How demonetisation affected the Indian economy, in 10 charts: |ForumIAS

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Context:

The rural economy suffered disproportionately due to demonetization because most transactions here are cash-based.
What is the meaning of demonetization?
Demonetization is the act of stripping a currency unit of its status as legal tender.
It occurs whenever there is a change of national currency.
Demonetization is necessary whenever there is a change of national currency. The old unit of currency must be retired and replaced with a new currency unit.
The opposite of demonetization is remonetization where a form of payment is restored as legal tender.

Background:

On November 8, 2016 Prime Minister announced that Rs 500 and Rs 1000 denomination notes will become invalid.
The government introduced new notes of Rs 2,000 and Rs 500 .
There was also no change effected in any other form of currency exchange like cheque, Demand draft (DD), payments made through credit cards and debit cards.
The move was taken to curb the menace of black money, fake notes and corruption by reducing the amount of cash available in the system.

Impact of demonetization on rural economy:

The hardest-hit were those in rural areas, where access to banking and the internet are quite low.
A 2016 Reserve Bank of India (RBI) report on branch authorization policy classified 93% of rural centres in the country as unbanked, with the population dependent on roving banking correspondents and on distant urban or semi-urban branches.
Access to the internet is equally patchy, with only 3% of households in underdeveloped rural access to internet in a 2016 consumer economy survey.
The liquidity squeeze led to a pile-up at wholesale markets, leading to a sharp decline in the Wholesale Price Index (WPI) of perishables such as fruits and vegetables in the immediate aftermath of demonetisation.
By turning farm markets into buyers’ markets, demonetisation may have also contributed to the decline in prices of pulses
Rural consumer sentiment too took a hit, with domestic sales of two-wheelers plunging sharply.
New project announcements declined sharply in the wake of demonetisation, a Centre for Monitoring Indian Economy (CMIE) analysis showed, hurting the capex cycle.

How the ground realities do are different from the stated aims of demonetization?

1- Uncertain benefits:

The one big promise of demonetisation was a rapid expansion in the tax base but the actual results have been quite modest. According to the finance ministry’s estimates published in the latest Economic Survey, the tax base expansion attributable to demonetisation was Rs10,600 crore, lower than what RBI spent on interest expenses, and equivalent to only 0.1% of India’s gross domestic product (GDP).

2- On counterfeit notes:

Another stated aim of demonetisation was to detect and eliminate counterfeit notes. The growth in detected counterfeit notes after demonetisation has not been unusually large, shows RBI data, even as counterfeits of the freshly issued notes have already emerged in the system.

3- On Black money:

Objective of demonetization:

By withdrawing the high currency notes, the government had reckoned that those holding unaccounted cash or black money would not deposit in the banking system, thereby hitting this hoard.

Reality:

Demonetisation did provide a boost to non-cash payments in the short term but that effect may be waning, with the cash-to-GDP ratio back to double-digits.
The proportion of high-value notes (Rs500 and above)—often viewed as conduits of black money—has also been rising as new notes have entered the system. At the end of fiscal year 2017 (FY17), the proportion of high-value notes stood at 74%, considerably lower than that in FY16. But this figure may rise significantly by the end of FY18.

4- Digital Transactions:

Objectives of demonitisation:

One of the aims was to bring about a shift from a cash based economy towards more digital or electronic forms of transactions.
After demonetization, there was a spurt in electronic transactions through prepaid wallets, debit and credit cards, NEET(National Electronic Fund Transfer).
From 671.49 million transactions in November last year, it rose to 957.50 million in December at the end of the government’s deadline on cash withdrawal.
July data shows that the number of transactions was 862.38 million, lower than in December.

In reality:

There is no evidence of expansion of digitization in any major economy through demonetization.

5- Anonymity of cash owners:

Objectives :

One of the arguments from government’s side has been that the anonymity about ownership of cash operating in the system has ended, with more people depositing it in the banking system.
The government claims that it now has details of all those who had deposited cash during demonetization period.
One of the objective of demonetization was to put identity on the cash holdings in the economy.

In reality:

The Income tax department, through its “Operation Clean Money” project launched in January, has tracked 13.33 lakh accounts with cash deposits of around Rs 2.89 lakh crore, and received over 9 lakh responses so far.
If the Income tax department is able to prove that a good proportion of this was not legitimate money, the outcome could meet this objective.

6- Tax base:

Objectives:

One of the stated objective of demonetization was to increase the tax base.
For this, personal income tax return have increased by over 25% as those dealing in cash were compelled to deposit it in banks.

In reality:

The real measure would be not just increasing the number of those filling income tax, but also how it translates into higher revenues.
More people may be added to the returns-filling list but if significant number of these people have income below the taxable limit, the gain will be limited.
Mutual funds, etc
According to the government estimates, the savings in the form of investment in equity mutual funds, life insurance premiums and other products have risen after demonetization.
According to the government, assets under management of mutual funds up 54% by June-end 2017 from March 2016.

In reality:

The growth in mutual funds, however, has been a story over the past few years.
Assets under management of the Indian mutual funds industry have risen sixfold over the last decade, with the Systematic Investment Plan gaining popularity in the last couple of years.
In a low-inflation scenario, investors used to higher returns on safer bank deposits have shifted to mutual funds and other instruments, with deposit rates sliding.

What are the other consequences of demonetization?

Positive consequences:

Negative consequences:

The main negative economic consequence of demonetisation has been the disruption of unorganized supply chains that are dependent on cash transactions.
Demonetisation leads to decline in economic growth to a three year low of 5.7 per cent.
RBI report had revealed that nearly 99 per cent of the scrapped currency notes had come back to the banks, and it would become 100 per cent if cash in the pipeline is accounted for.

How demonetisation affected the Indian economy, in 10 charts: