17th January 2017

On 8th November 2016, Prime Minister Narendra Modi announced the biggest-ever demonetization exercise India has ever seen by withdrawing Rs. 500 and Rs. 1,000 notes, which made up 86% of all rupees in circulation, from public use in a bid to clamp down black money, fake currency, terror funding and corruption. Creation of a new 500 and 2,000 rupee notes with effect from 10th November 2016 was also announced.

The people were given a set of protocols to follow in order to exchange their demonetized notes for the new ones (or the old 100 rupee or lower denomination notes which are still valid).
Reserve Bank of India (RBI) announced that Indian citizens can go to any RBI location or any bank branch and trade in their demonetized notes for credit into their accounts. 30th December 2016 was fixed as the deadline for the exchange.

RBI also specified two ways by which Indians could trade their old notes for new notes. They could go to a bank and, with a valid ID, fill-out a form to secure exchange. They could also withdraw money from their accounts in the form of valid notes. RBI put in place limits for both these mechanisms which are being increased gradually depending on the supply of new notes to banks.
Banned notes of the value of Rs. 14 Lac Crore have been deposited in banks and Rs. 6 Lac Crore new notes are in circulation.

As a next step in his war on corruption, Mr. Modi has pitched a transition to a cashless economy and the government has announced several incentives for making digital payments.
Cash to GDP ratio for India was pretty high nearly 12-13% of GDP, although average cash deposit ratio is 4-5% in global markets. The high cash component is the root cause of all evil. The demonetization and more of digital payments will eliminate corruption and black money significantly.

Views of eminent Economists on demonetization:

Mr. Kaushik Basu – India has a large amount of what is known as “black money” meaning cash or any other form of wealth that has evaded taxation. Modi’s approach will certainly eliminate some of the black money but it won’t be able to grapple with black money held in the form of precious metals and other assets, such as real estate holdings.
Mr. Paul Krugman – It is difficult to see major gains from India’s decision to drain out high value bank notes from the economy.
Dr. Amartya Sen – Only an authoritarian government can calmly cause such misery to the people.
Dr. Jagdish Bhagwati – This is a courageous and substantive economic reform that, despite the significant transition costs, has the potential to generate large future benefits. Although the process is inconvenient, and subjects many households to hardships, it forces the cash from the black economy to be deposited into the banking system, potentially increasing transparency and expanding the tax base and revenues to the government from taxes and surcharges. The following are the benefits:

  • Since individual deposits will now be matched with their tax returns and unaccounted deposits will be taxed, this will yield a windfall for the government permitting large increases in social expenditures
  • This one-time demonetisation itself could have long-term beneficial impact by nudging reluctant consumers into e-payments, whose transparency will ensure greater tax compliance and a higher permanent tax base.
  • The government’s action will put a major dent in counterfeiting. With the new notes being much less prone to counterfeiting, social benefits will be earned immediately.

Effect of Demonetization on Banks:

  • With demonetization more people are depositing money into the bank. This means the banks have more liquid funds and more money to lend.
  • Many banks have also slashed their deposit and lending rates.
  • The banks now are in dilemma as with the surge in deposits, there is decline in loan growth and this could affect their profitability.
  • There was Rs. 1 Lac Crore fall in bank credit growth in fortnight after 8th November 2016.

Performance of IndusInd Bank promoted by IIHL:

  • IndusInd Bank’s business model is helping it to ride through the transitory slower growth phase of demonetization and deliver outstanding performance during the quarter ended the 31st December 2016.
  • Despite fall in credit growth in the industry, the Bank’s advances during the quarter grew by 25%.
  • Net profit has shown a growth of 29%.
  • Mr. Romesh Sobti, MD & CEO of the Bank was awarded as the Best CEO (BFSI) at the Business Today Best CEO Awards 2016.

International Monetary Fund (IMF) on Indian Economic Growth:

  • IMF on Monday, the 16th January 2016 cut India’s economic growth for 2016-17 to 6.6% from its earlier projection of 7.6% due to temporary negative consumption shock induced by cash shortages and payment disruption associated with currency note withdrawal and exchange initiative.
  • IMF expects the economy to recover and grow by 7.2% in 2017-18 still lower than the previous estimate of 7.6%. In 2018-19, it expects the Indian economy to grow by 7.7%.


Several Economists say growth will slip below 7% in 2016-17 due to the impact of cash crunch on several sectors such as real estate, farming, consumers, small & medium industries and others. In 2017-18, there will be a pick-up and India will remain one of the fastest growing major economies globally. The adjustment and recovery period could stretch to 2-3 quarters. India’s economic growth will stabilize thereafter while remaining strong.

Demonetization has the potential to generate large long-term benefits including greater economic transparency.

S. Solomon Raj
17th January 2017