Effect of Demonetization in India- Economic, Political and Social Perspective

Transcription

1 Effect of Demonetization in India- Economic, Political and Social Perspective Sriram K.V* and Lewlyn L. R. Rodrigues** The demonetization exercise by the Indian government has been a widely debated topic in the media by economists, politicians and common public. The objective of the demonetization was to flush out the black money in the system, make counterfeits ineffective and to curb terrorist funding. The impact, however, was such that it changed the lives of people, displaced them, and created ripples in society. The purpose of this research is to study the effects of demonetization in India primarily focusing on Economic, Political, and Social Perspective. The study used qualitative research technique to find out the effects of demonetization relying primarily on newspaper content analysis. Since the topic is of current importance the author has mainly relied on personal observations, interview and related articles in newspapers and reports by government and private organizations. The relevant data and information has been taken from interviews of eminent economists in media and articles on demonetization published by leading newspapers that carried multidimensional views. Since demonetization has been considered as a very important step by the government, this study provides insight into the impact of this exercise on the social, economic and political perspective. JEL Codes: E44, H11, G28 and H60 1. Introduction Demonetization is defined as the act of stripping the status of a currency unit so that it ceases to be a legal tender (Investopedia, 2017). In India it means that the apex bank (Reserve Bank of India) is withdrawing the denominations of INR.500 and On November 8, 2016, the Indian Prime Minister announced that the denominations of INR.500 and INR 1000 will cease to be legal tender from midnight and will be replaced by denominations of INR 2000 and a new currency of INR This means replacing 86% of currency in circulation. Cash withdrawal limit in ATM was fixed at INR 2000 and in banks at INR The objective of the demonetization was to annul the effect of parallel economy created by hoarders of black money. The World Bank in July, 2010 estimated the size of the shadow economy for India at 20.7% of the Gross Domestic Product (GDP) in 1999 and rising to 23.2% in Assuming that this figure has not risen since then and that the cash component of the shadow economy is also proportional, the estimated unaccounted value of the currency could be to the tune of INR.3.3 trillion. (HDFC Bank Investment Advisory, 2016). The definition of black money is vague and it could be the shadow economy which is restricted only to legal production of goods and services to avoid taxes and regulations (Schneider, 2010). It is also said that black money is kept in form of physical assets like gold, land, building etc., (Jose, 2016). But the *Dr. Sriram K.V., Associate Professor, Department of Humanities and Management, Manipal Institute of Technology, Manipal, Karnataka, India, id: kv.sriram@manipal.edu Phone: Mobile **Dr. Lewlyn L. R. Rodrigues, Professor & Head, Department of Humanities and Management, Manipal Institute of Technology, Manipal University, India, l.rodrigues@manipal.edu

2 government in India meant black money as money hoarded by non-tax payers, political parties and counterfeit currency pushed into the country s economy by other countries. The government expected that after the window period for depositing old currencies with the bank the currencies that were not deposited would amount to the total black money in the system. Considering a situation that people who have unaccounted money would not deposit fearing legal action. The expectation was also that more deposits will come into the banking system as people would deposit currencies in exchange of new denominations. Media was very active during the entire period of demonetization. The national and regional media went frenzy with news reports on the effects demonetization had on the people and the country. This study has used the reports that came in various national, regional and international news sites and newspapers. The information was collected from national news media like Times of India, The Indian Express, The Hindu, The Hindu Business Line, Economic Times, Forbes, CNBC, DNA and First Post. Regional Newspapers like Dinamalar, Dinathanthi and Dinakaran were analyzed for localized effects and information between November 2016 and January Post announcement by the Prime Minister the government came up with multiple objectives for demonetization such as ending terrorist funding and counterfeiting, abolishing corruption, promotion of digital economy to name a few. Though the objective was appreciable, the common man had to suffer during this phase. A fifty day window was given to deposit old currencies in the bank and it was perceived that things will improve post this fifty day period. In this paper the demonetization exercise has been discussed keeping in mind the following effects it will have on the system. 1. Success or failure of demonetization in political perspective 2. Effects of demonetization from economical perspective 3. Effects of demonetization on social perspective of common public 2. Literature Review Demonetization is a very bold move considering the size of Indian Economy. Many countries in the past have practiced this including India but this time the value of currency is much more compared to any previous past. Moreover considering the size of informal sector the chaos and confusion expected out of such an exercise was phenomenal. An estimate says that about 80% of employment in manufacturing and about 75-90% in the service sector in 2005 in India was in informal sector (Ghani, 2013). This figure gives an idea that this major section of people will have to bear the brunt of the withdrawal of currency. India is a fast developing country and the infrastructure for digital economy is still fully not in its place. User education and secured transactions were always a matter of concern. Market analysts predicted the negative impact demonetization is going to have on some sector of the industries like consumer goods, real estate, gold and automobiles (Credit Analysis Research, 2016). These are the industries where cash transactions take place to a large extent. Demonetization is not new to India. This exercise has been carried way back in 1946 and in In Jan 1978 currency worth INR 1.46 billion (1.7% of total notes in circulation was demonetized. Of this INR 1.0 billion (or 68%) was tendered back. In 1978 the value of demonetization was very small (only 0.1% of

3 GDP). However, the 2016 demonetization efforts covers 86% of the total currency in circulation which is 11% of the GDP (Manohar Chowdhary & Associates, 2016). Because of this sheer size the impact of demonetization this time was predicted to be huge. Moreover the political climate in India has changed recently and the new government has been very clear in its focus on eradicating corruption and black money from the system. The expectation of the people are high and they are looking forward for a change. The menace of corruption and black money in the system has ruined the country s economy. To some extent the political system has to be blamed because the focus on bringing black money into the system has been only on words and when it comes to the implementation the initiative was lacking (Sukanta Sarkar, 2010). The political community lacked the will to bring hoarders in front of judiciary mainly because it was the politicians who have been rumored to have hoarded money in foreign accounts rather than an ordinary business man. Though this exercise was taken in a positive sense by the general public who supported the initiative it was a tough time for people in the lower rung who were totally dependent of cash transactions for their daily expenses. As far as business is concerned the small industries took the impact and the middle level moved on to credit purchases envisaging future payment once the cash crunch is over. It is a fact that demonetization shook the Indian political, social and economic system. This paper is an attempt to study the impact of this exercise on these key systems which is going to have a long lasting impact on the life of common Indian. The development of a country depends mainly on economy which in turn is embedded in politics and society (Basu, 2000). The study on these three systems (political, social and economic) should give an idea about the effects of demonetization on the entire country. Hence the objective of this research is to study the effects of demonetization on political, economic and social environment of India. 3. Methodology This study dwells into the behavioral aspects of people during the demonetization period and hence the focus in on a qualitative approach to research. Being a topic that is of current importance, the research focuses primarily of written content in various newspapers by leading economists and politicians and reports by government and private organizations. Since the author relies on a qualitative content analysis, data are presented in words and sentences, which makes it possible to draw some interpretation of the results. The methodological steps used in this research are depicted in Figure 1. Inductive reasoning (a logical process in which multiple premises all believed to be true or found true most of the time are combined to arrive at a conclusion) was done by reading these articles, reports and cases. Other relevant data and information has been taken from subject papers by economists, articles and reports given by leading private banks and financial consultants. The author relied on newspaper content analysis and literature because newspapers remain one of the few relevant sources of information for this current topic. They also provide an empirical analysis of the situation. Newspapers also carry a wealth of information regarding different aspects of the demonetization exercise, including opinions of eminent economists and politicians which was otherwise difficult to source. Different newspapers also carry different views and

4 opinions regarding the effectiveness of the exercise, alongside the socio-economic impact of the move. The flow chart below (Fig. 1) depicts the methodology used in this study. Fig. 1-Qualitative Content Analysis (Source: Mayring, 2000) Research Objectives Determination of categories / Inductive reasoning Mapping of concepts 4. Results and Analysis The Economic Perspective Interpretation of results Economists argue that removing 86% of the currencies from circulation would have an impact on the economy. Many leading economists came out aggressively against this decision of the government. To quote a few Amartya Sen Leading economist, Noble Laureate called the move authoritarian. He came down heavily on the exercise claiming this as anti-people. Manmohan Singh eminent economist, former Prime Minister and governor of the apex bank of India called demonetization an organized loot, legalized plunder and monumental mismanagement. Arun Shourie former economist at World Bank claimed that black money hoarders do not hold black money in form of cash. He viewed that the entire exercise was ill planned (Iyengar, 2016). There were also views that supported the efforts of the government. There has been a widespread criticism on economist view of demonetization because the effect on economy can only be felt in the long run. Economy as such is complex and cannot be predicted clearly. It is complicated hence only in the long run we get to know what exactly happens to the economy. (Worstell, 2016) So any conclusions on the effect just after 50 days of demonetization could not be justified. We can consider the effect into short and long term. Both the short term and long term effects of demonetization are important if we have to consider the effect on economy as a whole. It is understandable that in the short term there will be fall in GDP due to drop in consumer spending, drop in jobs in the informal

5 sector where unaccounted money was being used. But in the long run clean economy could emerge. Looking at the Reserve Bank of India and the Government s strategy only a part of cash that is being deposited is going to come back into circulation. Which means people are being encouraged to use internet banking and digital transactions to a greater extent and reduce use of cash transactions. In fact as per the RBI requests which was published in The Hindu a leading Indian National Newspaper (The Hindu, 2016) the supreme bank has asked people to switch to alternate methods of payment. The short term effect on economy could be seen with low consumption level in cash driven sectors like vegetables, fruits, flowers and other perishables due to less cash in the hands of consumers (Dr. Kavita Rao, 2016). The short term effect can also be seen in increasing collection of income taxes and indirect taxes as people would use the unaccounted cash to pay these off. There is a drop in savings in form of physical assets and financial savings has increased (Biswajit Chatterjee, 2016).The deposits in banks increased due to the demonetization and this has resulted in the capacity to lend more. This is likely to reduce the interest rates for loans. The Fast Moving Consumer Goods (FMCG) sector reported a drop in 1-1.5% if sales which is close to INR.3840 crores (38.40 billion) though the net impact is not much considering the size of FMCG market in India which is close to 2.56 lakh crores (INR 2560 billion) (Times of India, 2016). HSBC's chief India economist, Pranjul Bhandari, said in a report that about 60 percent to 80 percent of India's consumption basket is cash-intensive, including food, transport, real estate and restaurants. She expected India's full fiscal year gross domestic product (GDP) growth to be 0.7 to 1 percentage point lower (CNBC, 2016)The World Bank has put the growth of GDP of Indian Economy at 7 % from its earlier estimate of 7.6% post demonetization. The growth rate is still good compared to China which has a growth rate of 6.5% for the year 2016.But the macro effects of the demonetization could improve the Indian economy. Because of the reduction in unaccounted money and digital transaction there is possibility of increase in government finances and would reduce its liabilities. This means there is a good opportunity for the government to spend more money on infrastructure and other areas. The GDP projection given by the Central Statistics office (CSO) of the Government of India in January 2017 pegged the GDP for the financial year 2017 to be around 7.1% which is lower compared to the last year percentage of 7.6. This estimate had not taken into account the effect of demonetization which means the GDP will fall further and will have a huge impact in the Indian economy. The GVA (Gross Value Added) growth is also estimated at 7% which is less compared to previous year of 7.2% (The Hindu Businessline, 2017). Surprisingly the same CSO on March 1, 2017 has given the growth percentage of key sectors which is given below in Fig. 2 CSO has maintained its January 2017 estimate of 7.1% even after considering the demonetization (Hindu, 2017) which is a good news for the economy of the country.

6 Growth in % Proceedings of Annual Eurasian Business Research Conference Fig.2 Estimates of Economic Growth (Source: Central Statistics Office) *First advance estimate ** Second advance estimate Series 1: GDP growth, Series 2: GAV growth, Series 3: Agriculture growth, Series 4: Industry growth, Series 5: Services growth The short term effects are being seen in the economy and it is quite palpable due to the performance of certain sectors. It is more important to look into the long term effect the entire exercise is going to have on the Indian economy. Long term impact on the economy will be Growth of cleaner economy More deposits in bank so more loans to public Reduced lending rates by bank Reduction in taxes due to more money in coffer More people coming into tax brackets Ease of doing business due to digital transactions Lesser unaccounted money in the system Less corrupt economy so increase in FDI More government spending on infrastructure due to less liabilities Continuous monitoring by the government and sustained efforts for a less cash economy will be productive and drive the economy towards greater growth. Political Perspective The last three months were the politically most active climate in India. With announcement of demonetization the verbal war broke out between the ruling and the opposition parties. The opposition parties cried foul saying that the government had protected its party s interest before the announcement. They also commented on the lack of preparation for such an exercise. There were also widespread debates and discussions on whether really black money will be flushed out of the system. Political leaders were of the view that black

7 money circulation in India is not much but the amount of unaccounted money stashed in foreign banks with tax havens are comparatively more. The opposition parties vehemently attacked the government and stalled the entire session of the parliament in the month of November The sufferings of the people were highlighted and long queues in front of ATMs and banks were the examples shown of the failure of government to prepare itself before the implementation of such an exercise. Some of the political leaders were more careful and blamed the poor implementation of the exercise than blaming the objective of demonetization. The opposition also criticized the move saying that the entire announcement was an election gimmick for the forthcoming state election which included a major state like Uttar Pradesh. The forthcoming election result in the state of Uttar Pradesh, Punjab and Goa may be a referendum for the ruling party on the demonetization drive. The government of India in reply produced a report card post 50 day window period that gave the following data. Tax collection increased during this window Significant increase in collection of Indirect taxes Rabi crops sowing had little impact on demonetization rather it increased during this period GDP reduced but not to the extent predicted by economists Hoarded money recovered to the tune of 3500 crores According to RBI INR12.44 lakh crore (1 crore =10 million) of demonetized notes have been collected by the bank as on December 18, 2016 (DNA India, 2016). This return has ensured increase in taxes collected. The initial survey by the government showed 90% of the people supported the government move on demonetization as they believed that it will bring out black money from the system and bring hoarders to limelight. Political parties in India rejected the report card and cited continuing huge crowds in front of banks and ATMs and drop in purchases as a failure of the exercise. The government was firm on its stand and it defended the entire exercise promising a cleaner economy and bring more people into the banking and tax system. The government made it clear that in the long run this drive is sure to bring positive results. By and large the people supported the move and there were no major revolts or riots. Politically the exercise was in favor of the government. But the perception of people might change if the promised results did not happen in the coming financial year. The state elections in the coming months will also give us an indication of how people have taken this move politically. Social Perspective The social impact was drastic particularly among the lower economic section of the population. Employees on daily and weekly wages were adversely affected because of non-availability of cash. Due to this most of them were rendered jobless. These were the

8 people who relied on ATMs as a source of money and were therefore largely impacted due to the bottleneck created by the lack of printed currency when the exercise of rendering the larger denominations of currency as illegal tender was introduced by the popularly elected government in India without any prior notification. The initial weeks after announcement saw huge crowds in banks and in front of ATMs. On observation and interaction it was noticed that most of the people who stand in front of ATMs take money as a precautionary measure and not because of need to spend 2000 INR every day. It was also noticed that majority of the people who lined up in banks were elderly who are not familiar with internet banking or digital transactions. Many turned around to check balances or to update pass books and most of such transactions were triggered by sheer panic more than the real need for cash. Majority of the people seeing various television coverage and newspaper articles on the possible crisis had rushed to the bank to be on the safer side. Places like Bengaluru which employs majority of young people in IT sector did not get affected like other areas. This showed that digital economy supported these areas in spite of the lack of currency. Sellers of products like flowers, fruits and vegetables were affected since they are not equipped and educated to use cashless transactions. Kerala a state in India reported that 56% of its economy is in doldrums post demonetization. Cash-intensive sectors such as retail trade, hotels, and restaurants and transportation account for over 40 percent of the Kerala economy, and the primary sector accounts for another 16 percent of the economy. Thus, 56 percent of the economic activity of Kerala is immediately affected by the withdrawal of specified bank notes (Chandrashekar, 2016). The small scale industries which employ mostly labor who were paid in cash also got affected due to withdrawal of currencies. Tirupur a small industrial town in the state of Tamilnadu reported a drop in orders by 50% and drop in production by 20 to 40% (Times of India, 2016). Most of the laborers were forced to return to their native towns because of lack of work and shortage of currency. In spite of the difficulties people believe that a change is possible if there is a proper direction and are willing to put up with the hardship when change is happening. The society also witnessed positive trends which when sustained will result in a welcome change. Demonetization has brought in better discipline in many public places. People are willing to stand in queue without complaining People are learning more about digital economy and they do not mind going digital to curb corruption There is a general perception that corruption will end and people are ready to contribute a little by withstanding the hardships post demonetization People seem to have learnt to avoid unnecessary spending 5. Conclusion The economic effect of this exercise can only be felt on a long run. The immediate drop in GDP may last from a quarter or two but the long term effects needs to be seen to come

9 to a final conclusion about the success in the economic front. The expectation of economy to boost immediately after demonetization is highly impossible. Since the GDP drop seems to be minimal and India being a robust economy there are chances that the economy will improve much better in the year 2018 due to cleaner economy, widening tax collections and transparent transactions. The country should follow-up the demonetization exercise through constant effort to switch to digital transactions so that tax collections increase. Efforts should be made consistently to educate people to adapt to technology for faster growth and more efficient business dealings. The political effect seems to be positive for the ruling government since the post demonetization survey showed people supporting the move. Though the hardships of the people cannot be disparaged the majority seemed to have a taken this positively and are eagerly waiting for a cleaner economy. But the impact on political climate can be seen only in form of elections which is a couple of years away for the election of Central Government. There are various states going to polls in the month of February and March 2017 and the elections are fought with demonetization as a referendum. So the results of these polls could be an indication of how political climate is impacted because of this drive. Socially the impact was larger. The poor is suffering and it is very difficult to convert them to a cashless economy in the near future. The infrastructure does not support digital transactions and the people are not educated enough to change to a cashless economy. Hence there should be consistent effort to educate people in this front which will take time and effort. But if we educate and bring them to a cash less economy it will improve their

10 Fig.3 Impact of demonetization (Source: Authors) Political Referendum in form of elections Fall in GDP Results awaited Short term Small business affected Consumer Spending Lessens Demonetization Economical Clean and robust economy Digital and transparent operations Long Term Widening tax collections Reduction in bank lending rates Panic and confusion Social Short term Long Term Loss of jobs Poor digital education Discipline in public life Conversion to digital economy Positivity Prudent Spending social life. It was also observed that people by and large supported the entire move and were willing to take the pain for a long term good. The Fig.3 summarizes the effect of demonetization from the political, economic and social perspective. Limitations and Future Scope This research was carried out during the demonetization window and the immediate months thereafter that is between November 2016 and January 2017 hence the long term effects on economy and political climate could not be estimated in objective terms. The clear impact of this entire exercise can be well analyzed and discussed in years to come. This study focusses on reports and articles. A quantitative study to measure the impact of demonetization can be carried out. This topic is being extended to study the impact on economy on the long run. The study is also being continued to find out the impact of demonetization one particular section of the economy. The study can further be extended by comparing it with demonetization efforts of other countries in the past.

11 References Basu, K., In: Prelude to Political Economy-A Study of social and policial foundations of economy. New York: Oxford University Press, p. xi. Biswajit Chatterjee, A. B., The Impact of Demonetization in India. [Online] Available at: Chandrashekar, C. P., First Post. [Online] Available at: CNBC, [Online] Available at: 7. Credit Analysis Research, L., Economic consequences of demonetization of 500 and 1000 rupee notes. [Online] Available at: 500%20and%201000%20notes.pdf DNA India, DNA India. [Online] Available at: lakh-in-demonetizednotes-dg-gandhi Dr. Kavita Rao, D. S. M. D. S. K. M. D. S. S. T. a. S. H. N., Demonetization-Impact on Economy, New Delhi: National Institute of Public Policy and Finance. Ghani, E. W. J. K. S. D. O., The Exceptional Persistence of India's Unorganised Sector, s.l.: World Bank Policy Research Working Paper. HDFC Bank Investment Advisory, Demonetization and its Impact. [Online] Available at: Hindu, T., [Online]. Investopedia, Investopedia. [Online] Available at: [Accessed 28 February 2017]. Iyengar, R., Indian Express. [Online] Available at: Jose, T., [Online] Available at:

12 Manohar Chowdhary & Associates, C. A., Demonetization. [Online] Available at: Schneider, F. A. B. a. C. E. M., Shadow Economies All over the world New Estimates for 162 countries from 1999 to 2007, s.l.: World Bank Policy Research Working Paper. Sukanta Sarkar, The Parallel Economy in India: Causes, impacts & government initiatives. Economic Journal of Development Issues, pp The Hindu Businessline, Hindu Businessline. [Online] Available at: article ece The Hindu, The Hindu. [Online] Available at: Times of India, [Online] Available at: Rs-3-8k-cr-FMCG-sales/articleshow Times of India, [Online] Available at: Worstell, T., Forbes. [Online] Available at: