By Chaitanya Gupta

It has been more than a week since the Prime Minister, in a rare national telecast, announced the banning of Rs. 500 and Rs. 1000 currency notes. Since then, the issue has monopolized national interest.

Deposits are up

Over the past 10 days, banks have received cash deposits of over Rs. 3,00,000 crores (US$45 billion) from across the country. Still, this is just a small fraction of the total value of banned notes in circulation, estimated to be over Rs 17,00,000 crores (US$245 billion).

The increased deposits have led to a surge in the stock prices of Public sector banks (up 11.72%) in an otherwise falling market (down 5.6%). Online payments and particularly, e-wallet usage, have gone up dramatically. In fact, PayTM reported a 435% surge in traffic within 2 days of the announcement.

But, disruption still uninterrupted

While the financial sector is set to gain from this move, there are real expectations of a slowdown in the consumer & FMCG sectors as they depend heavily upon cash.

This move has been accompanied by its fair share of downsides. Apart from economic shifts, demonetization has activated severe societal disruption. There are reports of long queues, and in some cases, violence and death at bank counters. The banks are re-calibrating the ATMs to facilitate the printing of the new notes. So one notices a chaos in the ATMs as well.

While the financial sector is set to gain from this move, there are real expectations of a slowdown in the consumer & FMCG sectors as they depend heavily upon cash. For this reason, the GDP for the second half of this fiscal year is also expected to be down. Moreover, other cash driven businesses and rural areas with low banking access will also be hit.

Several clarifications, assurances and threats were made by ministers and finance ministry officials, further adding to the chaos and fear. One now expects that 20-30% (US$ 9-14 billion) of the banned currency, essentially unreported income, will not be exchanged by the holders for fear of tax, penalty and prosecution.

An unofficial parallel exchange economy has seemingly sprung up overnight; offering to exchange the banned notes with new notes, gold and foreign currency. Inherently,leading to many raids, especially of jewelers, across the country. 

A bird’s eye view

It is important to see the demonetization from a wide perspective. A broadened horizon will reveal a strong context for the implementation of such a move. The government is working on a larger strategic plan to integrate the national economy. From day one itself, the government’s focus has been formalizing the informal sector. Direct Benefits transfer, Universal financial inclusion through Jan Dhan Yojna, National Identity through Aadhar card and voluntary income disclosure schemes are just some of the steps taken in this direction. 

The government is working on a larger strategic plan to integrate the national economy. From day one itself, the government’s focus has been formalizing the informal sector.

Additionally, the government has formed a special investigation team (SIT) on black money and are renegotiating the controversial Double Tax Avoidance Treaties (DTAA) with Mauritius and Cyprus. This is done for curbing the avoidance of taxes and routing of illegal funds through shell companies incorporated in these ‘tax havens’. Harsher policies are expected to penalize defaulters and eliminate ‘black money’ after the December deadline. The much awaited rolling out of Goods and Services Tax (GST) will then soon follow. One can expect the multiplying impact of all these measures to be a game changer for the Indian economy.

Who gains from this?

Undoubtedly, the biggest beneficiary of the demonetization seems to be the government itself. The RBI can theoretically transfer any amount of unclaimed currency notes as dividends or windfall gains. 

Subsequently, there will be a decrease in inflation and improve the government’s finances. This should also help fiscal consolidation, investment in infrastructure and increased public spending.

The banking sector, particularly PSU banks, seem to be another major beneficiary of this exercise. Increased Current Accounts Savings Account (CASA) deposits will improve the borrowing cost structure. Thereby, reducing repo rates, credit growth and employment generation in the process.

government

Intended to be a revolutionary change in eradication of black money – demonetization has in turn, unleashed havoc on ordinary citizens.| Photo courtesy : Pixabay

Low cost of capital and increased availability of funds will have a massive impact on infrastructure investment and the pace of project executions. The housing sector is another area impacted by this move. The incidence of black money in this sector was always high. Following which, the sector is likely to be badly hit in the short term.

As the demand falls for the next few months, there will be increased delinquencies for housing finance companies with an expected price correction of 20-25%. However, the long-term prospects seem extremely encouraging with lower prices and housing finance rates.

End note

There is a division among analysts on the extent of the success of this measure. However, one thing is sure – the unfolding of this “demon”- etisation will go far beyond the economy. It will have an all-encompassing impact on the social and political life of this country.


Featured image : Pixabay

Fresh insights delivered to your phone each morning. Download our Android App today!

Posted by The Indian Economist