Impact of Demonetization of Rs 500, Rs 1000 notes

Here’s how the Demonetization of Rs 500 & Rs 1000 notes would affect the Indian economy:

demonitisation-9523909As the prime minister puts it “the mahayagna against corruption”, is all set to send ripples across the country. The demonetization is being made to curb black money, fake currency and terror financing in one go. Moreover, there’s a constant endeavor to make the plastic money a norm and cash an exception. New notes of Rs 500 and Rs 2000 are on its way. Still, the impact is going to be extensive and immediate. Cash intensive markets are already feeling the heat.

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If you track the series of events, then the crusade may not appear ad-hoc.  Beginning from the Jan-Dhan Yojana to Income Declaration Scheme, the intent had been made conspicuous. Demonetization is yet another feather added to the cap. The scrapping of currency has received opinions from all the corners. It has raised the anxiety and uncertainty among the masses.

Such a historic move would yield both short and long run effects. In the near term, the country will face constrained economic activity and instability. However, in the long-term, this will alleviate corruption and money laundering. As more transactions get tracked, the tax collection of the centre will surge substantially. It will improve the tax-to-GDP ratio of the country. Subsequently, the government expenditure in infrastructure and health could improve.

While a short-term slump may be experienced in the sectors like real estate, construction, and FMCGs. Long-term escalations in GDP will outweigh the short term transitions.

Also read: Interesting facts about Coinage and Currency notes in India

Meanwhile, let me take you through the impact of the demonetization on various macroeconomic variables.

Fiscal Deficit & Demonetization

Fiscal deficit refers to the excess of expenditure of the government over its revenue. The latest move could reduce the budget deficit in three ways. Initially, as more individuals fall under the tax net and make disclosures,  the direct tax collection of the government would surge.

Then, the fear of penalties upon income mismatch may stop people from depositing entire piled-up black money. RBI would have to replace lesser number of new notes of Rs 500 & Rs 1000. RBI’s liability may reduce and the surplus would be transferred to the central government.

Thirdly, the implementation of GST architecture would lead to expansion of organised sector. An efficient indirect taxation structure would cover majority of goods and services under appropriate tax rates. Hence, the centre’s kitty is going to swell up.

Thus, increase in the receipts is likely going to pull the rate of fiscal deficit down.

FDI & Demonetisation

FDI inflows to a nation are dependent on a variety of factors. The demonetization is going to trigger the rise in FDI inflows in the country. A significant increase in government revenue would enhance its expenditure in crucial areas especially infrastructure. A low corruption, greater transparency and a check on the parallel economy would boost the GDP rates. Better infrastructure and GDP growth would attract a large number of investors to India thereby raising the FDI inflows.

However, one thing needs to be underscored at this juncture. The centre & the state government needs to work in harmony to create a synergistic effect.

The impact on business & markets can be explained as follows:

Small businesses

Small scale business owners like jewellers, grocers and vendors are having a hard time coping with this sudden move.  They are finding it challenging to sell their products due to lack of hard cash. The absence of physical cash would cause people to use their credit/debit cards extensively. So, showrooms which accept credit and debit cards are expecting a spike in their revenue.

Real Estate

While the realty is already in a slump, the scrapping of Rs 500 & Rs 1000 may further reduce prices of the property. The demand for residential property is already muted among the end-users even when the developers are offering massive discounts. This demonetization would further diminish the chances of any surge. There are several reasons attributable to this phenomenon. Most of the time developers transact on cash-basis only. Now onwards, there will be severe liquidity crunch in the sector owing to the sudden withdrawal of funds. Then, homebuyers who preferred to pay in cash to save taxes would now be in difficulty.

Additionally, real estate has known to be an ideal haven for money launderers. The investors would be barred from parking their black money in property owing to mandatory disclosure of PAN on transactions of Rs 10 lakh or above.

Banking, Financial Services and Insurance (BFSI)

As people are rushing to deposit money in the banks, liquidity will be sucked out from the system. The deposit base of the banks would swell. It may cause a slip in the already low deposit rates. But at the same time, it may reduce the inflation as well. Then, this increase in the volume of transactions would reduce the cost of the funds. Banks may probably pass on the benefit via reducing interest rates on loans. RBI may go for another rate cut looking at the dwindling inflation.

Earlier, people used to invest in the unorganised instruments. An emphasis on the PAN disclosure may cause them to go organised this November. It looks like a blessing for the structured investment platforms. Investments in equities, ETFs, bonds and mutual funds may surge. As many individuals will come under the tax net, so demand for ELSS funds may increase to save tax. On the debt side, a liquidity crunch may promote investments in liquid funds and ultra-short term funds. The falling yields on the fixed-income instrument may boost the demand for debt funds in the long run.

The scrapping of Rs 500 & Rs 1000 notes has lead to a surge in use of digital money and plastic currency. As people are finding it difficult to conduct transactions on cash-basis, they are increasingly going digital. They are making use of debit cards/credit cards or the online digital payment platforms like Paytm. Hence, these digital platforms would grow in future owing to the mitigated use of physical cash.

Also read: All about Goods & Services Tax (GST) & its Implications

Gold

Demonetization of currency is making the investors go gold this November. Instead of consumption motives, they are routing black money via gold purchases. This has escalated the demand for gold in the economy. So much that October alone accounted for import of 56 tonnes of gold. This is as opposed to the average gold import of 30 tonnes since February. Government putting a cap on imports is on the cards.

Additionally, the gold prices have surged and the gold futures look buoyant. Footfalls at the jewellery stores have increased. To curb the rampant parking of black money in gold, government has made 15 November as the last currency exchange date for the jewellers.

Luxury Items

The black money is spent on luxury items like cars, interior décor, clothing, antiques, electronics, etc. Demonetization would directly impact the demand for luxury goods.

Entertainment & Leisure

Entertainment forms one of the ways to splurge black money. Black money is splurged on movies, dining out, exotic vacations, personal grooming at salons, etc. The scrapping of currency will now make such extravagant expenditure out of bounds. Consequently, this sector may witness a fall in demand from the customers

E-commerce Companies

E-commerce companies seem to be under pressure owing to the demonetization. The majority of customers in India prefer “cash on delivery (CoD)” mode for online shopping. The liquidity crunch has restrained the shopping traffic of e-tailers. Amazon has suspended CoD till the situation improves. Others like Flipkart & Shopclues have capped the limit on CoD. Online grocers like BigBasket & Grofers are still going on a cash basis but not accepting the scrapped notes. For the sales to pick-up, these e-tailers are encouraging customers to go digital and use debit cards. A delay in deliveries or cancellation of orders in bulk is on the cards for now.

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Final Words

The overall retail demand for goods & services has taken a hit owing to demonetization. At this juncture, the government needs to speed up the currency replenishment measures. Else, the danger of deflationary pressures looms large.  Again with the infusion of new currency notes, hoarding tendencies may crop up. There needs to be done something to prevent recurrence of black money and parallel economy. It needs to be supplemented by other holistic policy measures. Finally, there lies a growing need of attitudinal change among the public towards tax payment and income disclosures.

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