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The decision of the government to scrape 500 and 1000 currency notes is affecting different class of society in a different way. Let us analyze the bigger picture of India post this move.

The decision of the government to scrape 500 and 1000 currency notes is affecting different class of society in a different way. Let us analyse the bigger picture of India post this move.

1: Poor Class

This class is affected adversely immediately. This class hardly use debit or credit card. They also keep hardly any money in banks. They keep most of their money in cash in their home in the higher denominations. They have to, therefore, rush to the ATM and stand in the queue to withdraw their money to run their day-to-day affair. However, this problem is temporary and within a month, things are likely to return to normal.

This class is likely to make better use of banking channel and the cards in future. That will make their life more secure and help them earn more money through interest on their deposit.

They will also gain from the increases taxes and lower corruption in the government schemes that would follow this move.

2: Middle Class

The middle class of India is used to use credit/debit cards and other online methods to transact their business. They too have to stand on the big queue for short time because they still need the 100 rupee note for making petty payments. Yet they can buy most of things using their credit cards. This class would become more cashless now so that they can eliminate the need of currency notes as much as they can.

3: Upper Class

The honest upper class of the society is already making most of the transaction cashless even now using cards and electronic transactions. They too may face a few days of trouble but their life would become normal very soon.

The dishonest upper class is the worst hit due to this move of government because most of their black money is stored in 500/1000 notes which would go waste. They have to either burn their notes or give them to a large number of poor people (on commission) for converting that to white. The currency would become valid once replaced by new notes, but the black money would remain black. If they face the raid, they would end up becoming bankrupt once they have to pay 200% penalty on such money.

4: Politicians

Politicians are the worst affected class due to this move. They keep almost 90% of their money in black. Once that money is gone, they would no longer be able to buy the votes. It is for this reason that the move of Shri Narendra Modi is most significant. He has angered not only the corrupt and big businessmen but also his own class i.e. politicians. Every class that used to fund the elections must be angry with him.

Long Term Effects

In the long run, Indians would reap several benefits due to this move.

  1. Once the black money is reduced, taxes would leapfrog
  2. Developmental activities would pick up significantly as the tax revenue increases
  3. Government can reduce rates of taxes since they can raise significantly more revenue with lower rates
  4. Corruption would reduce since there would be little black money to pay bribe to government officials
  5. Dowry and other social practices like extravagant marriages would reduce due to white economy
  6. Illegal activities like murder, kidnapping, drug-paddling, prostitution, terrorism etc. would reduce since all these activities need black money
  7. The honest people would live life of much more respect as dishonest would no longer be displaying their wealth for long time to come.

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:

  • Consumer goods
  • Real Estate and Property
  • Gold and luxury goods
  • Automobiles (only to a certain limit)

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
  • SME
  • 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.

  • 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.

This Article is written by :- Subhash Jha, Founder – Legal Salah.

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