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Demonetisation and its Pros and Cons
Benefits of Demonetisation
- GDP in the long-term is likely to get a boost with a tax net widening to include non income agricultural households after restriction on cash economy.
- Inflation is likely to come down due to low demand owing to liquidity problem. Since effect of lower demand can have a lagging impact on inflation, prices may remain flat or fall in the long term.
- Activity in the real estate sector, which includes a lot of cash and undocumented transactions, slowed down significantly, Metropolitan and Tier 1 cities reported up to a 30% fall in house prices. Food item inflation, measured by changes in the Consumer Food Price Index, accounts for 47.3% of the overall CPI. Due to 86.4% of the value of the currency notes in circulation going out of the financial system and re-monetization being slow, the supply and demand of food items fell.
- In the short term, withdrawal of SBNs (specified bank notes) would boost financial services and soften inflation by 10-15 basis points.
- The sustained crackdown on black money will prevent people from parking their savings in physical assets such as gold and real estate. This should boost the flow of savings into the financial system to a significant extent. This in turn should spell a higher influx of flows for financial services providers such as banks, non-banking financial companies (NBFCs) and stockbrokers.
- Interest rates may come down in short term as the banks are flushed with cash. If demonetisation boots banking and more cash keeps flushing in the system, interest rates may fall further in the long term also. This may not be a good news for those putting their money in banks but people who wants to take any type of loan will be benefited as lending rates will also fall.
- Larger crackdown on black money and its resolve to check tax evasion will yield two distinct sets of benefits: A lower cost of capital and higher flows into the financial services sector.
- Tax collections would improve the country’s fiscal situation with likely increase in size of the formal economy.
- Government has tried to attack three major issues affecting the Indian economy through this single move of demonetisation, these issues are – a parallel economy, counterfeit currency in circulation and terror financing.
- Not all, but a lot of corrupted people having black money has been caught due to demonetisation and non-tax payers are penalized by the government. The government has recovered due taxes from culprits in short run by this move.
- As the informal sector shrinks due to demonetisation, the formal organised sector is likely to gain market share. The formal sector accounts for 60 percent of India’s GDP today and it is likely to increase from 60 to 80%.
- While the ongoing changes are likely to engender painful side effects in the short term, the long term benefits of the Modi government’s crackdown on tax evasion and black money are undeniable.
- A recent study had pegged India’s black market economy at over Rs 30 lakh crore or about 20 percent of total GDP. This is even bigger than the GDP of countries like Thailand and Argentina. Hence, this historic decision will surely impact the black money hoarders and will surely bring the economy back on track slowly and gradually.
- Demonetisation is going to help the country to become digital in all aspects in the long run. People will start using online money transfer through internet banking, paytm and e-wallets etc. This should eventually lead to strengthening of such systems and the infrastructure required.
Negatives of Demonetisation
- The decision to demonetise the Rs 500 and Rs 1,000 notes has created an immediate impact in terms of creating a shortage of hard currency. As a large mass of India does not know how to digitally transact money and many small dealers were used to transact money in the form of hard cash, people are facing inconvenience due to less availability of cash as well as due to the cash withdrawal limit from ATMs and banks.
- Demonetisation of high denomination notes (of Rs 1,000 and Rs 500) has put over 85% of currency out of circulation. This has resulted in short-term disruptions in transactions in agriculture and related sectors, small establishments, households and among professionals.
- The falling interest rates due to demonetisation is not a good news for those who save their money in banks as from now onwards, they are going to get less amount of interest from banks and thus, they will be less benefitted. Canara Bank, ICICI Bank and HDFC Bank have cut their fixed deposit rates by up to 1%. State Bank of India cut their fixed deposit interest rates by 0.15% on select maturities.
- The demonetisation-driven cash crunch that is playing out in India will create short-term economic pain in the form of the transactional hit created by a hard cash deficit and the structural hit to non-tax paying businesses that would become unviable.
- The informal sector accounts for more than 40 percent of India’s GDP and provides employment to close to 80 percent of the labour force. Due to demonetisation, the share of the informal economy in India could shrink from 40 percent to 20 percent. This shrinkage of the informal sector is likely to result in a short-term adverse effect as the informal sector is no longer able to employ the numbers that it did. So, demonetisation is going to result in increase in unemployment in informal sector.
- Due to drop in consumption, the GDP is likely to drop by 0.5-1% this fiscal year as compared to previous years. Ambit Capital, a respected Mumbai-based equity research firm, has officially estimated that the demonetisation-driven cash crunch will result in GDP growth crashing to 0.5% in the second half of financial year 2016-17. This means the GDP growth for six months, from October 2016 to March 2017, could decelerate to 0.5%, down from 6.4% in the previous six months.
- Any slow down in the economy or investment in bonds and securities due to demonetisation is going to affect the business firms especially the retail sector to a large extent in the short term.
- Industrial activity is going to slow down in the short term that will going to result in delay in payment of wages and purchases of input.
- Demonetisation has also affected media and advertising industry to a large extent as consumers have become more choosy about where to spend their money after demonetisation.