Demonetisation & Its (Side) Effects

While a large segment of the Indian population supports the post-Diwali demonetisation drive, that its impact on India's economy will be negative in the short term is a given. The Dollar Business analyses how the move could well prove a headwind for India's manufacturing, foreign trade and economic growth.

- Sairaj Iyer

The Government of India, in a sudden and shocking move, implemented demonetisation on November 8, 2016. The move rendered Rs.500 and Rs.1,000 bank notes illegal tender. According to the government, it's an attempt to reduce corruption in the country and clamp down down black money, smuggling, drugs, counterfeit money, etc. Banning 86% of the country’s money in circulation by value is surely a bold move, but will it turn out to be a good move as well? Or, is demonetisation a policy that has gone too far? Above all, can the move really benefit India's growing economy?

While the people of India are split on the decision, economists are unanimous that the move will not benefit the economy in the short run. Considering its impact on the Indian economy, Reserve Bank of India (RBI) itself has lowered the GDP growth forecast for FY2017 from 7.6% to 7.1%.

In fact, several market watchers like Mumbai-based Ambit Capital have brutally lowered India’s GDP growth forecast for the current fiscal from 6.8% to 3.5%. "The demonetisation-driven cash crunch that is playing out in India will paralyse economic activity in the short term. We expect a strong formalisation effect' to play out as nearly half of the non-tax paying businesses in the informal sector (40% share in GDP) will become unviable and cede market share to their organised sector counterparts," states a report from Ambit Capital.

While Dr. Narendra Jadhav, a noted economist who formerly donned the RBI’s Chief Economist hat, labels demonetisation as “constructive disruption”, former Prime Minister Manmohan Singh, a venerated economist himself, terms demonetisation as “organised loot, legalised plunder”. Certainly there are fierce supporters and naysayers on opposite sides of the aisle! Who is right and who isn't, that, only time will tell. But for now, the economy has to live with it.