NAME: HARINARAYAN MANI

ROLL NO: M18078

MANAGERIAL ECONOMICS
ASSIGNMENT

TOPIC: DEMONETISATION
CONTENT

Demonetisation is the act in which a currency unit is stripped of its status as legal
tender. On 8 November 2016, when our honourable Prime Minister Shri Narendra
Modi addressed the nation, he made an announcement that is considered to be the
most disruptive policy in his tenure so far: that the Rs. 500 and Rs. 1,000 currency
notes would cease to be accepted as legal tender from that midnight. This news
shook the nation. The objective was supposed to be economic as well as political.
Modi articulated a political angst against anti-national and anti-social elements, and
established that the rights and interests of the honest, hard-working people will be
protected as he cited high levels corruption and the huge spread of black money in
the economy. In addition, the objective was to curb counterfeit currency and terror
financing from across the border.

In the initial days of the policy announcement, people could exchange notes worth
Rs. 4,000 per person in banks, and ATM withdrawals were restricted to Rs. 2,000
(which was later raised to Rs. 4,000) per day, and the overall limit for the week was
Rs. 20,000.1 Human inconvenience and pain could have been lessened had there
been short or medium-term positive outcomes, as had been envisaged while drafting
and delivering the scheme which was accomplished first through Modi’s speech,
then by an 8 November 2016 Reserve Bank of India press release, followed by a 30
December 2016 Ordinance, and finally by the Specified Bank Notes Act passed by
Parliament on 27 February 2017.2 The Government permitted use and exchange of
old notes in government hospitals for treatment and purchase of medicines. Making
payments for milk and utility bills using old notes was also permitted. To ensure
convenience and freedom of travel within the country, purchasing tickets in
railways, bus and air travel were permitted using old notes, and exemptions were
laid on toll payments on highways. Use or exchange of old notes at international
airports was also permitted. A grace period was also offered on purchase of petrol,
diesel and gas and LPG gas cylinders for cooking. In view of sowing season, old
notes were permitted to be used for purchase of seeds. Provisions for marriage
functions were also made wherein cash was provided at the bank counters. Post
offices also helped in exchange of old notes. 3

However, with 98.96% of the notes returning to the banking system, demonetisation
created acute individual distress among the citizens, which the finance minister
declared anecdotal. It hit real estate, the unorganised sectors, growth slowed down
due to reduced demand, supply chains got disturbed and uncertainty rose to an all-
time high. Moreover, this also led to a decline in cash-sensitive stock-market
sectoral indices such as realty, fast-moving consumer goods, automobiles, and
specifically hurt the economy driven by cash. All this, without any tangible
destruction of unaccounted-for money, reduction in bribery or fall in the number of
counterfeit notes. All this led to a sharp exponential increase in digital transactions
amongst new users.

HISTORICAL BACKGROUND

But this was not first instance of an Indian currency being banned suddenly. Modi
wasn’t the first one who attempted demonetisation in India. While the policy caused
short-term problems for the economy, particularly the informal sector, the fact that
almost all the money had returned through accounts into the banking sector holds
potential to map and track unaccounted for inflows. Demonetisation has been
implemented twice in India in the past - 1946 and 1978. The currency notes of
Rs.1,000 and Rs.10,000 were removed from circulation when demonetisation took
place in 1946. The ban failed to have much of an impact, given the inability of the
common people to access notes of such a high denomination. However, both notes
were reintroduced in 1954 with an additional introduction of a currency of Rs 5,000.
The second demonetisation occurred in 1978; the then Prime Minister of India
Morarji Desai announced the ban and took Rs.1,000, Rs.5,000 and Rs.10,000 out of
circulation. The sole aim of the ban was to curb black money generation in the
country.

Modi’s primary aim was the same. Other reasons were to promote a more digitized
economy and lower the cash circulation in the country which is directly linked to
corruption. Another objective was to eliminate counterfeit currency and dodgy funds
which have been used by terror groups to fund terrorism in India. This has not only
led to innumerable terrorist attacks in the nation but the areas of Kashmir have been
particularly suffering for decades from several such attacks. The move is estimated
to scoop out more than Rs.5 lakh crores of black money from the economy. India is
an economy wherein 98% of transactions by volume and 65% by value are made
using cash. 4 Cash is difficult to handle and carry and tracking cash has become
difficult for the Government. With no demonetisation drive since 1980s and despite
opening up the conservative economy in 1991, there are cases of tax evaders
hoarding a lot of money in their homes, lockers, etc. which has disturbed the
economy in stabilising the rupee against the dollar. The proven fake currency route
through Pakistan, which is used in terror funding and other anti-national activities in
India were not being addressed as they were beyond Government control. The main
issue was believed to be that the fake notes are sourced from the same paper
manufacturer that supplies to the Reserve Bank of India. It is tedious for the
government of a country with a population of 1.25 Billion to handle various issues
and a stiff opposition which speaks against India for its political gains. With all these
in mind, this policy was introduced.

In 2016, the Modi-led government had controlled inflation and reduction of inflation
led to a reduction in interest rates which made India more investment friendly. It was
a kind of Swachch Bharat Abhiyan drive by the Government in the black money
segment to get more perspective points and reduce its effect on the economy
controlled by a select set of powerful politicians and businessmen. Barely 3% of the
population pay Income Tax in India of which nil return is filed by 66% of them. As a
result, India needed a route to get better revenues for the betterment of the nation as
a growing superpower. The honest taxpayers never had to worry as even a huge
amount (Rs.10 Lakhs) as cash in hand was acceptable provided its legitimacy could
be proven. This surprise move by Government was an unforeseen catastrophe for
people who accumulated lakhs and crores of unaccounted cash inside cupboards,
mattresses, etc. 5
DEMONETISATION IMPACT ON VARIOUS PARAMETERS

A year after demonetisation was announced, there was a substantial decline in

lending and deposit rates. The chart that is taken from the Reserve Bank of India’s
monetary policy report given below provides the details.

a. Interest Rates

From the chart we identify in the pre-demonetisation period- RBI lowered the repo
rate by 1.75 percentage points and the weighted average lending rate(WALR) on
loans that were outstanding went down by 0.75% points. But in the year following
demonetisation, despite the repo rate being lowered by a mere 0.25% points, the fall
in WALR on outstanding loans was 0.50% points. We see that the fall in interest
rates in the year post-demonetisation was equal to the fall pre-demonetisation,
despite much lower reduction in the policy rates. The chart also exhibits how term
deposit rates for banks decreased after demonetisation. Demonetisation and the
resultant surge of deposits into banks ensured banks passed on reductions in the
policy rate, helping borrowers. On the flip side, the very low interest rates on bank
deposits led to a good flow of funds to the capital markets as one of the most used
financial instruments by the middle class did not offer significant returns. 6

b. Impact on National Income Growth rate and GDP of our nation

The values recorded in both gross domestic product (GDP) and gross value added
(GVA) measures show that growth was on the decline. The data indicates that
growth, closer to 8% in the first quarter of the year, had slipped to 6.1% by the end
of the financial year. The GVA measure reveals the same sentiment, with growth
sliding from 7.6% in the first quarter to 5.6 %. Most extreme drop in growth rates
were recorded in the fourth quarter. Full year GDP growth slipped to 7.1% in fiscal
2017 compared to 8% the previous quarter. In GVA terms, the economy grew at
6.6% in fiscal 2017 compared to 7.9% last year. GVA growth is a measure of
economic growth which eliminates the impact of subsidies and indirect taxes. 7

c. Impact on price levels

Prices of commonly consumed commodities like pulses, fruits, vegetables reduced

substantially post-demonetisation. This was also due to the fact people were
reluctant to spend on such items as the usual grocery stores or the vegetables seller
did not have digital payments system, a huge deterrent due to limited withdrawals,
less cash in hand and the complications involved in withdrawal of money. This also
brought down the rate of inflation during the months that followed demonetisation.
The chart above represents the impact of demonization on commodities. India's retail
inflation actually hit a two-year low in January at 3.17% as various businesses
resorted to methods such as price discounting for boosting sales as they were in
danger of accumulating inventory, following Government's cash crackdown.
d. Business Cycle Phases

Demonetisation was a boon for Fintech companies as people accepted digital

payments as part of their lives and moved towards a cashless economy. The above
chart shared by RBI regarding digital transactions since January 2016 to August
2017 reflects that NEFT transactions involving Rs.7,086 billion increased to
Rs.12,500 billion and IMPS transactions, otherwise used very sparsely by people,
got a share of Rs.651 billion. People also used more mobile wallets than cash due to
paucity of cash in hand and difficulties involved in obtaining the same.

Post demonetisation, the sentiment of people investing in stock market in India

became bullish. The BSE index was 27,459 on November 7, 2016 and rose to
33680.92 a year later. The NSE rose from 8497 to 10,443. Above data shared by
Bloomberg reflects an upswing in the stock market.

In the automobile sector, sales of two and four-wheelers showed a decline in 2016.
This increased substantially in 2017 and recovered to perform well in a high positive
growth as reflected in the chart below.

Banks’ finance to small businesses was decreasing in pre-demonetisation period. As

on November 2016, there was actually a decline of 7.71% that was recorded in
Banks’ lending to small businesses. However, in September 2017, the RBI reported
a positive growth of 1.65% in the same. The chart below depicts that.

Thus, the above sectors enjoyed an upswing in their business cycles.

However, there were downswings in some businesses due to demonetisation. Small
businesses suffered in the initial days of policy introduction due to lack of cash.
Farmers also suffered in the initial days due to the same reason. The real estate
sector was the worst hit. The supply of new housing units in the top-6 cities in India
during the first three quarters of 2017 was down by around 60%, compared with the
corresponding period of 2016. With respect to property sales, the secondary market
was heavily susceptible to demonetisation compared to the primary market. Property
transactions in secondary sales and luxury housing segments had significant cash
components, and such sales suffered significantly. The below chart has the details of
stalled projects. 8

SUGGESTIONS THAT COULD HAVE BETTERED THE

IMPLEMENTATION OF THE POLICY

The implementation of any idea and specially a crucial one such as demonetisation
is almost equally critical if not more, than the policy itself, in a country like India.
The Government could have certainly minimised the suffering with better planning.
During the initial stages, sole dependence on bank approved security vehicles should
have been avoided and could have additionally used BSF/CRPF/Police vehicles to
transfer funds to far flung locations. There is an abundance of companies in the
FMCG as well as financial services in our country that have extensive country wide
network like ITS, Sundaram Finance etc. Also Oil companies and LIC are examples
of those who have branches and distribution network in far flung locations. Co-
opting them as temporary or correspondence Banks to distribute new notes etc
would have eased the pressure on banks as customers would have not felt the need to
stand in long queues for replacing their old notes.

The second possible change that could have been brought in the implementation is
that the RBI should have alerted the Government about incompatibility of ATMs
with new notes and time taken for re-calibration as the amount of new notes loaded
in ATMs was insufficient and this further added the number of people waiting in
queues for withdrawals and exchanging of notes.

It is estimated that around 10 percent of our GDP every year is not accounted or
black money. The GDP was around Rs 150 lakh crore in 2016-17 – 10% of which is
Rs.15 lakh crore. The next step would be to limit the holding of cash to Rs.15 lakhs
per individual which, if implemented would have dramatically changed the whole
situation. Even as of now, there is no restriction on holding any amount of cash.
Before the onset of 2009 general elections, an expert committee formed by L K
Advani in 2008, had proposed certain measures to curb the menace arising out of
black money, one of which was to declare the possession of cash above, say Rs.15
lakhs as a punishable offence. That would automatically lead to reduction in stashing
the cash. In the budget, the Government had made cash transactions to be limited to
Rs.2 lakhs in case of capital items and Rs.10,000 in case of revenue expenditure. But
there was no such limit for holding cash for individuals as well households.9

Lots of small businesses were impacted, cash being the primary medium of
transactions for them. However, their case is different from that of black money. To
alleviate their struggles, the Government could have passed the Mudra Act before
introducing the demonetisation policy as that would have increased the availability
of credit to small businesses which would have also reduced their dependence on
money lenders and cash.

LEARNINGS FROM THE COURSE

To begin with, as a business student, the Economics course was not only helpful in
setting up a foundation for grasping the tougher concepts in economics and finance
but also helped me in gaining an overview of important policies and matters related
to our country.

From a layman’s perspective we always comment on how any policy or issue that is
introduced into the country is harmful or beneficial but this subject in our first
semester helped us in attaining an elaborate knowledge of what all is contemplated
by either the Prime Minister or the Reserve Bank of India before taking a final
decision on the matter.

Being an engineering student, the Law of Demand, Demand analysis helped me

learn the basics of microeconomics. It was very useful in linking consumer
behaviour with the movement of demand and supply. This made grasping the
concept of Demand elasticity easier than how it would have been otherwise.

The importance of regression testing cannot be underestimated as it helps in

quantifying the relationship between two different variables. It also helps in
identifying if the variables are correlated and how are they correlated. Regression
analysis in the initial stages of this course, thus was of great learning.

The concept of production – Total Physical Production(TPP), Marginal Physical

Production(MPP) and Average Physical Production(APP) helped understand the
stages of production and its application in life as to how electronic companies
provide their services such as extended warranty, free services, etc. The concept also
explains why highly reputed firms go for full replacement rather than repair.

The revenue analysis taught me the concepts of fixed (establishment) costs, variable
(operational) costs, and marginal costs. It also gave me knowledge of short run and
long run costs, the relationship between AC and MC curves, internal and external
economies and diseconomies of scale and its applications in real-life.

Perfect Competition is a necessity in order to understand imperfect competition and

this enables us to understand how competition exists in the market. The topic also
discusses about AR-MR relationship and I also learnt the short-run and long-run
dynamics of the competitions. This also helped us in understanding how dominant
firms price their products and how maximum sales and maximum profit is achieved.
We also learnt about supernormal, normal and subnormal profits.

There were sixteen different cases of either demand or supply either increasing,
decreasing or remaining constant and this helped me understand what happens when
demand and supply react in different situations. I also learnt about monopolistic
competition.

In macroeconomics, I learnt about the circular flow of income which depicts how
money flows in an economy. I also learnt about Gross Domestic Product(GDP),
Gross National Product(GNP) and their significance, National Income
Accounting(NIA) and Personal Income.

Business Cycles helped us understand the different phases of a business.

Macroeconomics also taught us about monetary policies – inflation and its types and
policies to control them, determination of interest rates, open market operations and
also about qualitative and quantitative instruments (disinflationary policies).

Finally we also learnt about IS(Investment Savings) and LM(Liquidity Motive)

models and the crowding out and crowding in effects and what policies are needed
to combat these issues.

Keynesian economics and classical economics are some of the most important
concepts that a masters student should know and I was fortunate enough to gain
knowledge from one of the best professors I have ever had, Prof. Menezes. His
lectures were not restricted to the syllabus, he used to go deep and give us various
instances of various concepts. The lectures were intense and filled with passion and
it was of utmost importance that we paid careful attention. He had lots of patience
and was really helpful in clearing our doubts. We are indebted to him for the
invaluable knowledge he shared with us.
BIBLOGRAPHY
1
https://www.freepressjournal.in/featured-blog/indias-history-with-demonetisation-
from-1946-to-2016/988212
2
70 Policies that shaped India (Author: Gautam Chikermane)
3
http://www.iimb.ac.in/sites/default/files/2018-06/Demonetisation.pdf
4
http://awordtotheworld.com/need-know-demonetization-india-2016
5
https://economictimes.indiatimes.com/news/economy/policy/what-is-
demonetisation-and-why-was-it-done/articleshow/55326862.cms
6
https://www.livemint.com/Money/R4MSapI8pDWmu4DA7QNB4O/The-impact-
of-demonetisation-on-interest-rates.html
7
https://www.bloombergquint.com/opinion/demonetisation-leaves-an-imprint-on-
gdp-growth-in-fy17#gs.DyMEB90
8
http://www.mbauniverse.com/group-discussion/topic/business-
economy/demonetisation
9
https://www.firstpost.com/business/demonetisation-anniversary-better-
implementation-could-have-minimised-peoples-suffering-4199407.html