Demonetization in India

Published: 2018-07-26 20:20:34
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What is Demonetization?

Demonetization is the process of withdrawing or pulling out a currency from being used or circulated in exchange of a new currency of the same legal status. De-monetization usually replaces the old currency with a new currency of the same or equal legal status. There are reasons why India and many other countries de-monetize currency which include; to reduce corruption and crime such as money laundering, to reduce inflation, and to facilitate trade with a more valuable currency.

The India government decided to de-monetize the 500 and 1000 rupee notes for the new 2000 and 500 rupee bills. The notes represent approximately 90% of the cash that was circulating in the economy, as majority citizen prefer to transact in cash. The India’s Prime Minister Mr. Nerandra Modi stated that the currency was worthless and needs to be replaced immediately (Mehta and Mehta, 2016). The implications of the de-monetization currency include; fall in the economic growth of the country, Change in consumption pattern lead to loss of revenue, E-commerce increased, reduction in repo rate, effect on employment, reduction on interest rate, effect on financial market, and foreign direct incentives,

The India’s fiscal year falls between April and March the following year. Through economic analysis, the first quarter of the fiscal year 2016-2017 before demonetization the GDP rose by 7%, and the GVA also rose by 7.3% which is almost in the equal proposition. But the introduction of demonetization led to a decline in GDP and GVA due to a fall in economic activity (Kumar and Kumar, 2016). Economist predicts that during the first quarter of 2017-2018, the GDP and GVA is likely to grow due to the absence of counterfeit money which in turn will attract more foreign investors into the economy. 

Economic Growth of India

The economic growth of India is likely to fall as there is a shift in the consumption pattern. Consumers are spending their money on the essential commodities such as food, health care. This implication has hurt the companies operating in India as they experienced a fall in revenue. The fall in revenue has adversely affected the international companies as they have to pay more taxes. The imports to the country reduced by about 35% which implies that the international companies had a fall in revenue due to change in consumption pattern. Similarly, companies dealing with real estate reported a 30% fall in house prices. The automobile industry similarly experienced a fall by 35% in the revenue generated (Mehta and Mehta, 2016). The change in consumption pattern is a clear indication of a fall in inflation as less money is in the economy to spend.

Demonetization in India has affected the exchange rates in the cross-border trade. Exchange rates have risen as there was more demand for the new currency as therefore became expensive to acquire. Most foreign investors preferred to pay up their bills in other currency or another form of payments. As a result of the appreciation of India rupees in the exchange market, most traders preferred e-commerce transaction and abandoned the usual cash transaction (Tandon and Kulkarni, 2017). According to Central Statistics Office, India, e-commerce transaction rose by approximately 65%, which was one of the aims of the government when demonetizing currency as cash based transaction was proven too expensive.

Demonetization caused a reduction in repo rate. The repo rate was reduced by the Reserve Bank of India by 25 basis point, which translates approximately 6% reduction in the lending rate to commercial banks. The reduction in the lending rate to commercial banks immediately translated to a reduction in the loans being offered to individuals and companies hence a reduction in the consumer purchasing power (Mehta and Mehta, 2016). The reduction in repo rate implies that the people will only focus on buying the basic needs and thus most industries such as an automobile, real estate, and even the banking sector was adversely affected. International trade was adversely affected as imports declined by 35% while exports increased by 20%.

India being known as the leading country in outsourcing services, demonetization caused increased in cost of labor, and thus international companies such as Tata consultancy services had to lay off a significant number of employees. According to central statistics office India, 0.5% of the employees in all sectors were laid off (Kumar and Kumar, 2016). The laying off of staffs attributed to lower revenue being reported in the period and thus translated to losses as a result of increased in the cost of operation. 

Repo Rate

After the repo rate had been reduced, the banks reduced the interest rates so as to make consumer borrow the money to finance most of their operations. The decline in interest rates, however, was a remedy to increase the money into the economy so that the process of demonetization can be successful and also to restore different sectors of the economy that had been sufficiently affected for example the real-estate sector. The decline in interest rate had no effect on international trade as foreign investors rejected cash-based transactions for other modes of payments such as cheque or online payments. The locals and the businessmen had little or no motive of borrowing as they were in the process of eradicating the unwanted currency (Tandon and Kulkarni, 2017). Demonetization caused a negative effect on borrowing as there was little or no motive of holding more cash in the economy despite effort from the bank to reduce the interest rate.

Demonetization had a huge implication on the financial markets. The two large financial markets S&P BSE Sensex and Nifty 50 fell by 5.5% and 6.3%. This was due to an increase in the value of US dollar as compare to India Rupees. Similarly, demonization caused investors to shift their focus from investing in Indian companies to other companies as there was speculation that investing in the Indian companies could not yield adequate returns (Kumar and Kumar, 2016). This only was short-term as December 2016; the market reached the normal mark.

Demonetization had a positive impact on foreign direct investment as it rose by 30% to 21.6 billion dollars. The foreign direct investment recognized that the government is eradicating malpractices such as money laundering, counterfeit and corruption and their by setting up an enabling business environment to trade (Tandon and Kulkarni, 2017). Different companies such as Panasonic and Pepsi have come up to set up manufacturing facilities in India in 2016. Since the government introduced demonetization; different foreign companies have come up with investment in India. Similarly, the government has encouraged foreign investment by coming up with initiatives such as “Make in India.” This has made the GDP in the last quarter of 2016- 2017 to rise by about 7%.

In conclusion, although demonetization has many disadvantages to the economy and globally, it is only short-term, and the benefits are usually high in the long-term. Demonetization usually eradicates malpractices that have been happening and thereby fostering an enabling business environment for trading activities.

 

References

Kumar, S. V., & Kumar, T. S. (2016). DEMONETIZATION AND COMPLETE FINANCIAL INCLUSION. International Journal of Management Research and Reviews, 6(12), 1703.

Mehta, S., Patel, K., & Mehta, K. (2016). Demonetisation: Shifting Gears From Physical Cash To Digital Cash (No. 2016-12-14).

Tandon, D., & Kulkarni, B. (2017). Demonetization in India: The Good, Bad and Ugly Facets. Asian Journal of Research in Business Economics and Management, 7(1), 41-47.

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