Macroeconomics Effects of Indian Demonetisation

Demonetisation had huge impacts on the economy by affecting macroeconomic indicators like growth level of GDP, consumption and investment behaviours, employment levels etc.

Many changes, for example: change in consumption behaviour of the public were observed immediately in the short run and other changes like drop in employment levels took place in the long run period.

Effects:

1)On banks:

The banks were occupied receiving the old currency from the public and returning it to the RBI. The banks were not able to lend credit in the market for many reasons, including the voluminous job of demonetisation.

We can see in Table 18, the total bank credit available in different periods of 2015 and 2016. Table A represents the year on year growth of bank credit to help us compare the effect of demonetisation on credit giving abilities of banks.

The credit growth of all banks was improving, and it can be observed that it was better than the corresponding period of preceding year up till 30-Sep-2016. From 12.1% y.o.y growth on 30-Sep-2016 it declined to 7.51% right after demonetisation was introduced and further declined to 5.15% in December.

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Segments like agriculture, industry, loans, priority sector have higher number of unorganised activities and will suffer the most due to decreases in credit inflow. Post demonetisation, there is a heavy effect on the growth of bank credit to all the major sectors of the economy and they are exhibiting a declining trend in credit growth. In table 19 you can observe the growth rates of deployment of gross bank credit to major sectors. During December 2016, the growth has declined compared to previous years for all sectors.

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2) Consumption:

Large variations in supply of money in the form of new currency had a huge impact on supply of M3. We can see in the Table 16, currency with public saw a heavy decline of -47.8 % one month after demonetisation was implemented. This shortage of currency impacted the velocity of money circulation and has impacted the level of economic transactions in the county.

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We know through the discussions in previous topics, the transactions in India are largely cash based and a significant size of GDP falls under the informal sector. This means that the value of multiplier will decrease due to demonetisation. Thus, this will not only decrease consumption due to the lack of cash in short run but due to the fall in the multiplier, public spending is much less even after the cash is recovered.