Impact of Demonetisation


Impact of Demonetisation

Sector Impact
Effect through end-December Likely longer-term effect
Money/interest rates Cash declined sharply Cash will recover but settle at a lower level
Bank deposits increased sharply Deposits will decline, but probably settle at a slightly higher level
RBI’s balance sheet largely unchanged: return of currency reduced the central bank’s cash liabilities but increased its deposit liabilities to commercial banks RBI’s balance sheet will shrink, after the deadline for redeeming outstanding notes
Interest rates on deposits, loans, and government securities declined; implicit rate on cash increased Loan rates could fall further, if much of the deposit increase proves durable
Financial System Savings Increased Increase, to the extent that the cash-deposit ratio falls permanently
Corruption (underlying illicit activities)   Could decline, if incentives for compliance improve
Unaccounted income/black money (underlying activity may or may not be illicit) Stock of black money fell, as some holders came into the tax net Formalization should reduce the flow of unaccounted income
Private Wealth Private sector wealth declined, since some high denomination notes were not returned and real estate prices fell Wealth could fall further, if real estate prices continue to decline

Public Sector Wealth

No effect. Government/RBI’s wealth will increase when unreturned cash is extinguished, reducing liabilities


Digital transactions amongst new users (RuPay/ AEPS) increased sharply; existing users’ transactions increased in line with historical trend Some return to cash as supply normalises, but the now-launched digital revolution will continue
Real estate Prices declined, as wealth fell while cash shortages impeded transactions Prices could fall further as investing undeclared income in real estate becomes more difficult;  but tax component could rise, especially if GST imposed on real estate
Broader economy Job losses, decline in farm incomes, social disruption, especially in cash-intensive sectors Should gradually stabilize as the economy is remonetized
GDP Growth slowed, as demonetisation reduced demand (cash, private wealth), supply (reduced liquidity and working capital, and disrupted supply chains), and increased uncertainty Could be beneficial in the long run if formalization increases and corruption falls
Cash-intensive sectors (agriculture, real estate, jewellery) were affected more.

Recorded GDP will understate impact on informal sector because informal manufacturing is estimated using formal sector indicators (Index of Industrial Production).

But over time as the economy becomes more formalized the underestimation will decline.

Recorded GDP will also be overstated because banking sector value added is based (inter alia) on deposits which have surged temporarily

Informal output could decline but recorded GDP would increase as the economy becomes more formalized
Tax collection Income taxes rose because of increased disclosure

Payments to local bodies and discoms increased because demonetised notes remained legal tender for tax payments/clearances of arrears

Indirect and corporate taxes could decline, to the extent growth slows

Over long run, taxes should increase as formalization expands and compliance improves



Uncertainty increased, as firms and households were unsure of the economic impact and implications for future policy

Investment decisions and durable goods purchases postponed

Credibility will be strengthened if demonetisation is accompanied by complementary measures. Early and full remonetisation essential. Tax arbitrariness and harassment could attenuate credibility

Source: PIB News

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