Demonetization in India: Impact on the Economy

On November 8, 2016, the government of India took away the legal tender character of 500 and 1000

Rupee denomination of banknotes. As a result, 86 percent of the currency (nearly 11 percent of GDP) in circulation was reduced suddenly from the economy. The shortage of currency created a shock to the economy which has several implications. Of course, the capacity to spend by the people had affected directly reducing the consumption demand in the domestic economy. The unorganised sector operates substantially outside the formal banking channels and uses cash for its transactions. The unorganised sector affected badly sinking their production. This affects demand in the entire economy since. As this sector still produces 45 percent of the national output, it has significant contractionary effect in the economy.The rate of growth of the economy as a whole would come down.

Related: India's Demonetization Is a Distraction, Not a Solution

Demonetization reduces the cash in the economy. But, cash in the Indian economy represents only less than one fourth of total money supply. While the Reserve Bank of India supplies the cash circulating in the economy, the banking system as a whole creates more money by lending the deposits it gets to others. While the amount of currency in circulation sharply declines, the deposits with the banks increases although slowly. The money multiplier, the ratio of money in the economy to the cash that the central bank releases in the economy, rises as the people uses less and less of cash and more and more of the deposits with the banks. Cash held by the people is a leakage from the banking system and not available to be further circulated.

New Delhi: People queue up at out side of banks ATM to get money in New Delhi on Sunday. PTI photo by Vijay Verma

Related:  India Set For Slowest Growth Period As Demonetization Dents Economy

It is argued that there are agents in the economy who are hoarding currency as a method for storing savings, especially by people earning unaccounted or illegal incomes. Demonetization has been introduced for reining in the unaccounted incomes or wealth in the economy. It is being argued that the part of wealth held by people as cash would be extinguished as a result of demonetization. There is artificial suppression of demand because of the cash crunch. After remonetisation with the new series of bank notes, consumption demand has started to rise, and if the items are in short supply because of the contraction in economic activity or because of supply chain management, inflation may go up.

Follow economic performance of over 40 countries on www.glarius.com Main stock market indices, inflation, real estate prices, prognoses.

Mr. Panchanan Das
Professor of Economics,
University of Kolkata
Kolkata, West Bengal, India

Does the movements in the BSE Sensex Index Reflect the State of the Indian Economy?

BSE Sensex building     Source: financialexpress.com

The movement in BSE Sensex (Mumbai, India) largely depends on major macroeconomic parameters like GDP growth, inflation, fiscal deficit, foreign exchange stability, industrial output etc. affecting the expectations of future performances of the companies. Let’s say RBI (Royal Bank of India) increases interest rates because of rising inflation. This increases the borrowing cost of companies which is expected to add to their cost of production and bring down their profits. This will bring down share prices of most of the companies in the market.

Related: Sensex rallies 145 points, best weekly jump since May

Mumbai business district  Source: mumbaithemegacity.weebly.com

The Sensex is also affected by the macroeconomic indicators of the global economy. The debt crisis in the Eurozone, for example affected the Sensex after the integration of the domestic financial market to the global market. Recently, the sensitive index decreased 604 points to 26398 on June 24^th because of the Brexit effect. Stock prices and the BSE Sensex index can be regarded as a good mirror of the Indian economy. However, it must not be forgotten that Stock Markets in general are subject to a deal of emotions, opportunism and hustlers looking for an overnight profit. For serious, long-term investments it is important to look at the results and opportunities over a long period of time.

Daily BSE Sensex movements but also long-term results, average return on investments can be followed live on Glarius Investments Intelligence Platform. Glarius has developed models, graphs and tools to monitor performances of stock market indices worldwide. Also, we have developed an econometric model to predict future movements in indices such as BSE Sensex. www.glarius.com

Related: Modi's magic: Is India's economic miracle a mirage?

Mr. Panchanan Das
Associate Professor at the Department of Economics, University of Calcutta
Kolkata, West Bengal, India