Demonetisation: a Bold Move to Clean Up India’s Economy

27 March 2017
On 8 November 2016, the Government of India demonetised all Rs 500 and Rs 1000 banknotes overnight. This represented 86% of Indian currency and 12% of the country’s GDP. At the same time, cash withdrawal limits were imposed on the public.

This was the government’s most drastic move in a series of initiatives to combat black money and terrorist financing. While the effects on these areas are yet to be seen, there has been an immediate impact on many aspects of India’s economy.

Short-term pain for long-term gain

Initially, demonetisation has hit India’s cash-intensive sectors. These include agriculture, construction, gems and jewellery, textiles, trade, transportation, tourism and real estate.

  • Automobiles: In December 2016, automobile sales fell 19%, the steepest fall in 16 years.
  • Hospitality and tourism: Cancellations and no-shows at fine-dining restaurants increased by 33% immediately after demonetisation and visitors to national monuments dropped significantly. Although airlines flew 24% more passengers in December 2016 than the year before, this may be due to advance bookings.
  • Manufacturing and micro-industries: The All India Manufacturers’ Organisation reported a 35% loss in jobs and 50% dip in revenue after the first 34 days of demonetization
  • There has also been a notable fall in housing demand in the last quarter of 2016, sales were down 44% and new projects were down 61%. A key driver here is a reduction in household cash following demonetisation causing individuals to postpone spending and borrowing.

Immediately after demonetisation, India’s debt markets and funds business experienced a slowdown due to delayed investment activity. Many Corporates adopted a wait-and-see approach, expecting a rate correction and other government announcements. Bond issuances fell in the last 3-4 months, credit growth has declined although one cannot attribute it to demonetisation. In the short term, demonetisation has impacted various sectors of the economy in varying degrees, however the adverse impact has been transient. The impact has moderated significantly in March 2017, reflecting the fast pace of remonetisation.

In the longer term, however, the elimination of black money should benefit all these sectors with increased transparency, revived trust and capital inflow.

Meanwhile, although GDP growth projections for the Indian economy in 2017 have been revised downwards, they remain strong at around 7%.

Government expects to collect more revenue

Given the immediate contraction in the economy, it might come as a surprise that government revenue is due to rise.

This is the result of another measure introduced by the Government: the requirement to disclose all bank account details on income tax returns. High penalties will be imposed if an individual’s cash deposits do not match their tax returns. For the period April to December 2016, indirect tax collections grew by 25% and direct tax collections were up by 12% on the previous year.

Greater transparency to boost investment activity

In the medium term, demonetisation is expected to have positive impact: Corporates will seek capital markets sources of funding, and Boards, Investors and Shareholders will call for greater transparency and oversight. India’s economy should benefit from this measure, encouraging both local and international investors to establish their businesses in India and access Indian Capital markets.