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April 04, 2017 @ 01:15 PM

Complexities Of Demonetization


Published : Tuesday, 10 January, 2017 10:30 AM


Complexities Of Demonetization

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Read Current Affairs Topic:  Complexities Of Demonetization

On November 8, 2016, India had another ‘Tryst With Destiny’ when Prime Minister of India announced the demonetization of the currency notes of INR500 and 1000 denominations. Whenever a currency is stripped of its status as a legal tender, it is called as demonetization. The demonetization of currency was introduced with the objective of twin objectives of fighting black money as well as fake currency. Ever since the demonetization move, India is divided into two blocks, one is vehemently opposing the move while the other is supporting it at any cost.

Since the demonetization, non-ending queues have become a characteristic features of banks in India. However, according to the Indian Bank Association, the use of indelible ink had reduced the length of queues outside the banks by around 40%. Also, situation markedly improved on November 19 as apart from senior citizens, only bank customers were allowed to exchange currency at their respective banks. 

Since the demonetized currency accounted for 86% of the total liquidity in the economy, the move had brought cash crisis like situation in the economy. The current rate of withdrawal from banks and ATMs is much more than the supply of new currency from the central bank. The financial analysts have different views about the time required to replenish the currency shortage varying from 45 days to six months against the government’s view that situation will normalise within two to three weeks. The recalibration of all ATMs across the country to dispense the new currency may take another couple of weeks. The situation is expected to start normalising only when all ATMs across the country become fully functional,

The main target of demonetization was black money which is believed to be around 20% of the GDP. The black money is hoarded not only in the form of cash but in the form of bullion and benami property as well. Nevertheless, it will definitely affect the money supply as people with ample cash, which will soon become junk, will have only two options, either to disclose it by depositing in bank or let it become junk. The demonetization is expected to reduce the overall money supply by 16-17% which in turn will bring down the prices.

Current estimates suggest that out of INR140,000 crore, which is in the form of INR500 and 1000 notes and forms 86% of the money supply, roughly INR300,000 crore would not be exchanged for new notes ever. This entire disappeared black money will be profit to the Reserve Bank of India (RBI), and will be transferred to the central government as dividend. That money will be a boon for social and economic infrastructure. Also it would reduce the fiscal deficit of the government.

Over the past ten days, deposits at banks have increased a lot. Rising deposits coupled with low inflation puts a suitable case for lowering of interest rates. In fact the State Bank of India (SBI) had already reduced the rates by 15 basis points to 6.90% on deposits of one year to 455 days. The SBI Chairman Arundhati Bhattacharya said, “All rates will fall. The bank has seen huge inflow of deposits but demand for credit has slowed down. Therefore, lending rates too will fall but after a gap.” The low interest rate regime is expected to produce stimulus for the economy.

A lower deficit along with low inflation and low interest rates would definitely be a best bet for the economy given that loss in the production due to shock of demonetization will not offset the benefits. If the government will be able to move out of the current currency crisis, the long term benefits will be definitely immense for the economy.

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