Indian Demonetisation

Posted: 24th September 2017

By: Alex Barrat

In a bold and unprecedented move last November, Indian Prime Minister Narendra Modi announced the removal of all ₹500 (US7.80) and ₹1000(US $15.60) notes. The effort, which removed 86% of all currency in circulation, aims to limit terrorist funding, reclaim counterfeit banknotes, expose undeclared money and restrict the flow of money through the black market. To compensate for the loss of so many notes, a new issue ₹500 note and brand new ₹2000 denomination were introduced.

Just 8 months on it is difficult to analyse and assess the demonetisation but while unpopular, it seems to be on track to reaching its objectives. It is such an unprecedented yet completely textbook example of short term pain vs long term gain; the ultimate economic question.

In a country of over a billion people, such an effort requires exact and careful planning…that’s what would be expected at least. Civilians were forced to queue for days in front of ATMs hoping that they had not been emptied by the time they reached the machine. Store’s simply stopped accepting the now redundant notes fearing there would be no way to exchange money in the till. Hospitals and health care centres could no longer deliver treatments, again, fearing they would receive no return for their collections. The immediate effect of the procedure was nothing short of chaos and statistics have indicated that 100 deaths occurred as a direct or indirect result: be it through exhaustion queuing, or inability to pay for needed medical treatment.

In certain regions, including Hyderabad, 83% of people were unable to withdraw money, either through ATMs running out of currency or reaching their personal withdraw limits.

Despite the associated pains, 97% of demonetised notes were deposited into bank accounts, as expressed by the times of India, by the end of the 50 day period. It is evident that even if poorly planned out, the measures were simply unavoidable and widely accepted by all.

An analysis of what was expected to occur theoretically will be compared to limited yet insightful information available regarding real life findings.

Quite simply, demonetisation can be expected to place contractionary pressure on the economy. In the short run, the time lag between exchange of invalid to valid currency slows the economy as money can no longer flow freely through the economy; marginal propensity to consume is severely impacted. Whether it be an inability to upgrade broken machinery, to pay wages or to purchase seeds and fertiliser, production decreases and overall levels of GDP growth slow.

The first week after demonetisation, cigarette sales decreased by 30-40%, a clear expression of a decreased propensity to consume. Farmers were forced to dump produce at heavily reduced prices, or even physically dump huge amounts of produce as consumers had no way of paying for the goods. Quality and quantity of produce also fell as crops could no longer be maintained. On a larger scale, the unexpected led to GDP growth of 6.1%, a full 1% below forecasted 7.1% growth; some economists completely contribute this discrepancy to demonetisation.

Despite this overall slowing, Point Of Sale (POS) software and hardware saw a double in demand as online businesses and storefronts looked to take advantage of increased bank deposits and card usage. POS provider, Pine Labs reported a 108% increase in demand for its debit cards and 60% increase in credit card applications. Though, this expectedly came from the more affluent members of society and the full brunt of the changes were felt by the poor. Immediately following the announcement of the decision it was calculated that the bottom 90% of Indians went from controlling 16% of all wealth to a shocking 3%. This can be simply explained by the fact that their highest value assets, high value banknotes, were now obsolete. More wealthy individuals, those who held their wealth in property or stocks, saw their assets hold the same value.

Still, the intentions behind demonetisation were to curtail the aforementioned illicit behaviours, not to act as a form of monetary policy and when judged against its objectives, it can be said that it was somewhat misinformed.

While an objective was to reclaim counterfeit notes, a pressing need with one of every four thousand notes thought to be counterfeit, new counterfeit notes are circulating through the economy as criminals act quickly to reclaim their losses. Moreover, these counterfeit notes function as accepted currency among the people. While demonetisation does work towards justice, it fails to consider the everyday man who is being punished rather unjustly be the actions of a few.

As a tool to reveal black money around the economy it again proved ineffective. The vast majority of black money holders, high net worth individuals, have more intricate “money cleaning” methods and offshore bank accounts. If necessary, so called “money mules”, were paid to exchange large sums of black money in the streets on behalf of these individuals.

While the painstaking process was compliantly received by Indians countrywide, considering the relatively few protests, the damaging effects have not rewarded these same people. While the effort has struggled to achieve its objectives so far, the immediate short term effect on the economy and the people has indicated that demonetisation was not worth the cost. Still, we are yet to experience the new economy in the long run and only time will tell whether Modi’s bold move did indeed pay off.