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Business News/ Politics / Policy/  How demonetisation impacted the Indian economy
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How demonetisation impacted the Indian economy

The negative impact of demonetisation was felt in all segments, especially in farm and industry

The RBI annual report for 2017-18 shows that almost all the banned banknotes, or 99.3% of the notes withdrawn, were returned to the central bank. Photo: MintPremium
The RBI annual report for 2017-18 shows that almost all the banned banknotes, or 99.3% of the notes withdrawn, were returned to the central bank. Photo: Mint

Mumbai: Reserve Bank of India’s (RBI’s) confirmation that most demonetised notes were returned to the central bank finally confirms the long-held suspicion that the unilateral executive decision to ban specified notes not only failed in its stated objective of flushing out hidden wealth but also ended up causing some damage to the economy. The RBI annual report for 2017-18, released on Wednesday, shows that almost all the banned banknotes, or 99.3% of the notes withdrawn, were returned to the central bank.

The government had on 8 November 2016 abruptly withdrawn currency notes of 500 and 1000 denominations without providing for adequate replenishment. All economic agents were given a limited time window to deposit their existing notes with banks and replace those with new notes. This created a huge pressure on the banking system, marked by lengthening queues outside banks for about two months.

The sudden decision had a two-fold impact on the Indian economy: an aggregate demand shock by reducing the supply of money, and, an aggregate supply shock by constraining availability of cash as a critical input for specified economic activities, such as purchase of inputs in the agriculture sector. Growth slowed down to a four-year low of 6.7%.

Kavita Chacko, senior economist with Care ratings agency, says: “Demonetisation led to disruptions in economic and industrial activity. The lower domestic GDP growth in the past two years is largely on account of demonetisation and GST implementation led turbulence."

At the same time, RBI data indicates that the desired effect of a substantial reduction in frequency of cash transactions remains largely unfulfilled.

Immediately after demonetisation (November-December 2016), sales of consumer durables and appliances slipped by 40%. The effect of demonetisation was more pronounced in Tier-II towns and beyond, generally referred to as up-country markets. The impact on the durables and appliances segment was palpable as this market still operates 80% on cash.

Schemes encouraging digital payments, special discount offers and promotions did not ease demonetisation’s impact on consumer durables market.

That year, companies in the sector were expecting a 30% growth on improved household income, backed by a good monsoon and the 7th Pay Commission. But that did not materialize.

The after-effects have also taken some time to feed through the system. In its latest Article IV Consultation report on India, released in August 2018, the International Monetary Fund (IMF) has said: “The impact on growth appears to have been more severe and longer-lasting than anticipated at the time of the 2017 Article IV Consultation with a disproportionate impact on the informal sector."

The negative impact of demonetisation was felt across the all segments of economy, especially agriculture and industry. The worst impacted were segments that relied on high-volume cash transaction, such as organized and unorganized retail. The impact was felt at both the firm level as well as at the consumer level. The IMF report quoted above also states that the disruption caused by cash shortages dampened consumer and business sentiments, leading to a decline in high-frequency consumption and production indicators, such as sales of two-wheelers and cement output, respectively.

ALSO READ | From GDP growth to black money, costs outweigh benefits of demonetisation

Praveen Khandelwal, secretary general of the Confederation of All India Traders (CAIT), said: “In the first four months after demonetisation, business was down by as much as 50% for small traders. It took about six months for the situation, currency flow and business to normalize."

Even in agriculture, demonetisation aggravated the sector’s existing stress points by creating new choke points within the supply-chain. Cash is a critical input in the agricultural production process and its unexpected shortage had an impact at many levels, including a slowdown in employment of labour and a dip in overall farm incomes. The Economic Survey for 2016-17, authored under the stewardship of former chief economic adviser Arvind Subramanian and released in January 2017, also echoed these concerns at that time.

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Published: 30 Aug 2018, 09:01 AM IST
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