The Prime Minister's move on demonetising Rs 500 and Rs 1,000 notes is now slowly beginning to play out. Apart from inconvenience which the move is causing, it is still too early to say what this really means for a large section of the population.
But nonetheless, some things are becoming clear.
- The move is one of the most radical experiments in trying to solve the black money and counterfeit currency conundrum in not just India but across the world
- There is expected to be a demand-side shock which has the potential to impact business activity sectors in the coming months.
- With the parking of funds in the banking sector, there is expected to be a drop in interest rates and moderation in prices in the medium-to-long-term.
- The move will also see a change in habits of people, probably reducing dependence on cash. Another change will be dependence on gold and housing as a stock of money.
- The move could have been implemented better and the inconvenience somewhat reduced.
Impact of Demonetisation on the Indian Economy
It is clear that the event is entirely unprecedented. No other country has tried this kind of radical demonetisation, especially when the economy was growing at more than seven percent relatively consistently and inflation was under control.
The sectors of the economy which transact more cash are expected to be the most impacted. These include supply chain, logistics, agricultural farm produce and most of all, sectors like real estate where 60:40 is the norm. Apart from this, consumer durables as well as Fast-Moving Consumer Goods (FMCG) sectors are expected to see a slowdown in consumption. This is expected to slow down growth in the economy with no money to buy goods and services in the short term.
People are also trying to get around the problem. Sometimes transactions are also being done based on trust/barter.
However, if the banking system is not able to efficiently recalibrate the economy, the Supreme Court has noted that there “could be riots”.
A Move Towards Digital Transaction
Post the announcement, people have already replaced a large stock of their cash. The Prime Minister quoted a figure of Rs 5 lakh crore being deposited in banks which could be used to give loans to entrepreneurs and the common people.
Seeing the influx of money, banks are likely to cut interest rates. This will have a positive impact on growth in the medium- to-long-term economy. The impact of this needs to be greater than the demand-side shock for this gamble to pay off economically. Most economists are divided on this, but it likely seems to be a step in the right direction.
An interesting outcome of the move will be a reduction on the dependence on cash.
This is expected to bring more transactions into the formal economy and most likely increase the tax base.
In India, roughly two percent of the people file their tax returns. Tax evasion is thus a significant problem. So far, the transitioning from cash to a cashless economy was incremental in nature but in the coming months, this is expected to increase exponentially.
The kirana stores will most likely move to using credit card machines and mobile wallets have benefited from the move. Besides this, people will also move away from holding cash as a source of money. They will most likely convert money into gold or real estate.
Also Read- RBI Governor Must Resign: Bankers’ Confederation on Demonetisationrds Digital Transaction
Businesses Shaken up After the Demonetisation Move
India's perennial problem seems to be implementation. This was on full display in this case as well. The floating of Rs 5,000 or Rs 10,000 notes in the previous two years could have helped in moving cash to those notes and subsequently these could have been demonetised, reducing the large serpentine queues that we now see outside banks and ATMs.
With the unprecedented move, the Prime Minister has signaled one thing: A shake-up of the business as usual norm.
It is a good first step, but more needs to be done on the corruption front. This includes a war on hawala, cleaning up funding of political parties, better tax administration and doing away with burdensome regulations which inhibits growth and a mentality to avoid compliance.
(Sankalp Sharma is a Senior Researcher at the Institute for Competitiveness, India. Amit Kapoor is Chair, Institute for Competitiveness & Editor of Thinkers. The views expressed are personal. Amit can be reached at amit.kapoor@competitiveness.in and tweets @kautilya)
(Published in arrangement with IANS)
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