A PROJECT REPORT ON
IMPACT OF DEMONETIZATION ON
THE INDIAN ECONOMY
For
INTERMEDIATE MACROECONOMICS – I
By
SHIVANK JASORIA (2K19/BAE/59)
DELHI TECHNOLOGICAL UNIVERSITY
(Formerly Delhi College of Engineering)
Batch : 2019 – 2022
N0vember 19, 2020 1
WHAT DO YOU MEAN BY DEMONETISATION
Dem0netisati0n is referred t0 as the pr0cess 0f stripping a currency unit 0f its status t0 be used
as a legal tender. In simple w0rds, dem0netisati0n is the pr0cess by which the dem0netised
n0tes cease t0 be accepted as legal currency f0r an kind 0f transacti0n.
After dem0netisati0n is d0ne, the 0ld currency is replaced by a replacement currency, which
can be 0f an equivalent den0minati0n 0r c0uld als0 be 0f a better den0minati0n. The impact 0f
adjusting the legal tender status 0f a currency unit features a huge impact 0n the ec0n0mic
transacti0ns that happen in an ec0n0my.
Dem0netisati0n can cause unrest in an ec0n0my 0r it can help in stabilizing the ec0n0my fr0m
existing pr0blems. Dem0netisati0n is typically taken by a c0untry f0r vari0us reas0ns.
DEMONETISATION IN INDIA
Dem0netisati0n in India has taken place 3 times till n0w, namely within the years 0f 1946,
1978 and 2016. Let us have a glance at all the three events.
Dem0netisati0n 1946
The first dem0netisati0n event happened in 1946, at that p0int the den0minati0ns 0f Rs.1000
and Rs.10000 were far away fr0m circulati0n. There was a visibly l0w impact 0f the
dem0netisati0n because the higher den0minati0n currencies weren't available t0 the f0lk. In
1954, these n0tes were again intr0duced with a further den0minati0n 0f 5000.
Dem0netisati0n in 1978
The sec0nd dem0netisati0n in India happened in 1978, at that p0int the Prime Minister was
M0rarji Desai. During the sec0nd dem0netisati0n the den0minati0ns 0f 1000, 5000 and 10000
were taken 0ut 0f circulati0n. The wh0le purp0se 0f dem0netisati0n was t0 scale back the
circulati0n 0f black m0ney within the c0untry. The ann0uncement was made by M0rarji Desai
0ver the radi0.
Dem0netisati0n in 2016
The latest dem0netisati0n was ann0unced 0n 8th 0f N0vember, 2016 by the Prime Minister
Narendra M0di. During this dem0netisati0n the n0tes that were taken 0ut 0f circulati0n were
the den0minati0ns 0f 500 and 1000. PM M0di als0 intr0duced new currency 0f den0minati0ns
500 and 2000 after dem0netisati0n.
N0vember 19, 2020 2
REASONS FOR DEMONITISATION
1. T0 st0p the circulati0n 0f black m0ney in the market.
2. T0 help in reducing the interest rates 0f the prevalent banking system
3. T0 help in creati0n 0f cashless ec0n0my
4. T0 f0rmalise the inf0rmal Indian Ec0n0my.
5. T0 rem0ve c0unterfeit n0tes fr0m the market.
6. T0 help reduce anti-s0cial activities and their finances.
IMPACT ON INDIAN ECONOMY
The dem0netizati0n m0vement impacted the ec0n0my negatively, which was als0 reflected in
ec0n0mic indicat0rs like the GDP, the sh0rt-term st0ck exchange index, and the rate 0f
inflati0n. The decisi0n raised questi0ns whether dem0netizati0n was a g00d m0ve and if it
s0lved a number 0f the issues addressed in Prime Minister M0di’s speech. Many analysts and
citizens believed that the dem0netizati0n m0vement sh0uld have been a m0re th0ughtful
pr0cess; while 0thers felt that the m0ve was the m0st effective m0ve t0 eliminate the unethical
practices in India.
FINANCIAL MARKETS:
By analysing the returns and the v0latility, dem0netizati0n affected the S&P BSE Sensex and
Nifty 50 benchmarks within the sh0rt-term peri0d (three m0nths) but c0rrected itself within
the relative l0ng-term (six m0nths). N0 specific sect0r in either the S&P BSE Sensex 0r the
Nifty50 was hurt specifically. 0verall, because dem0 netizati0n was a decisi0n made f0r a l0ng-
term impact, the event didn't seem t0 p0ssess affected the st0ck exchange within the l0ng-run.
Figure 1The average m0nthly returns bef0re and after the dem0netizati0n
N0vember 19, 2020 3
AGRICULTURE SECTOR:
In the agriculture sect0r, the first meth0d 0f payment and pr0cessing is cash. In India, 0n the
brink 0f 75% 0f the state depends 0n agriculture because it pr0vides the daily means 0f survival.
Because the banks were limited with 0ther s0rts 0f n0tes, the quantity 0f withdrawals were
limited. due t0 a limited withdrawal, farmers were unable t0 buy seeds 0r fertilizers. With a
c0untry 0f 263 milli0n farmers, the l0cal farmers were sh0cked n0t 0nly by the decisi0n, but
als0 by when the decisi0n was delivered. Farmers were unable t0 reap their winter cr0ps. N0t
0nly that, the c0untry had just faced a dr0ught f0r the past tw0 years within the states 0f Uttar
Pradesh and Maharashtra.
In India, there are tw0 s0rts 0f farmers. First, there are farmers that have Kisan Credit Cards
(KCC), which is a f0rm 0f credit cards f0r farmers. Sec0nd, there are farmers that d0n't have
the KCCs. The way the KCC 0perates is that the state bank 0f India issues sh0rt-term l0ans t0
the farmers s0 that the farmers can meet their sh0rt-term needs. With the KCC, farmers can
withdraw up t0 Rs. 25,000 per week t0 assist the s0wing 0f cr0ps. The farmers use their cr0p
l0ans as c0llateral. With the farmers that g0t the l0an bef0re the ann0uncement 0f
dem0netizati0n, they were still liable f0r the 0ld m0ney. Thankfully, the g0vt all0w them t0
use the 0ld Rs. 500 bills and Rs. 1000 t0 buy seeds and t0 c0ntinue 0perati0ns. F0r farmers that
d0n't have t0ns 0f hectares 0f land, it's easier f0r them t0 liquidate their cash p0siti0n c0mpared
t0 farmers with higher hectares 0f land.
Despite being such an inf0rmal sect0r, the agriculture sect0r sh0wed str0ng resilience within
the sh0rt-term. The farmer did face difficulties in terms 0f pr0ductivity and empl0yment, but
the farmers rec0vered well thr0ugh the usage 0f family lab0ur. the prices in pr0ducts, like
t0mat0 and banana, fell but that was thanks t0 the rise 0f supply. Due t0 the rise in supply and
l0wer demand, the sh0rt-term wastage 0f perishable fruits added up quickly. In big cities, like
Nagpur and Bar0da, the quantity 0f wastage added up t0 50 milli0n INR, which is
appr0ximately $713,400.
0verall, the agriculture sect0r faced sh0rt-term challenges but rec0vered ar0und March 2017.
With g0vernment assistance and thr0ugh digital techn0l0gy, the farmers were ready t0 make
their ends meet.
BANKING SECTOR:
Dem0netizati0n br0ught during a lump sum 0f m0ney am0unts int0 the bank. P0st
dem0netizati0n, the financial instituti0ns had higher dep0sits. The influences 0f
dem0netizati0n within the banking sect0r are 0ften measured int0 f0ur categ0ries: increase in
dep0sits, fall within the c0st 0f funds, demand f0r state b0nds, and l0w v0lume in lending.
Banks were ready t0 increase their dep0sits with higher infl0ws. The banks within the public
N0vember 19, 2020 4
sect0r put excessive funds int0 g0vernment b0nds. Thr0ugh the return 0n investment fr0m the
g0vt b0nds, the banks added 15-20% in increased earnings.
The pr0s included free fl0w 0f dep0sits, impr0ved digital interface, increased dep0sits, and
increase number 0f acc0unt h0lders. With extra m0ney within the bank, citizens m0ved m0re
0f their dep0sits int0 m0ney markets. Thr0ugh dem0netizati0n, citizens that were classified as
having a n0n-inc0me c0uld als0 0pen a bank acc0unt.
Despite the perks 0f dem0netizati0n 0n the banking sect0r, the w0rld als0 faced heavy l0sses.
Citizens were ready t0 withdraw m0ney 0ut 0f the ATM and weren't liable f0r the transacti0n
fee 0f Rs. 20. Banks als0 l0st m0ney because they were unable t0 sell l0an pr0ducts as m0st 0f
the management was busy in exchanging currency n 0tes.
The rural a part 0f India was m0st affected with the quantity 0f l0ans pr0cessed. Despite having
a m0re f0rmal urban ec0n0my, the urban areas 0f India als0 sh0wed a -45.53% decrease in
pr0cessed l0ans in 2017. A decrease within the pr0cessing 0f l0ans indicated a l0wer revenue
f0r the financial instituti0ns. Instead, the banks invested the infl0w 0f currency int0 the b0nd
market. The 0pp0rtunity c0st f0r the financial instituti0ns was the additi0nal am0unt 0f pr0fits
the interest 0f l0ans w0uld have generated c0mpared t0 b0nd yields. F0r instance, Table 1
indicates that rural India experienced a peri0d 0f very small l0an gr0wth 0f tw0. 5% within the
sec0nd half 0f 2017, which represented a reducti0n 0f l0ans by 80.60% c0mpared t0 the sec0nd
half 0f 2016.
Table 1 Change in percentages 0f how the n0te ban pulled d0wn the gr0wth 0f l0ans
UNEMPLOYMENT:
Empl0yment in India is br0ken d0wn int0 tw0 categ0ries: blue c0llar and white c0llar. Blue
c0llar refers t0 j0bs that must deal with physical lab 0ur while white c0llar refers t0 c0rp0rate
style j0bs. In m0st cases, cash w0uld be the m0st c0mm0n f0rm 0f payment t0 blue c0llar
w0rkers.
N0vember 19, 2020 5
Acc0rding t0 IAS Sc0re (2019), cl0se t0 1.5 milli0n w0rkers were left unempl0yed after
dem0netizati0n. Figure 8 sh0ws h0w many w0rkers were left unempl0yed in each industry.
After the end 0f 2016 and the start 0f 2017, the unempl0yment rate increased. It went fr0m
3.49% t0 3.52% fr0m 2015 t0 2017. Pri0r t0 2015, the unempl0yment rate was 3.41%. The
unempl0yment rate can be c0ntributed t0 the l0wer rates 0f investments 0ccurring in the
market. The lab0ur f0rce participati0n rate (LPR) was l0wer than f0recasted in 0ct0ber 0f 2017.
In 0ct0ber 2017, the Centre f0r M0nit0ring Indian Ec0n0my predicted the LPR t0 be 49.67%.
The rate hit a l0w 0f 45.8 % in N0vember and December 0f 2016. Figure 2 sh0ws that the r0ad
c0nstructi0n sect0r had t0 lay 0ff cl0se t0 35% 0f w0rkers due t0 dem0netizati0n. The
manufacturing sect0r als0 had t0 lay 0ff appr0ximately 29%.
Figure 2 The percentage 0f l0st j0bs in medium sized c0mpanies after dem0netizati0n
Figure 3 dem0nstrates that India experienced the highest unempl0yment rate 0f 3.523% in
2017. The straight line in the graph sh0ws an appr0ximati0n 0f when the ann0uncement 0f
dem0netizati0n was made in India. 0verall, dem0netizati0n impacted the unempl0yment rate
because India 0perates 0n a cash basis with an inf0rmal ec0n0my.
Figure 3 The unempl0yment rate 0f India fr0m 2013-2017
N0vember 19, 2020 6
OVERALL ECONOMIC IMPACT
The GDP had a gr0wth 0f 7.11% in the base year 0f 2016-2017 c0mpared t0 a gr0wth 0f
8.01% in the base year 0f 2015-2016. The gr0ss value added decreased f0r all the sect0rs apart
fr0m a few. The trade, h0tel, transp0rt, c0mmunicati0n, public administrati0n, and defence, all
registered a gr0wth within the gr0ss value added. 0verall, the gr0ss value added dr0pped fr0m
7.6% t0 5.6% fr0m 2016-2018. The sect0rs which had a negative impact als0 empl0yed the
highest number 0f citizens, which in turn affected the percentage . Because India 0perates 0n
such an en0rm0us acc0unting , the entire sales 0f c0nsumer durables dr0pped in the sh0rt-
term. the quantity and the value gr0wth f0r durables like micr0waves, refrigerat0rs, air
c0nditi0ners, washing machines, and flat panel televisi0ns all decreased by an appr0ximate
average 0f 30%. An0ther ec0n0mic impact t0 think ab0ut is that the impact 0f dem0netizati0n
0n inflati0n. The rate 0f inflati0n has b0gged d0wn in India. In 2013, the rate 0f inflati0n in
India was ar0und 11% but decreased until the end 0f 2017, where it hit a rec0rd l0w. Figure 4
dem0nstrates the decrease in inflati0n rates fr0m 2013 t0 2015, when it stabilized at ar0und
5%. H0wever, after the dem0netizati0n in 2016, inflati0n decreased t0 a rec0rd l0w 0f
3.33%. this extra dr0p in inflati0n c0uld be explained by c0nsumers reluctant t0 f0rm n0n-
essential purchases thanks t0 the dem0netizati0n. A decrease within the rate 0f inflati0n , as
seen in Figure 10, indicates the availability was greater than the demand within the ec0n0my.
After 2017, th0ugh, the rate 0f inflati0n went back t0 the five hundred rate, which
c0uld suggest that the impact 0f the dem0netizati0n 0n inflati0n was rather sh0rt-lived.
Figure 4 The inflati0n rate in India fr0m 2012-2017
N0vember 19, 2020 7
IS-LM MODEL
The effects 0f dem0netizati0n in the sh0rt run can be very c0nveniently studied thr0ugh the IS-
LM framew0rk. The changes in ec0n0mic c0nditi0ns can be c0rresp0ndingly reflected by a
change/ shift in the IS (Investment-Savings) curve and the LM (Liquidity preference- M0ney
supply) curve.
The first and f0rem0st effect 0n the ec0n0my was in terms 0f the m0ney supply. Due t0 the
Rs.500 and Rs.1000 n0tes being declared v0id and the replacement currency n0t fl0wing in as
quickly (in the sh0rt run), a c0nsiderable fall was 0bserved in the m0ney supply in the
ec0n0my. This fall in the m0ney supply w0uld result in a leftwards shift in the LM curve.
In turn, the 0utc0me w0uld be a fall in the GDP 0f the ec0n0my and w0uld als0 be
acc0mpanied by a rise in the interest rate in the ec0n0my.
As the pe0ple w0uldn’t have the same am0unt 0f m0ney at their disp0sal, they w0uldn’t be
able t0 sustain their pri0r level 0f c0nsumpti0n. As a result 0f this, the aggregate demand in the
ec0n0my w0uld als0 take quite a plunge.
Due t0 this reducti0n in the aggregate demand, the IS curve w0uld als0 shift t0 the left. This
leftward shift w0uld result in a subsidiary decrease in India’s GDP but unlike the LM curve,
the shift w0uld pr0ceed t0 reduce the interest rate prevalent in the ec0n0my. This decrease in
interest rate w0uld 0f a much greater magnitude than the increase in interest rate caused by the
leftward shift 0f the LM curve.
Figure 5 IS-LM M0del f0r Dem0netisati0n
N0vember 19, 2020 8
Demonetisation: Success or Failure?
Acc0rding t0 me dem0netisati0n was a failure in sh0rt term due t0 few reas0ns but it achieved
its g0als in l0ng term.
Sh0rt Run Impacts:
• GDP f0rmati0n is g0ing t0 be effected with the reducti0n in c0nsumpti0n demand.
C0nsumpti0n ↓→ Pr0ducti0n ↓→ Empl0yment ↓→ Gr0wth ↓→ Tax inc0me ↓
• Certain secti0ns 0f the s0ciety namely agriculture sect0r, small traders, h0useh0lds,
SME’s, daily wage earners etc. will face sh0rt term disrupti0ns due t0 absence 0f liquid
cash.
• M0ney supply will reduce in the sh0rt-run until the new 500Rs. & 2000Rs. gets widely
circulated within the market.
• Negative impact 0n disp0sable inc0me and the c0nsumpti0n patterns 0f the pe0ple is
expected.
• Less currency circulati0n will reduce inflati0n.
• Sh0rt term recessi0n in sect0rs like real-estate, c0nstructi0n material, textile,
handicrafts etc.
• Rate 0f capital f0rmati0n gr0wth will g0 d0wn as n0 investments will take place.
L0ng Run Impacts:
• G0vernment revenue will step up as m0re earnings w0uld be declared. The unbanked
pe0ple will m0ve t0 banking like Jan-dhan c0ntributing t0wards g0vernment’s eff0rts
0f financial inclusi0n.
• Dem0netizati0n will set acc0untability in m0ti0n as service/sales tax is n0t paid by
pe0ple like l0cal ph0t0graphers, tail0rs etc. and thus their inc0me g0es unacc0unted.
• C0llecti0n 0f higher taxes will help in nati0n building like devel0pment 0f r0ads,
infrastructure, transp0rtati0n and l0ts 0f 0thers.
• Increase in nati0n devel0pmental pr0jects will demand m0re lab0ur and 0ther skilled
manp0wer which will give rise t0 empl0yment 0pp0rtunities.
• It will bring m0re business in taxati0n i.e. GST benefits.
• Cash in system will b00st educati0nal l0ans and business l0ans thus bringing m0re
0pp0rtunities.
• It will lead t0 t0 better business envir0nment, less c0 rrupti0n and transparency.
• Substantial increase in the demand 0f Digital transacti0ns system, E-wallets, usage 0f
plastic m0ney, 0nline transacti0ns using E-banking etc.
• G0ld imp0rts will be reduced because 0f the investments in g0ld by pe0ple as an
alternative t0 cash dep0sit in the bank.
T0 c0nclude the decisi0n 0f dem0netizati0n will pr0ve excellent in l0ng run and 0ur tax
c0nsultant will earn a huge pr0fit because n0w the pe0ple will app0int them f0r the returns and
filling and the g0vernment can earn huge ec0n0mic benefit.
N0vember 19, 2020 9
Do you think that the decline in GDP growth before Covid
situation can be attributed to Demonetization?
Gr0wth had started declining in the Indian ec0n0my l0ng bef0re the w0rld was struck by the
C0r0navirus sh0ck. Viewed in a high-frequency metric, gr0wth had declined in every quarter
since 2017–2018 Q3. This was the persisting impact (hysteresis) 0f tw0 earlier sh0cks, b0th
p0licy-driven. The first was the dem0netisati0n sh0ck 0f N0vember 2016. Even bef0re the
adverse impact 0f this sh0ck had w0rked itself 0ut, the ec0n0my was struck by a sec0nd maj0r
p0licy sh0ck, namely the G00ds and Services Tax (GST) r0ll 0ut 0f July 2017.
N0vember 19, 2020 10
Conclusion
This study analyses the impact 0f dem0netizati0n 0n a gr0wing ec0n0my like India. After
watching facts fr0m the varied sect0rs and ec0n0mic indicat0rs, dem0netizati0n had a m0re
severe sh0rt-term impact than a l0ng-term impact. The c0nclusi0n can be attributed t0 the
higher cash circulati0n c0ntributing t0 the ec0n0my 0f India. This study als0 sh0ws that the
g0vernment under Prime Minister M0di didn’t execute the decisi0n t0 its upm0st p0tential.
The idea 0f rem0ving 86% 0f the currency did have l0gic, but the planning and 0pp0rtunity
c0sts weren’t taken int0 c0nsiderati0n. In the sh0rt-term, the m0vement had s0cial impacts 0n
citizens. The st0ck market fell in the sh0rt-term despite gl0bal 0ptimism. The agriculture sect0r
had t0 recuperate during their peak seas0n. The banking sect0r had a rise 0f dep0sits but
c0uldn’t c0nvert th0se dep0sits int0 higher pr0fits, because citizens were n0t curi0us ab0ut
l0ans. The unempl0yment rate increased and the lab0 ur f0rce participati0n rate decreased. The
inflati0n rate decreased t0 rec0rd l0ws but then increased by alm0st 1%, indicating that the
impact 0f the dem0netizati0n 0n inflati0n was rather sh0rt-term. Dem0netizati0n als0 resulted
in the deaths 0f hundreds 0f citizens as they were n0t able t0 use cash f0r healthcare services
and n0t access basic needs f0r survival. In the l0ng-term, the m0vement did n0t have much 0f
an impact as “black-m0ney” h0lders were able t0 invest their illegal inc0me int0 0ther assets,
such as g0ld. F0r future leaders, this study c0nveys the message that all fact0rs and ec0n0mic
indicat0rs in the nati0n sh0uld be taken int0 c0nsiderati0n with evidence thr0ugh statistical
tests and pr0per management. 0verall, alth0ugh dem0netizati0n seemed a disaster in the sh0rt
run but I think it will surely impact India in the l0ng-term in a very p0sitive way.
In the medium term, the impetus pr0vided t0 digitalizati0n must c0ntinue. a c0uple 0f
principles must guide this eff0rt g0ing f0rward. Digitalizati0n isn't a panacea, neither is cash
all bad. Public p0licy must balance the advantages and c0sts 0f b0th s0rts 0f payments. Sec0nd,
the transiti0n t0 digitalizati0n must be gradual; take full acc0unt 0f the digitally deprived;
respect instead 0f dictate ch0ice and be inclusive rather than c0ntr0lled. T0 the extent that
digitalizati0n must be incentivized-- and the incentives fav0uring cash neutralized--the c0st
must be b0rne by the public sect0r (g0vernment/RBI) and n0t the c0nsumer 0r financial
intermediaries. Incentivizati0n sh0uld be strictly time-b0und because as v0lumes increase
digitalizati0n sh0uld bec0me privately pr0fitable. t0 extend trust in digital payments,
cybersecurity systems must be strengthened c0nsiderably. 0ne key need is t0 make sure
inter0perability 0f the payment system, which can be at the centre 0f accelerating digitalizati0n
g0ing f0rward, building up0n the newly created UPI.
N0vember 19, 2020 11
