After Effects of Banning 500 & 1000 Rupees Notes on Indian Economy

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On the evening of 8th November, 2016 Prime Minister addressed the Nation by throwing a master stroke news of banning of 500/- and 1000/- rupees currency notes with effect from midnight starting from 9th November, 2016. It is very important to note that these two currencies hold 86% of the total currency in circulation in India. Therefore, it was obvious that a chaotic type of situation arose on the very first day of such announcement, because all Banks were kept closed on 9th November, but certain public utility service providers like hospitals, petrol pumps, railways, airlines, government departments were instructed to accept 500 &1000 denomination notes for the services.

What is demonetization of currency?

Central Bank of a country, whereas in India Reserve Bank of India has been the central bank of the country, issues currency on behalf of the central government of the country. Sometimes the central bank acting on behalf of the central government bans/cancels the currency and replaces that currency notes with new one, such a situation is called Demonetization of currency.

When in a country following happenings start prevailing:

  • Corruption level becomes out of control
  • Unaccounted/black money overpowers the legitimate money over period of time inspite of the various warnings by the government
  • Purchasing power of the people takes a hit due to inflationary pressure on economy
  • Smugglers, bad elements, terrorist try to circulate fake/counterfeit currency in an economy
  • Prevalence of Hawala/Illegal Transactions
  • Real Estate prices sky-rocket and become out of reach of the common man
  • Economic Disbalance and concentration of money/wealth in few hands

Then government has to take such an extreme step to ban currency notes or demonetize the currency.

There have been previous instances when Indian Currency was demonetized, first in 1946 when 1000 & 10000 rupees notes were withdrawn from circulation and were  brought to circulation notes of 1000, 5000 & 10000 rupees in 1954. Again in 1978 all the notes of 1000, 5000 & 10000 rupees notes were declared illegal tender. In 2014, RBI made a successful attempt to replace all currency notes printed on or before 2005.

 In the history of demonetization, there has always been impact on the economy of the country, may it be on the short term or the long run, good effect or bad effect, the same is been discussed as under:

Short Term Effects:

  • Immediate effect on the lower class/ common man such as cash/liquidity crunch creating misunderstanding amongst people at large, long queues in Banks, refusal of certain section of people to accept cash etc.
  • Specially in unorganized sector, rural areas, lower level labour class shall be affected.
  • Massive jams on petrol pumps, railway/airlines ticket counters, toll plazas, purchase of essential commodities/groceries
  • Growth, production to take immediate decline, GDP growth is likely to be reduced by one percent point in 2016-17
  • Deflationary type of situation shall prevail as a result of lower money supply in the short run because unaccounted money, counterfeit/fake currency does not come out in the system.
  • Precious metal like gold/silver prices take a hit
  • Exchange rate of Foreign Currency are adversely affected
  • New currency if received is not accepted at few places.
  • Share Markets became volatile showing unexpected behavior
  • Foreign Tourists coming to India may face problems during their stay in India
  • Political parties of 5 states in India shall feel the heat of this demonetization and they shall find it hard to fight election and previous trends of winning with cash strength may reverse.

But these short term effects do not have any standing and slowly and steadily the things shall normalize except minor and negligible adjustments.

Long Term Effects:

  • Liquidity position will improve gradually, inflationary trend will be arrested.
  • It will help to minimize the legally circulated currency in the channel.
  • With the black money coming through the Banking channel, position of Banks will improve.
  • Foreign Currency market shall stabalize
  • Illegal/unaccounted transactions shall show a drastic decline.
  • Terrorist activities will slow down because of non availability of local funds.
  • In Real Estate sector cash component shall decline, thereby increasing the incidence of Capital Gain Tax, a gain for the ex-chequer.
  • Property prices shall see a sharp downward trend in short term but shall stabilize in the long run because of the legal funds available with people.
  • Unaccounted money from Higher Education Sector shall also be reduced, making it legally cheap.
  • Manufacturing and Service Sector will see a significant increase.
  • People will shift their focus from cash to cashless mode of payments like digital payments, Virtual Wallet payment like Paytm, Ola money, Unified Payment Interface (UPI) introduced by RBI, plastic money like debit and credit cards, Net banking etc.

It is clear that even the short term ill-effects of this demonetization has long term benefits and from the government’s  perspective people have supported this move to curb inflation, fighting corruption & terrorism, weeding out black money and counterfeit currency and end to illegal activities.

In the Balance Sheet of RBI, the liabilities towards the issued currency will be reduced if people fail to deposit or we can say do not deposit the unaccounted part of the 500 & 1000 rupees notes.
It is humble request to the people in general not to panic but follow the official instruction of the government, get full value of their hard earned money and do not fall in prey of unscrupulous people in this matter.

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