INRODUCTION

The government has implemented a major change in the economic environment by demonetizing
the high value currency notes – of Rs 500 and Rs 1000 denomination. These ceased to be legal
tender from the midnight of 8th of November 2016. People have been given upto December 30,
2016 to exchange the notes held by them.1 The proposal by the government involves the
elimination of these existing notes from circulation and a gradual replacement with a new set of
notes. In the short term, it is intended that the cash in circulation would be substantially squeezed
since there are limits placed on the amount that individuals can withdraw. In the months to come,
this squeeze may be relaxed somewhat. The reasons offered for demonetization are two-fold:
one, to control counterfeit notes that could be contributing to terrorism, in other words a national
security concern and second, to undermine or eliminate the “black economy”.
There are potentially two ways in which the pre-demonetization money supply will stand altered
in the new regime: one, there would be agents in the economy who are holding cash which they
cannot explain and hence they cannot deposit in the banking system. This part of the currency
will be extinguished since it would not be replaced in any manner. Second, the government
might choose to replace only a part of the currency which was in circulation as cash. In the other
words, the rest would be available only as electronic money. This could be a mechanism used to
force a transition to cashless medium of exchange. The empirical extent of these two components
will be unravelled only over the next six months. These two would have different effects on the
economy in the short term and in the medium term, as will be explored below.
To understand the effects of these dimensions, it is important to first understand what is it that
cash does in the economy? There are broadly four kinds of transactions in the economy:
accounted transactions, unaccounted transactions, those that belong to the informal sector and
illegal transactions. The first two categories relate to whether transactions and the corresponding
incomes are reported for tax purposes or not. The third category would consist largely of agents
who earn incomes below the exemption threshold and therefore do not have any tax liabilities.
The uses that cash is put to for these various segments of the economy can be summarized in the
form of Table 1. Finally, there would be demand for cash for illegal purposes like bribes in
elections, spending over sanctioned limits, dealings in crime and corruption. If one takes a
snapshot of the location of cash at any given point of time, it is difficult to predict what the
breakup of the cash according to these categories would be, but it would be safe to say that each
of these components would be represented in that snapshot. Turning to the effects of
demonetization, the first major and sustained effect of demonetization would follow from the
extent to which the currency is extinguished and what this currency was being used for. It is
being assumed that all currency which will potentially be extinguished would be currency being
used as a store of value in the first and second category of transactions in the table above. If this
assumption is correct, then the impact of extinguishing this currency would be limited. On the
other hand, if the currency is used for any of the other transactions in the economy, either as a
store of value or more importantly, as a medium of exchange, then the impact on the economy
and the agents in the economy could be substantial. If, for instance, the extinguished cash was
used as a medium of exchange in financing unaccounted income generation or income in the
informal sector, demonetization would result in these activities closing down and a
corresponding reduction in the incomes and employment associated with these activities. The
spillover effect would be felt by the organized sector as well since the consumption from the
incomes generated would extend to the formal sector as well. The next question to ask would be:

Would these activities/agents choose to come within the folds of the formal sector as a result of
the changed economic environment or would they remain outside or worsen the activities and
would be extinguished along with the losses generated from the cash that was extinguished.
The second change as discussed above, from demonetization would arise if only a part of the
currency deposited in the banks is returned to circulation as cash. This change, if it is executed,
would dramatically change the economic environment in the country by forcing agents to move
from using cash as a medium of exchange to using cash substitutes. This appears to be a real
possibility given that the Finance Minister as well as the Governor of the Reserve Bank of India
have repeatedly emphasized that agents should be moving to the use of cashless medium where
there are no problems in comparison to the cash based medium. For instance, The Hindu
reported that “Reserve Bank of India (RBI) has urged citizens to switch to alternative modes of
payments such as pre-paid cards, credit and debit cards, mobile banking, and Internet banking.”2
In a press conference on November 12, the Union Finance Minister too said that “Those in
businesses should start using digital payment gateways, cards and banking system. Life will
become simpler in the new financial system that is the only viableoption.”3 The effect of this
change too would be felt differently across the different segments of the economy – agents
operating within the formal sector and agents who are familiar with the modern technology
would be placed on different footing compared to other agents who need to make the transition.
In what follows, an attempt is made to present a discussion of the likely effects classified into
very short term as in the next two months, the short term as in a six months to a year and the rest
as medium term. Within these, an attempt is made to distinguish between the effects if there is
full remonetization to the extent of deposits made in banks and a scenario of partial
remonetization.

DEFINITION of 'Demonetization'
Demonetization is the act of stripping a currency unit of its status as legal tender. It occurs
whenever there is a change of national currency: The current form or forms of money is pulled
from circulation and retired, often to be replaced with new notes or coins. Sometimes, a country
completely replaces the old currency with new currency.

The opposite of demonetization is remonetization, in which a form of payment is restored as

legal tender.
A brief history of India pulling bank notes from circulation
The whole country was taken aback when Prime Minister Narendra Modi on November 8
announced that the currencies in the denominations of Rs 500 and Rs 1,000 will be invalid post
midnight. However, the lower denomination –Rs 10, Rs 20, Rs 50, Rs 100 and coins –will be
valid. He further announced that new notes of Rs 500 and Rs 2,000 would introduce shortly.
Thus, giving millions of Indians a panic attack.

If third time’s the charm, the ban on Rs500 and Rs1,000 notes could finally wipe off corruption
in India. Narendra Modi may have shocked the nation with his Nov. 8 announcement, but the
prime minister’s move was hardly unprecedented. India has pulled select denominations of its
currency twice before.

The first was when Rs1,000, Rs5,000, and Rs10,000 notes were taken out of circulation in
January 1946, a year and a half before the country won independence from the British. The
Rs10,000 notes were the largest currency denomination ever printed by the Reserve Bank of
India, introduced for the first time in 1938. All three notes were reintroduced in 1954.

In the early ’70s, the Wanchoo committee, a direct tax inquiry committee set up by the
government, suggested demonetization as a measure to unearth and counter the spread of black
money. However, the public nature of the recommendation sparked black money hoarders to act
fast and rid themselves of high denominations before the government was able to clamp down on
them, Mint reported.

Then, in 1977, the Janata Party coalition government came into power. A year into the
government’s term, party leader Morarji Desai was more bullish about cracking down on
counterfeits and black money. The High Denomination Bank Notes (Demonetisation) Act,
instated by the ruling party on Jan. 16, 1978, deemed the Rs1,000, Rs5,000 and Rs10,000 notes
illegal for the second time.
At the time, then-RBI governor I.G. Patel disagreed with the measure and accused the Janata
coalition government of trying to cripple the corrupt predecessor governments instead of simply
eradicating black money.

For the most part, Modi’s measure mirrors Desai’s—except this time, he has the backing of his
RBI governor, Urjit Patel, who applauded Modi’s “very bold step” addressing concerns about the
“growing menace of fake Indian currency notes.” But that doesn’t mean all the skeptics are off
his back. Economists doubt the impact of his decision.

“That’s because people don’t stack black money in cash. Rather, they stash it in undisclosed
accounts in Swiss Banks,” said Abhiroop Sarkar, a professor at the Indian Statistical Institute.
“So the demonetization won’t affect the biggest fish.”

Similarities in 1978 and 2016 ban:

The note ban by Morarji Desai also aimed to drive away black money out of circulation in the
economy. Hence, The High Denomination Bank Notes (Demonestisation) Act was implemented.

Narendra Modi announced the currency ban is an address that was broadcasted across all news
channels. Similarly, Desai announced the ban over the radio after which the banks were closed
the following day.

Both the affairs were kept confidential.

Differences in the ban:

Unlike Modi, Desai didn’t have the backing of the RBI Governor. The Governor I.G. Patel
believed that the ban was implemented simply to immobilize the funds of the opposition party.
Patel also believed that people never store black money in the form of currency for too long.

It didn’t have much effect on the people and affected only the privilege few. While the recent
ban had shaken the whole country.

Coming back to 2016, there is also a buzz that smaller denomination currency notes like Rs 50
and Rs 100 will also be replaced by incorporating new features and design. And that reminds us
of an incident dating back to early 70s, when there were rumours of withdrawing Rs 100 note
from circulation, and immediately hoards of people were seen rushing to banks to exchange their
Rs 10 and Rs 20 currencies.
“Myths and Realities of Demonetization”
Prime Minister Narendra Modi announcement on November 8, withdrawing the legal tender
status of `500 and `1000 notes that account for 86 per cent of the total cash in circulation,
received mixed responses from different quarters. Fight against black money and curb on
terrorism financing were the stated objectives of demonetisation in India. Even though various
amnesty schemes were introduced as a means for fighting black money, the success rate of these
schemes was far from the optimal. In this respect, the Central Government claims
demonetisation as a big step forward in the fight against black money. There had been various
attempts to unearth black money by the successive governments in the last decade. For instance,
the list furnished by HSBC had helped the Government of India to access the details of black
money account holders. The issue of black money was raised by India at the G20 summit in
Turkey. The top leaders of the government had vowed to fight the black money menace in their
run up to the office in the General Elections of 2014. They had also promised that every Indian
would be credited with `15 lakh by bringing back the money stashed abroad. Now, the question
is whether demonetisation is the right and the best way to fight black money and whether they
had taken into account its consequences. Post demonetisation, the country has been facing an
acute shortage of liquid cash. This has sent a wave of panic across the businesses and households
in the country. A debate on whether banking penetration and ATM reach are enough for the
country’s huge population has emerged. As per government reports, banking penetration in the
country is only 58.7 per cent. According to the World Bank Statistics, the number of ATMs per
100,000 adults in India was only 18.07 in 2014 compared to the global average of 43.9. Along
with the objective of fighting black money, the government alleges demonetisation as a step
towards less cash society. But the financial institutions in the country are not developed to meet
the needs of a less cash society, as shown by the above statistics. The government argues that by
moving the informal economy into the formal economy, more transactions will be reported that
can lead to a spurt in the country’s GDP. Earlier, it was expected that a favourable monsoon and
the implementation of the Seventh Pay Commission would push the consumption demand, which
would be reflected in the GDP of the country. But demonetisation has negatively affected
consumer sentiments that can have an adverse effect on the GDP growth of the country.

CPPR–Centre for Comparative Studies in association with Centre for Economy Development
and Law of Government Law College, Thrissur, are organising this seminar to explore the
different issues and avenues of demonetisation. The seminar will look into the following
concerns: Is demonetisation the best way to fight black money? Theoretical aspects of
demonetisation Impact of demonetisation on economy Demonetisation – are we realistic in
advocating a less cash economy? Demonetisation and political economy

Important Questions & Facts about Demonetization in India – Banking and SSC On
the evening of 8th November 2016, the Prime Minister of India announced one of the
boldest moves in the history of India’s socio-economic scene – demonetization of old Rs.
500 notes and Rs. 1000. Soon after, new notes of Rs. 500 and Rs. 2000 notes were pumped into
the economy. Since the concept of demonetization is relatively less common among the
Indian masses, most of you are unaware of the effects, history, legality and technicalities
related to demonetization. However, to tackle questions on demonetization in Banking
exams, you need to know important trivia and facts about demonetization. This article
will provide you information regarding - - - - - History of demonetization in India Other
countries where demonization has taken place previously Articles and laws related to
demonetization Role of political bodies, RBI and institutions in the process Other Important
facts about demonetization Read this article carefully and download it as PDF to revisit it
in future. Other countries where demonization has taken place previously Many countries
have experimented with the process of demonetization in the past. Some countries
benefitted tremendously from the move while some terribly failed at it. Here is a list of
some countries that have implemented the policy of demonetization: France US
(1969) Britain (1971) Ghana (1982) Myanmar (1987) Nigeria (1984) Zaire
(1990) Congo (1990) Soviet Union (1991) Australia (1996) Zimbabwe North
Korea (2010) Pakistan (2015) Historical Facts about demonetization in India Although
the history of demonetization in India dates back to the time when various rulers ruled
this country, the freshest and most significant instances of demonetization in India are:

1. On 12th January 1946, Rs. 500, Rs. 1,000 and Rs. 10,000 notes were declared invalid as
legal tender.

2. New notes of Rs. 1000, Rs. 5000 and Rs. 10,000 came into economy in 1954.

3. On 16th January 1978, the Morarji Desai led-Janata Party demonetized banknotes of
Rs. 1000, 5000 and 10000. Note that, the finance minister at that time was H.M. Patel.

4. RBI introduced a new banknote of Rs. 500 into the economy in 1987 to contain inflation.

5. On 8th November 2016, the old banknotes of Rs. 500 and Rs. 1000 were barred from
being legal tender and new notes of Rs. 2000 were soon introduced. Also, Denominations
of 1, 2, 3, 5, 10, 20 & 25 paise were in circulation till June 30, 2011 but were then
withdrawn. 50 paise coins are still in circulation and are called small coins. Other
denominations called as rupee coins. Let us now review some legal facts about
demonetization.
 Impact of demonetization on business
Very short-term impact
The demonetization, by removing 86 per cent of the currency in circulation, has resulted in a
very severe contraction in money supply in the economy. This contraction, by wiping out cash
balances in the economy, will eliminate a number of transactions for a while, since there is no or
not enough of a medium of exchange available. Since income and consumption are intrinsically
related to transactions in the economy, the above would mean a severe contraction in income and
consumption in the economy. This effect would be more severe on individuals who earn incomes
in cash and spend it in cash. To a lesser extent it would also affect individuals who earn incomes
in non-cash forms but need to withdraw in cash for consumption purposes, since a number of
sectors in the economy still work predominantly with cash.

In terms of the sectors in the economy, the sectors to be adversely affected are all those sectors
where demand is usually backed by cash, especially those not within the organised retailing. For
instance, transport services, kirana, fruits and vegetables and all other perishables, would face
compression in demand which is backed by purchasing power. This in turn can have two effects:
while it is expected that supply exceeds demand, there would be a fall in prices, however, if
supply too gets curtailed for want of a medium of exchange, prices might, in fact, rise. Thus,
while generally people seem to expect prices to fall, it is quite possible that prices would instead
rise.

Alternatively, to keep the flows going, people might take recourse to credit - both the retailers
and other agents in the economy might make supplies on credit in the hope that when the
liquidity status is corrected, the payments can be realised. In these cases, the price of
commodities might rise instead of falling. In other words, the impact of an incremental reduction
in money supply where the demand and the supply chain remain unaffected would be different
from a case where there is a drastic reduction in money supply and outputs might adjust rather
than the adjustment being in prices. In other words, the expectation that inflation would decline
might be belied.

A further impact would be a compression of the demand for non-essentials by all the agents in
the economy in the face of uncertainty in the availability of cash. The demand from segments
which have access to digital medium of exchange would remain unaffected, but that from the rest
of the economy would get compressed. This would transmit the effect to the rest of the sectors in
the economy as well.

Another sector where one expects to see effects in the very short run is the real estate space.
With contraction in demand from one set of agents – say agents who have earned unaccounted
incomes and placed them within the real estate space – either prices within this segment would
fall or transactions would cease to happen. While of itself, this would be considered a positive
development and evidence of a correction in the unaccounted incomes, it could lead to a
compression in investments in the construction sector which can have adverse income and
There are likely to be two spin-offs from this change – one, there would be some increase in tax
collections in the short term, and second; various IOUs could emerge as currency substitutes. To
the extent people attempt to get rid of unaccounted cash balances through purchase of goods and
services and/or payment of property taxes, one should witness a spurt in tax collections in
indirect taxes as well as property tax in the month after demonetisation which would disappear
thereafter. There is evidence already that property tax collections in some cities are higher than
last year. Similarly, in the case of currency substitutes, at MCD tax collection centres at the
border, people are being given IOUs in lieu of the balance they were entitled to, which would be
valid for six months.

Short-term effect with complete replacement:

The short-term effect on the economy would depend on the speed with which and the extent to
which the cash is replaced by the authorities. If the entire cash is replaced within a short duration
of time, the effects beyond the very short term of 1-2 months might be little. But a few sectors
are likely to be seriously affected. To give an example from two sectors which are supposed to
have large employment effect on the economy, we can talk about agriculture, automobiles and
construction.
This is the sowing season for the Rabi crop in some parts of the country and the harvesting
season for the Kharif crop. Most of the purchases and sales in this segment of the economy are
carried out through cash. With the elimination of cash from the economy, sale of kharif crop
would be difficult unless the crop is sold on the promise of payment in future. Given the limited
bargaining power of the farmer, the price they can realise for the crop can be adversely affected.
On the other hand, in the sowing activity, people would not get access to the inputs required
since most of the inputs are now purchased from the market unless they seek access to credit
from the supplier. In other words, with demonetisation, there would be a significant
strengthening of the informal sector credit market in the rural economy. Further, if there are
agents who do not get access to credit from the informal sector agents, their sowing activity and
hence their incomes in the next season would be adversely affected. Thus, in spite of a good
monsoon in large parts of the country, the farmer might not get the benefits.
The second sector which could be adversely affected would be the construction sector. The
sector, it is often argued, works with a significant amount of cash. Payments to workers as well
as a variety of purchases might be carried out in cash. So, on the supply side, this sector can be
adversely affected. On the other hand, on the demand side, the demand for houses and buildings
would appear as a demand for non-essentials and might be pushed on to the back burner until the
economic situation normalises. Thus, to the extent there are agents in the economy whose
demand was backed by savings from unaccounted incomes held in the form of cash which got
extinguished on demonetisation, there would be a compression of demand.

Short-term effect with incomplete replacement:

If, on the other hand, the authorities choose to replace only a fraction of the total cash that was
surrendered by the people to the banking sector, then one would witness some other
changes/effects in the economy. For transactions to be restored to the pre-change level, a number
of agents who are using cash as a medium of exchange have to move to using digital versions of
money as the medium of exchange. While this change is gradually happening in the economy, if
it is forced by making cash inaccessible, the compression in demand as well as in income
generation in the economy would continue for a longer period until people get familiar with the
functioning and use of these media.

Medium-term effects:
In the medium term, the effects would be related to the extent to which the currency is not
replaced within the economy. If the entire currency is replaced, there would not be any major
effects on the economy. However, it is to be expected that the entire currency would not be
replaced – to the extent currency is extinguished and to the extent some of the currency remains
as bank deposits, there would be some impact on the economy. The first effect would be a
compression of the economy to the extent the extinguished currency was working as a medium
of exchange. The currency that is placed in Accessed at: the banks but not withdrawn, it is
argued, would generate an expansion in deposits in the economy. In the discussions on
demonetisation, there is a consistent reference to the resultant increase in credit creation in the
economy. Like Finance Minister Arun Jaitley says, “Bank deposits will increase and they will
have more capacity to support the economy.”4 The total cumulative credit that can potentially be
generated is defined in terms of the reserve ratio. Total credit potential = incremental deposit
generated*(1/reserve ratio)
In India, the cash reserve ratio is 4 per cent while there is a statutory liquidity ratio of 22 per
cent5. In determining the credit creation, it is important to take into account only the CRR and
the additional credit creation can be 25 times the amount of money deposited in the banks as a
result of the proposed demonetisation.6 This amount however, will be generated only if there
exists an equivalent demand for credit in the economy. The banks but not withdrawn, it is
argued, would generate an expansion in deposits in the economy. In the discussions on
demonetisation, there is a consistent reference to the resultant increase in credit creation in the
economy. Like Finance Minister Arun Jaitley says, “Bank deposits will increase and they will
have more capacity to support the economy.”4 The total cumulative credit that can potentially be
generated is defined in terms of the reserve ratio. Total credit potential = incremental deposit
generated *(1/reserve ratio)

In India, the cash reserve ratio is 4 per cent while there is a statutory liquidity ratio of 22 per
cent5. In determining the credit creation, it is important to take into account only the CRR and
the additional credit creation can be 25 times the amount of money deposited in the banks as a
result of the proposed demonetisation.6 This amount however, will be generated only if there
exists an equivalent demand for credit in the economy.
EFFECT ON DEMONETISATION

1) Effect on parallel economy

The removal of these 500 and 1000 notes and replacement of the same with new 500 and 2000
Rupee Notes is expected to
- remove black money from the economy as they will be blocked since the owners will not be in
a position to deposit the same in the banks,
- Temporarily stall the circulation of large volume of counterfeit currency and
- curb the funding for anti-social elements like smuggling, terrorism, espionage, etc.
2) Effect on Money Supply
With the older 500 and 1000 Rupees notes being scrapped, until the new 500 and 2000 Rupees
notes get widely circulated in the market, money supply is expected to reduce in the short run.
To the extent that black money (which is not counterfeit) does not re-enter the system, reserve
money and hence money supply will decrease permanently. However gradually as the new notes
get circulated in the market and the mismatch gets corrected, money supply will pick up.
3) Effect on Demand
The overall demand is expected to be affected to an extent. The demand in following areas is to
be impacted particularly:

a Consumer goods

b Real Estate and Property

c Gold and luxury goods

All these mentioned sectors are expected to face certain moderation in demand from the
consumer side, owing to the significant amount of cash transactions involved in these sectors.
4) Effect on Prices
Price level is expected to be lowered due to moderation from demand side. This demand driven
fall in prices could be understood as follows:
Consumer goods: Prices are expected to fall only marginally due to moderation in demand as
use of cards and cheques would compensate for some purchases.
Real Estate and Property: Prices in this sector are largely expected to fall, especially for sales
of properties where major part of the transaction is cash based, rather than based on banks
transfer or cheque transactions. In the medium term, however the prices in this sector could
regain some levels as developers rebalance their prices (probably charging more on cheque
payment).
5) Effect on various economic entities
With cash transaction lowering in the short run, until the new notes are spread widely into
circulation, certain sections of the society could face short term disruptions in facilitation of their
transactions. These sections are:
Agriculture and related sector
Small traders
Services Sector
Households
 Political Parties
Professionals like doctor, carpenter, utility service providers, etc.
Retail outlets
The nature, frequency and amounts of the commercial transactions involved with these sections
of the economy necessitate cash transactions on more frequent basis. Thus, these segments are
expected to have the most significant impact post this demonetization process and the
introduction of new notes in circulation.
6) Effect on GDP
The GDP formation could be impacted by this measure, with reduction in the consumption
demand. However with the recent rise in festival demand is expected to offset this fall in overall
impact. Moreover, this expected impact on GDP may not be significant as some of this demand
will only be deferred and re-enter the stream once the cash situation becomes normal.
7) Effect on Banks
As directed by the Government, the 500 and 1000 Rupee notes which now cease to be legal
tender are to be deposited or exchanged in banks (subject to certain limits). This will
automatically lead to more amounts being deposited in Savings and Current Account of
commercial banks. This in turn will enhance the liquidity position of the banks, which can be
utilized further for lending purposes. However, to the extent that households have held on to
these funds for emergency purposes, there would be withdrawals at the second stage.
8) Effect on Online Transactions and alternative modes of payment :
With cash transactions facing a reduction, alternative forms of payment will see a surge in
demand. Digital transaction systems, E wallets and apps, online transactions using E banking,
usage of Plastic money (Debit and Credit Cards), etc. will definitely see substantial increase in
demand. This should eventually lead to strengthening of such systems and the infrastructure
required.
CARE’s View
In spite of the initial hiccups and disruptions in the system, eventually this change will be well
assimilated and will prove positive for the economy in the long run.
Black money hoarders will definitely lose out, eventually boosting the formal economy in the
long run.
Short term fall in real estate prices might benefit middle class citizens.
This move by the Government along with the implementation of the GST will eventually
make the system more accountable and efficient.

Appendix: Guidelines by the Government as to what citizens could do post this decision
Deposit old notes of RS. 500 or Rs. 1000 in bank or post office accounts from 10th November
till 30th December, 2016 without any limit. There will be a limit on withdrawal: Rs. 10,000 per
day and Rs. 20, 000 per week. This limit will be increased in the coming days.
Exchange old notes of Rs. 500 or Rs. 1000 at any bank, head post office or sub post office
while showing ID proof. The limit for this is Rs. 4000 upto 24th November.
No restriction of any kind on non-cash payments by cheques, demand drafts, debit or credit
cards and electronic fund transfer.
On 9th November and in some places on 10th November also ATMs will not work. In the first
few days, there will be a limit of Rs.2000 per day per card. This will be raised to Rs.4000 later.
 ‘Demonetization’ and its implications
The demonetization drive initiated by the Indian Government is going to have far reaching
impact on the Indian Economy. It is being considered as one of the most significant step in
tackling the black money issue that has gripped our country since many years. Some of the
effects of the demonetization measure are:
a) The total currency in circulation as on Oct 28, 2016 was INR 17.54 lakh crores. According to
the Reserve Bank of India (RBI), 86% of this component is in currency notes of INR 500 and
INR 1000 denomination. Therefore, the currency that is being attempted to be demonetized is
around Rs. 15 lakh crores. It is being estimated (internal estimates) that around 20% of this
currency is in black. We believe that this money either will not come back into the system for
exchange for new notes or will be surrendered as black money and taxes thereon will be paid.
b) The deposit of these notes with the Commercial Banks ends on December 30th, 2016.
Thereafter, currency notes will have to be deposited with RBI till Mar 31st, 2017. We believe
that after this date, the RBI will reduce Notes in Circulation to the extent of the money not
deposited. To match its liability, it will have to reduce it asset or increase its liability. Increasing
its liability would mean increase in its Net Non- Monetary Liabilities (or reserves) and declare
special dividend (just an accounting entry) to the Government. The Government, in turn can
reduce its bonds on the RBI’s balance sheet by buying its bonds back from the reserves
transferred by the RBI. The government will have multiple options about what it could to do
with this special dividend. It may reduce domestic outstanding debt, prepay external debt, reduce
fiscal deficit as interest cost drops, and reduce its borrowing for following years. Improvement in
debt/Gross Domestic Product (GDP) ratio should also help improve the country’s sovereign
rating by the International Agencies. RBI’s balance sheet also frees up for supporting liquidity
requirements of the banking system.
c) On the other hand, the banking sector is going to see a surge of liquidity as deposits get
collected. Based on our assumption (internal estimates) that (20% of currency will not be
tendered back), there is going to be tendering of currency from the public to the tune of Rs. 12
lakh crores (80% of Rs. 15 lakh crores). Due to the temporary restrictions on withdrawing cash,
our internal estimate is that at least 50% of the cash will remain within the banking system, i.e.
of Rs. 6 lakh crores. This sudden surge in deposit of 6% of current aggregate deposits will help
in improvement of liquidity. This will lead to demand for fixed income securities, particularly
government securities.
d) According to a World Bank estimate in 2007, around 20-25 % of India’s GDP is the size of
the parallel black economy. The steps taken by the Indian Government has led to a scare in the
parallel black economy and should lead to better tax compliance going ahead. This will have a
telling effect on the other heavens of black money i.e. real estate and gold. Both these sectors are
going to witness reduced demand. Lower demand for gold resulting ultimately in lower import of
gold is expected to improve the current account balances. The Indian rupee should remain stable
and display appreciating bias against hard currencies, as the current account improves and may
also move into surplus.
e) The sudden change due to reduced cash transaction will lead to reduction in economic activity.
We believe that the services sector growth will be majorly affected. This will lead to lowering of
inflation expectation and moderation of headline inflation too. However, the effect on inflation
would depend on the moderation in economic activity in those sectors that have heavy cash
transactions. RBI will find larger room to reduce repo rates with moderation in inflation.
f) There are some other positives expected over the medium to long term. A more compliant
economy should increase tax collections and tax to GDP ratio should improve from both direct
and indirect tax. In future, an increase in use of plastic money rather than hard currency would
also lead to higher money multiplier which will be more productive. To sum up, the fight against
corruption, terror funding, counterfeit currency and the black economy should result in,
• Increased systemic liquidity leading to higher demand for bonds
• Rate reductions due to lower inflation and inflationary expectations
• Stable to appreciating INR as Current account deficit improves due to lower demand for gold
• Higher tax to GDP
• RBI freeing up balance sheet as liability declines
• Government would be able to bring down its outstanding debt liability and improve fiscal
deficit
• Immediate near term impact – decline in cash transactions may lead to reduction in
consumption demand leading to some decline in the GDP growth.

Disclaimer: This document alone is not sufficient and shouldn’t be used for the development or
implementation of an investment strategy. It should not be construed as investment advice to any
party. All figures and data included in this document are as on date and are subject to change
without notice. The statements contained herein may include statements of future expectations
and other forward looking statements that are based on prevailing market conditions / various
other factors and involve known and unknown risks and uncertainties that could cause actual
results, performance or events to differ materially from those expressed or implied in such
statements. The data used in this document is obtained by Invesco Asset Management (India)
Private Limited (IAMI) from the sources which it considers reliable. While utmost care has been
exercised while preparing this document, IAMI does not warrant the completeness or accuracy of
the information and disclaims all liabilities, losses and damages arising out of the use of this
information. The content of this document is intended solely for the use of the addressee. If you
are not the addressee or the person responsible for delivering it to the addressee, any disclosure,
copying, distribution or any action taken or omitted to be taken in reliance on it is prohibited and
may be unlawful. The distribution of this document in certain jurisdictions may be restricted or
totally prohibited to registration requirements and accordingly, persons who come into
possession of this presentation are required to inform themselves about and to observe any such
restrictions and/ or legal compliance requirements. The readers should exercise due caution
and/or seek appropriate professional advice before making any decision or entering into any
financial obligation based on information, statement or opinion which is expressed herein.
Mutual Fund investments are subject to market risks, read all scheme related documents
carefully.
 Advantages and Disadvantages of Demonetization
Disadvantages of Demonetization

1. Chaos: After the demonetization of currency was announced, people wanted to get rid of Rs
500 and 1,000 notes at the earliest. As a result, many people have collapsed and died during note
exchange rush.

The Cost to the Government : Replacing Rs 500 and 1,00 notes with other denominations could
cost the Reserve Bank of India more than 12,000 crores, taking into account the notes in
circulation and the cost incurred to print them.

2.Loss of Business : Due to demonetization, the business has been negatively affected as the
vendors don’t have enough change to return to their customers. Some of them are still accepting
credits and the old currency, but still, people are spending less than they used to. This has even
affected restaurants and other business which accepts digital mode of payment.

3.GDP Growth : It is estimated that the demonetization-driven cash crunch will result in GDP
growth crashing to 0.5% in the second half of the financial year 2016-17.

4.Fake News : Some big media houses and well-known persons are spreading and sharing news
incidents that occurred a few months ago and are linking it to demonetization without knowing
the truth behind it.

5.Exploitation : As it is hard to get your hands on the new currency without standing in a queue,
those who are in urgent need of money are getting the currency exchanged from others for
commissions ranging up to 40%. Owners of petrol pumps and other services are demanding the
customer to avail their service for a minimum of Rs 500 or 1,000. Some black money holders
haven even hired people to stand in queue for them throughout the day to get their note
exchanged for a small commission.

6.Not as Effective : Demonetization was mainly targeted at black money holders, but they have
found a way around it by getting the currency exchanged from others for a commission of 20 to
40 percent. Some people have died and there are even variations in some of the printed notes.

Advantages of Demonetization

1. Rise of the cashless economy: Spread of the digital payment culture will start the
‘formalisaton’ process in the economy. It will reduce the use of physical cash as well. Once bulk
of the economic transactions are digitalized it will result in revealing the expenditure made by
individuals to the tax authorities especially big transactions.
2. formal economy: Growth of the formal economy will be another associated long term gain.
If additional measures like cleansing the real estate sector and bringing all traders under the
digital payment system, the unorganised sector transaction will be made accountable. Even if it is
a slow process, bringing the informal sector into the formal economy will reduce black money.

3. Social shake up: Black money can be eliminated only if we eliminate the deep rooted social
mentality that dealing with black money is economically rewarding and legally feasible.
Demonetization may bring a social shake up in the country by destroying this mentality. It will
spread an attitude against black money. People will be averse to deal with black money if they
know that they are easily traceable and harder legal steps are initiated against them. Such an
awareness and conscience can reduce the area available for the activation of black money.

4. Demonetization will reduce the circumference available for the activities of parallel
economy: Demonetization is not an isolate arm or not the only one against black money. It may
be complemented by several other steps. One such supportive step is making PAN compulsory
for high value transactions up to Rs 10000. Similarly, PAN documentation should be made
compulsory against all investment in physical assets like gold, land etc. If these happens, parallel
economic activities can be reduced substantially.

5. Tax payers: Large number of new tax payers may appear with demonetization. This is
because demonetized money will reveal their income size and tax officials may check them in
future, compelling to pay tax.

6. Real estate sector: Cleaning of the real estate sector will be associated long term gain of
demonetization. Modification of stamp duty structure is badly needed to provide energy to the
sector at the same time, making it accountable.

7. Rise in financial savings: At present, more than 50% of household savings are in physical
savings like gold and land. Significant portion of these are in black money. Now with the low
reward in the real estate and gold holdings, people may tempt to save in financial forms like bank
deposits, mutual funds etc.

As Krugman suggested, demonetization is a highly disruptive way to fight black money and it is
only a one-time effort to flush out hoarded money. We can’t do it always. Similarly, only a
fraction of black money is stored in liquid cash. All these indicate that fight against black money
will be successful in the long term only if the other measures suggested here are adopted.

Above all, the legal system should be prudent to prevent people to invent new ways of hoarding
and dealing with black income.
 Procedure
The plan to demonetize the 500 and 1000 bank notes began six to ten months prior, and was kept
highly confidential with only about ten people aware of it completely. The logistical processes
and preparations for printing the new 500 and 2000 bank notes began in early-May. The cabinet
was informed about the demonetisation on 8 November 2016 in a meeting called by the Prime
Minister of India Narendra Modi which was followed by Modi's public announcement about the
demonetisation in a televised address.

Televised address

On 8 November 2016, Prime Minister of India Narendra Modi announced the demonetisation in
an unscheduled live televised address to the nation at 20:15 IST. In the announcement, Modi
declared circulation of all 500 and 1,000 banknotes of the Mahatma Gandhi Series as invalid
effective from the midnight of the same day, and announced the issuance of new 500 and 2,000
banknotes of the Mahatma Gandhi New Series in exchange for the old banknotes.

After Modi's announcement, the Governor of the Reserve Bank of India, Urjit Patel, and
Economic Affairs secretary, Shaktikanta Das explained in a press conference that one purpose of
the action was to fight terrorism funded by counterfeit notes. While the supply of notes of all
denominations had increased by 40 percent between 2011 and 2016, the 500 and 1,000
banknotes increased by 76 percent and 109 percent, respectively, owing to forgery. They said
that forged cash was used to fund terrorist activities against India and that the demonetisation
had a counter-terrorism purpose.

Patel also informed that the decision had been made about six months ago, and the printing of
new banknotes of denomination 500 and 2,000 had already started. However, only the top
members of the government, security agencies and the central bank were aware of the move. But
media had reported in October 2016 about the introduction of 2,000 denomination well before
the official announcement by RBI. This statement has led to much debate, because the Reserve
Bank governor six months before the announcement was Raghuram Rajan, while the new
banknotes have the signature of the newly appointed governor, Urjit Patel.

Government ordinance

The Specified Bank Notes (Cessation of Liabilities) Ordinance, 2016 was issued by the
Government of India on 28 December 2016 ceasing the liability of the government for the
banned bank notes, and also imposing a fine upto 10,000 or five times the amount of the face
value of the bank notes, whichever is higher, for people transacting with them after 8 November
2016; or holding more than ten of them after 30 December 2016. The ordinance also provided
for the exchange of the bank notes after December 30 for non-resident citizens and others on a
case by case basis.
However, Petrol, CNG and gas stations, government hospitals, railway and airline booking
counters, state-government recognised dairies and ration stores, and crematoriums were allowed
to accept the banned 500 and 1,000 bank notes until December 2, 2017.

Exchange of old notes

People gathered at ATM of Axis Bank in Mehsana, Gujarat to withdraw cash following deposit
of demonetised currency notes in bank on 15 November 2016.

The Reserve Bank of India stipulated a window of fifty days until 30 December 2016 to deposit
the demonetised banknotes as credit in bank accounts. The banknotes could also be exchanged
over the counter of bank branches upto a limit that varied over the days:

Initially, the limit was fixed at 4,000 per person from 8 to 13 November.

This limit was increased to 4,500 per person from 14 to 17 November.

The limit was reduced to 2,000 per person from 18 November.

All exchange of banknotes was abruptly stopped from 25 November 2016.

International airports were also instructed to facilitate an exchange of notes amounting to a total
value of 5,000 for foreign tourists and out-bound passengers.

Withdrawal limits

Cash withdrawals from bank accounts were restricted to 10,000 per day and 20,000 per week per
account from 10 to 13 November. This limit was increased to 24,000 per week from 14
November 2016.

A daily limit on withdrawals from ATMs was also imposed varying from 2,000 per day till 14
November, and 2,500 per day till 31 December. This limit was increased to 4,500 per day from
January 1, and again to 10,000 from January 16, 2017. Limits placed vide the circulars cited
above on cash withdrawals from Current accounts/ Cash credit accounts/ Overdraft accounts
stand withdrawn with immediate effect. The limits on Savings Bank accounts will continue for
the present and are under consideration for withdrawal in the near future. Limits vide the
circulars cited above placed on cash withdrawals from ATMs stand withdrawn from February 1,
2017. However, banks may, at their discretion, have their own operating limits as was the case
before November 8, 2016, subject to 2 (ii) above.

Exceptions: Under the revised guidelines issued on 17 November 2016, families were allowed
to withdraw 250,000 for wedding expenses from one account provided it was KYC compliant.
The rules were also changed for farmers who are permitted to withdraw 25,000 per week from
their accounts against crop loans.
 Evasion attempts
A jewellery store in a shopping mall with a notice "We accept 500 and 1000 notes", even after
they were no longer valid banknotes.

Gold purchases:

In Gujarat, Delhi and many other major cities, sales of gold increased on 9 November, with an
increased 20 to 30% premium surging the price as much as 45,000 (US$670) from the ruling
price of 31,900 (US$470) per 10 grams (0.35 oz).

Income Tax officials raided multiple branches of Axis Bank and found bank officials involved in
money laundering acts, exchanging old notes for gold.

Donations in temples :

In India, the cash deposited into hundis, or cash collection boxes in temples and gurudwaras are
exempted from inquiry by the tax department. This exemption is sometimes misused to launder
money. After the note ban, there was a spike in donations in the form of the demonetised notes in
temples.Authorities of Sri Jalakanteswarar temple at Vellore discovered cash worth 4.4 million
(US$65,000) from the temple hundi in the form of defunct notes.

Multiple bank transactions

There have been reports of people circumventing the restrictions imposed on exchange
transactions by conducting multiple transactions at different bank branches and also sending
hired people, employees and followers in groups to exchange large amounts of banned currency
at banks.In response, the government announced that it would start marking customers with
indelible ink. This was in addition to other measures proposed to ensure that the exchange
transactions are carried out only once by each person.
Railway bookings:

As soon as the demonetisation was announced, it was observed by the Indian Railways
authorities that a large number of people started booking tickets particularly in classes 1A and
2A for the longest distance possible, to get rid of unaccounted cash. A senior official said, "On
November 13, 42.7 million passengers were nationally booked across all classes. Of these, only
1,209 were 1A and 16,999 for 2A. It is a sharp dip from the number of passengers booked on
November 9, when 27,237 passengers had booked tickets in 1A and 69,950 in 2A."

The Railways Ministry and the Railway Board responded swiftly and decided that cancellation
and refund of tickets of value ₹10,000 and above will not be allowed by any means involving
cash. The payment can only be through cheque/electronic payment. Tickets above ₹10,000 can
be refunded by filing ticket deposit receipt only on surrendering the original ticket. A copy of the
PAN card must be submitted for any cash transaction above 50,000. The railway claimed that
since the Railway Board on 10 November imposed a number of restrictions to book and cancel
tickets, the number of people booking 1A and 2A tickets came down.

Municipal and local tax payments:

As the use of the demonetised notes had been allowed by the government for the payment of
municipal and local body taxes, it led to people using the demonetised 500 and 1,000 notes to
pay large amounts of outstanding and advance taxes. As a result, revenue collections of the local
civic bodies jumped. The Greater Hyderabad Municipal Corporation reported collecting about
1.6 billion (US$24 million) in cash payments of outstanding and advance taxes, within 4 days.

The tax collection by local bodies have surged over 260% and more than 15000 crore mare after
14 days of demonetization. The total indirect tax collection rose to 14.2% only in the month of
December according to Finance Minister Arun Jaitley.

Backdated accounting:

The Enforcement Directorate raided several forex establishments making back dated entries.
Money laundering using backdated accounting was carried out by co-operative banks, jewellers,
sellers of iPhones, and several other businesses.
 Transition Issues

There are a number of transition issues that need to be managed for this transition to be
effective:

1. Infrastructure Issues:

There is need for a significant upgrade of the banking system as well as in the telecom
infrastructure that would provide the backbone for digital transactions. For people to be able to
transact at any time and place as well as for them to consider it a reliable medium of exchange, it
is important that not only the banking system is upgraded to ensure that transactions can be
completed without a hitch, but the supporting infrastructure too is up to the mark. For instance,
in many parts of the economy, there is limited and intermittent supply of electricity as well as
mobile connectivity. In these areas, it would be difficult to expect people to shift to electronic
medium of exchange.

2. Consumer behaviour Issues:

Apart from the technological issues, there is a behavioural change that is being expected in
people from using cash as a medium of exchange to using other cash substitutes both for making
payments and receiving payments. This transition requires individuals to make two changes in
their behaviour: one, agents need to move from tangible means which can be seen and felt to
forms which are less tangible or not tangible, and second, they have to learn to rely on
technologically advanced tools to undertake regular day to day operations. The latter requires
agents to be educated to the extent of comprehending the content of transactions. If this transition
is not suitably managed, agents might be tempted to move to non-official cash substitutes.

3. Accessibility in language:

In addition to all of the above, most of the banks and the mobile instruments for transaction are
currently adapted to a single to two languages. If the bulk of the population of this country needs
to come on board, it might be important to make these facilities available in a myriad of Indian
languages to ensure that the user can comprehend the transaction that they are entering into.

4. Transition issues for banking sector:

There are multiple issues here.

a. The banks too might have a transition issue to deal with. Banks would have a model of the
fraction of deposits that they can safely lend without an excessive risk of withdrawal of the
amount. This is important since, while banks can borrow money from the call money market, the
costs of such borrowings can be large. These models, however, might need to be altered in the
new regime since the character of the new deposits that come into the bank would be different
from the pre-existing deposits. In the latter, while a fraction of the deposits would be for
transactional purposes – e.g. salary earners – another fraction would be depositing only savings
into the account. By eliminating high value currency notes, these agents who were operating
through cash, would now have to move to non-cash instruments and hence, the balances in their
accounts would not be savings but transaction values which will be retained in the account for
shorter durations of time. The banks therefore would need to re-model their decisions on how
much of the deposits can be lent out and for what duration. It is, for instance possible, that a
larger proportion of the deposits would be retained for short-term lending and can even be
dedicated to the call money market.

b. Second, while 1/reserve ratio defines the potential maximum amount of credit that can be
generated in the economy, the actual credit generation would be defined both by the demand for
credit and the extent to which cash intervenes in the functioning of the economy. For instance, if
people who receive credit from the bank make payments through cheques alone and they in turn
make payments through cheques, then the potential credit creation can be realised. However, if
on receipt of payment, the agent withdraws the money to cash and makes payments, only a
fraction of the credit/deposit will return to the banking system. Thus, larger is the extent to which
cash is used as a means of transacting, smaller is the total credit that can be generated. With a
withdrawal of cash from circulation, the deposits will continue to remain in the bank, it would
merely shift from account to account or from bank to bank. Thus, even on the earlier deposits,
the amount of credit that can be generated would be larger. This is another reason why the banks
would need to remodel their investment decisions corresponding to a given level of deposits.

c. A third issue that might arise as a transition issue is because of the mismatch between people’s
preferences for cash and the availability of cash. In the interim, until people adjust to the use of
non-cash instruments, there would be an increased demand for the cash that is available and that
might generate a situation where the agents have to pay a premium to access legal tender. In
periods of scarcity of coins for instance, it is commonly known that people pay a premium to get
the change. While this can be considered a transition issue, there are two different implications
of such a development:

i. If the premium on cash is high, it would encourage both the shift to non-cash instruments on
one hand, and to informal substitutes of cash on the other.

ii. This might undermine the confidence that people have in the currency and hence, encourage
move to other currencies.
 ` 500 and ` 1000 - Features

1. In terms of Gazette Notification No 2652 dated November 08, 2016 issued by

Government of India, existing series of banknotes in the denominations of ` 500/- and `
1000/- issued by the Reserve Bank of India upto November 08, 2016, hereinafter referred to
as Specified Bank Notes (SBN), shall cease to be legal tender in payment or on account
at any place with effect from the November 09, 2016.

2. SBN held by a person other than a bank or Government Treasury may be exchanged
at the 19 Issue Offices of the Reserve Bank of India and all branches of public sector
banks, private sector banks, foreign banks, Regional Rural Banks, Urban Cooperative Banks
and State Cooperative banks only upto and including December 30, 2016, on tender of the
SBN subject to the following conditions:

(a) SBN of aggregate value upto ` 4000 only held by a person can be exchanged by him/her
at any bank branch or Issue Office of Reserve Bank of India for any other denomination
of Banknotes, provided a Requisition Slip as per format prescribed in Annex-5 is presented
with proof of identity (as indicated in Annex-5), along with the High Denomination
Banknotes.

(b) Where the aggregate value of the SBN tendered exceeds ` 4000, the equivalent value
will be credited to the account of the tenderer maintained with the bank where the High
Denomination Banknotes are tendered. The limit of ` 4000/- for exchanging SBN at bank
branches or at Issue Offices of Reserve Bank of India will be reviewed after 15 days.

(c) There will be not be any limit on the quantity or value of SBN to be credited to the
account of the tenderer, maintained with the bank where the SBN are tendered.

(d) The equivalent value of the SBN tendered can be credited to an account maintained by
the tenderer at any bank in accordance with standard banking procedure and on production
of valid proof of Identity.

(e) The equivalent value of the SBN tendered can be credited to a third party account
provided specific authorization therefor accorded by the said account holder is presented to
the bank, following standard banking procedure and on production of valid proof of Identity
of the person actually tendering.

(f) In accounts where compliance with extant Know Your Customer (KYC) norms is not
complete, a maximum value of ` 50,000/- of SBN can be deposited. (g) Cash Withdrawal
from a bank account over the counter will be restricted to ` 10,000/- subject to an overall
limit of ` 20,000/- in a week for the first fortnight.
(h) There will be no restriction on the use of any non-cash method of operating the account
which will include cheques, demand drafts, credit/debit cards, mobile wallets and electronic
fund transfer mechanisms.

(i) Withdrawal from ATMs would be restricted to ` 2,000/- per day per card up to
November 18, 2016. The limit will be raised to ` 4,000/- per day per card from
November 19, 2016 onwards. All ATMs will dispense ` 100 and/or ` 50 denomination
Banknotes only until further instructions from RBI.

(j) For those who are unable to exchange their SBN on or before December 30, 2016, an
opportunity will be given to them to do so at specified offices of the RBI until a later date,
along with necessary documentation as may be specified by the Reserve Bank of India.

Security features of the new Rs. 2000 and Rs. 500 notes
A look at the security features of the newly-launched Rs. 2,000 and Rs. 500 notes from the RBI's
stable.

Rs. 2,000

(colour: magenta)
* Is a part of the Mahatma Gandhi (New) series, with a motif of India's Mars orbiter, the
Mangalyaan on the reverse

* Size: 66mm x 166mm

Front side:

1. See through register where the numeral 2,000 can be seen when note is held against light

2. Latent image of 2,000 can be seen when the note is tilted

3. Devanagari denomination

4. Portrait of Mahatma Gandhi

5. Micro letters 'RBI' and '2,000'

6. Colour shift security thread with 'RBI' and '2,000'

7. Guarantee clause, Governor's signature and RBI emblem on the right

8. Watermarks of Mahatma Gandhi and electrotype 2,000 numeral

9. Number panel with numerals growing from small to big on top left and bottom right sides

10. Denominational numeral with Rupee symbol, 2,000 in colour changing ink

11. Ashoka pillar emblem

For visually impaired:

12. Rectangle with Rs.2,000 in raised print on right

13. Seven angular bleed lines in raised print

Rs. 500

The size is 63mm x 150mm, colour is stone grey with Red Fort and Mahatma Gandhi's image on
each sides

Features:

1. See through register in denomination numeral

2. Latent image of the denomination numeral

3. Denomination numeral in Devnagari

4. Orientation of Mahatma Gandhi's portrait changed

5. Windowed security thread changes from green to blue when note is tilted

6. Guarantee clause, Governor's signature, RBI emblem shifted towards right

7. Portrait and electrotype watermarks

8. Number panel with numerals growing from small to big on top left and bottom right sides

9. Denomination in nuemrals with Rupee symbol in colour changing ink (green to blue) on
bottom right

10. Ashoka pillar emblem on right

For visually impaired:

11. Circle with Rs. 500 in raised print on the right

12. Bleed lines on left and right in raised print

Conclusion:
The demonetisation undertaken by the government is a large shock to the economy. The impact
of the shock in the medium term is a function of how much of the currency will be replaced at
the end of the replacement process and the extent to which currency in circulation is
extinguished. While it has been argued that the cash that would be extinguished would be “black
money” and hence, should be rightfully extinguished to set right the perverse incentive structure
in the economy, this argument is based on impressions rather than on facts.
While the facts are not available to anybody, it would be foolhardy to argue that this
is the only possibility. As argued above, it is possible that these cash balances were used as a
medium of exchange. In other words, while the cash was mediating in legitimate economic
activity, if this currency is extinguished there would be a contraction of economic activity in the
economy and that is a cost that needs to be factored in while assessing the impact of the
demonetisation on the economy and its agents.
It is likely that there would be a spurt in the banking deposits. While interpreting the
phenomenon, however, one has to keep in mind that a large part of their deposits were earlier
used for transactional purposes. For example, if a small trader deposits 2 lakh Rupees in the Jan
Dhan account since the currency in which he held these balances in for transactional purposes
has been scrapped, it would be incorrect to interpret this as success of the programme in bringing
in people who were hiding black money. Nor can they be interpreted as additional balances that
the banking sector can lend out on the same basis as earlier deposits, since the deposits now
would remain in accounts for much shorter periods that deposits based on savings would be.
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