Demonetization shocks India
Let’s take a look at the graph below. Now imagine what could happen if the two largest chunks of the pie, which combine to form 86% of the currency in circulation, had their legal tender status retracted.
This is exactly what happened in India at 8:15 PM on November 8. Prime Minister Narendra Modi, in a nationally televised address, announced that 500 rupee and 1,000 rupee currency notes will have their legal tender withdrawn starting at midnight of that same day.
According to RBI’s (Reserve Bank of India) Annual Report for April 2015 to March 2016, these two notes combined to form 86.4% of the total value of the currency at the end of March 2016, which came to 16.42 trillion Indian rupees. With one stroke, the government removed 86.4% of the currency in circulation by value. In terms of volume, the currency notes of these two denominations formed 24.4% of a total 90.27 billion pieces.
The rationale behind the move
The primary reason for the sudden demonetization move by the NDA (National Democratic Alliance) government was to fulfill its political campaign promise of checking the rise of black money in the financial system. Narendra Modi-led BJP (Bharatiya Janata Party) had campaigned extensively to crack down on black money during its election campaign in 2014.
A minor goal of the move was also to increase the use of digital and electronic platforms for payments. The government has stated several times in the past that during the ongoing remonetization, it will not disburse the entire value of currency that was wiped out by demonetization.
Impact on the economy
Immediately following the move, there was a lot of debate regarding the impact of demonetization on India’s economy, which had been growing at 7%+ levels – outpacing even China.
Expectations ranged from a minor impact to a catastrophe with some research reports suggesting that the rate of growth may decline to as low as 3.5%.
Prior to looking at the estimates of India’s statistics agency and why they have rekindled the economic growth debate, let’s look at what aspects of India’s economy have been most vulnerable to the demonetization two month ago.