Demonetisation

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Definition of Demonetisation

Demonetisation is an act of cancelling the legal tender status of a currency unit in circulation. Anticipating positive changes on the liquidity structure as a whole, nations often adopt Demonetisation policy as a measure to counterbalance the current economic condition. Countries across the globe have used Demonetisation at some or the other point to control situations such as inflation and to boost economy. In November, Indian government banned the high denomination notes of Rs.1000 and Rs.500 as move to curb counterfeiting and money laundering.

Effects of Demonetisation on various sections of Indian Economy

Demonetisation, that sent a shockwave across the Indian economy, completes one month since its announcement on the midnight of November 9. To uproot the problems of corruption, black money, and counterfeiting, Prime Minister Narendra Modi orchestrated this master plan which has reportedly swept off a mammoth portion of India’s monetary base. It is anticipated that this surgical strike on black money will also increase cashless transactions in the country and untie all knots in tax collection. But on the other hand, rural households and elder citizens have been worst hit due to the sudden monetary reform.  The decision to scrap all Rs.1000 and Rs.500 notes have made it to headlines all over the world, attracting both positive and negative comments.

Demonetized currency and small savings schemes

Government has notified banks to not accept the discontinued currency notes for deposit in small saving schemes. However, no reasons have been specified for such a move by the competent authority. Small savings schemes are one of the most sustainable financial options which provide greater returns with low risk factor. Some of the popular savings schemes are Kisan Vikas Patra, Sukanya Samridhi, Post Office Savings Schemes, etc. For those without access to banks, cash transactions are the only practical means to meet their everyday requirements and for small scale investments. The statement also mentions that Post Office accounts have been excluded from the rule imposed on small savings schemes.

Impact of Demonetisation on Indian economy

In a country where 85% of transactions take place by cash, cancelling the legal tender character of two high denomination banknotes arises a lot of questions. The service sector in the country that depends mostly on cash transactions will be adversely hit because of Demonetisation. Not to mention, the consumption activity of India has come to a screeching halt.  This drop in economic activity could last for a few months and as a result, GDP could fall significantly from the previous year’s values.

Even as country faces the greatest financial crunch of all times, some analysts predict the economic conditions to stabilize in a few quarters. Deutsche bank and Goldman Sachs expect India to join the list of the fastest growing economies by next fiscal year. An improved monsoon season in 2017 can favor agricultural economy of the nation, which in turn will add to the financial recovery as a whole. Economists also predict that the decision to scrap high-value currency notes will lead to GDP growth by 2%.

Effect of Demonetisation on bullion market

Demonetisation is expected to bring sharp changes in the prices of gold, and it is likely to start reflecting from the first quarter of 2017. At present, gold rates are not being announced by most of the jewelers due to dampening trade. Recently, government also announced the exemption limits on gold ornaments as the next giant move to curb black money. The notification comes within weeks after invalidation of Rs.500 and Rs.1000 notes. The following restrictions have been placed on the possession of gold:

• A married woman in India cannot keep more than 500 grams of gold in custody
• The limits for unmarried women are 250 grams
• Male members of the family can keep only 100 grams of gold.
• The rule is not applicable for legitimate gold belongings

Effects of Demonetisation on real estate

The unorganized sector will be largely affected by the invalidation of the higher denomination currency notes. However, there won’t be much of a change in the primary real estate market as property buyers make purchases either in the form of cheques or through loans. The impact of Demonetisation may be felt in secondary markets where most of the property dealings happen through cash. The currency reform is likely to yield positive results in the real estate sector with increased transparency in dealings. More opportunities can be expected from debt investment, private equity, and FDIs as well.

Demonetisation impact on equity and mutual funds

The effect of Demonetisation on equity funds is expected to be positive with more money entering the organized system of financial transactions. If cash flow across the nation is fully tracked, equities will strengthen significantly, as more people will invest in equity linked savings schemes to save on taxes.

Tax to GDP ratio

In an economic survey conducted last year, the tax to GDP ratio of India was found to be at 16.6%, which is comparatively low when compared to emerging markets across the world. But with deposits drifting away from the unorganized zones and getting channelized to banks, the tax to GDP ratio is expected to rise drastically. Analysts also predict a significant rise in the tax collection percentage, as all financial transactions will be under the scanner. Owing to the same reasons, government may also reduce tax rates.

Jan Dhan accounts

At present, the contribution of Jan Dhan accounts in terms of deposits has been significantly low in the overall banking domain. But post Demonetisation, these idle accounts are witnessing a steep surge in deposits. Another positive side of the Demonetisation is that government’s financial inclusion plan will gain momentum with a large number of people—including those from rural areas—opting for bank-based transactions.

E-wallets getting a major push

With the cancellation of Rs.500 and Rs.1000 currency notes, e-wallet companies such as Paytm, PayU India, Mobikwik, etc. are witnessing a sudden rise in their daily transactions. Demonetisation will also have an impact on the hiring needs and other business functions of these companies. Even app-based cab companies are launching their promotional materials to encourage cashless transactions.

Pre-owned vehicles market

Sales activities in the in used vehicle market is expected to decline following the Demonetisation move. This can adversely affect the original manufacturers to a certain degree, as prospective buyers may not find it easy to discard their old vehicles and go for a new one.

Effect of Demonetisation on interest rates

As a result of increased liquidity, RBI is likely to cut down the rates of interests applicable on fixed deposits, recurring deposits, and the like. Since banks are sure to accumulate huge deposits in the months that follow, the borrowing cost for Banks will be reduced. This benefit will be extended to customers in the form of lower interest rates on loan products.

Cement and steel industry

A temporary decline in sales can be observed in the cement and steel sectors which are closely linked to real estate. A closer look at the situation reveals sizeable impact of Demonetisation on construction industry—daily wage earners being the worst sufferers. However, with an increase in bank deposits complementing the savings rate, the short-term difficulties will be outstripped soon.

Short-term effect on GDP

Reduced consumer demands owing to dulled cash flow will trigger a considerable decline in GDP figures for a few quarters. The effect of Demonetisation on the above-mentioned industries such as construction, gold, and other secondary markets will be reflected in GDP. But, the situation will be under control once cash flow is normalized in these areas of business.

FAQs

1. Why did India demonetize the higher denomination currency notes?

   The scheme was introduced by government to eliminate black money and counterfeiting. Reportedly, a surplus amount of higher denomination fake currency notes were in circulation which accounts for a rise in crime rate too. The Rs.1000 and Rs.500 notes made up 86% of the monetary base of India and removal of these currency units will bring down cases of money laundering and tax evasion.

2. How to use the digital modes of payment?

   You can simply login to your internet banking account and access a multitude of services online. Through internet banking you can transfer funds, shop online, pay bills, recharge your phone, and do a lot more. You can also download the mobile banking app of your bank to transact online with your smartphone.

3. Does Demonetisation affect the notes issued prior to 2005?

   Yes, even the Rs.500 and Rs.1000 notes issued prior to 2005 have lost its legal tender status after Demonetisation. These notes can now be exchanged at the RBI offices.

4. What is the withdrawal limit on Jan Dhan Yojna accounts?

   The withdrawal limits on JDY accounts have temporarily been set to Rs.10,000 by RBI. However, account holders who wish to withdraw more than the specified limit will have to furnish valid reasons in support of the same.

5. Where can I exchange the banned currency notes?

   After 25 November, 2016, the exchange of the currency notes at the bank counters is not permitted. You can deposit the specified bank notes into your accounts.

6. How can I deposit cash without a bank account?

   Banks have been directed to expedite account openings for the unbanked sections. You can visit any bank with the required documents and open a new account.