 and 2000 rs notes. As of Dec 9, 95% of the ATM’s were calibrated to provide new notes but nearly all of them were running short on cash. The Tier III, tier IV cities along with the rural areas have a limited reach to banking facilities and they are the ones suffering the most. In addition, the district cooperative banks are not allowed to exchange the bank notes who are financial lifeline in rural areas. Hence the replacement of the old notes and return to normalcy through the scheduled banks in rural areas is a major challenge.

As per reports 85% of the notes have been exchanged with 20 days to go, so it fair