In an important move, the Government of India declared yesterday that the five hundred and one thousand rupee notes will no longer be legal tender from midnight, 8th November 2016. The RBI will issue Two thousand rupee notes and new notes of Five hundred rupees which will be placed in circulation from November 10, 2016.
Notes of one hundred, fifty, twenty, ten, five, two and one rupee will remain legal tender and will remain unaffected by this decision. This measure has been taken by the PM in an attempt to address the resolve against corruption, black money and counterfeit notes. This move is expected to cleanse the formal economic system and discard black money from the same.
The views shared belong to Credit Ananlysis & Research Limited (CARE Ratings) - Madan Sabnavis, chief economist and Anushka Sawarkar, associate economist.
Effect on parallel economy
The removal of these 500 and 1000 notes and replacement of the same with new Rs 500 and 2000 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
Curb the funding for anti-social elements like smuggling, terrorism, espionage, etc.
Effect on Demand
The overall demand is expected to be affected to an extent. The demand in following areas is to be impacted particularly:
Real Estate and Property
Gold and luxury goods
Automobiles (only to a certain limit)
All 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.
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
Professionals like doctor, carpenter, utility service providers, etc.
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.
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.
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.