Demonetization – The Economy and its Economics

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The Indian currency ban, demonization, jolt on black money, cashless economy, financial inclusion, and counterfeited currency- all these words have become synonymous to each other in the current scenario. As we all know that Mr. Modi has made this move of banning Rs 1000 and Rs 500 notes to get rid of the black money and fake money in circulation it has ignites varied views related to it. Let’s try to understand its economics.

What is Black Money

First of all what is black money? Most of us think that, the money which is not been disclosed and is kept hidden at homes and offices is black money. While it’s a broad term meaning, income or business which is been obtained illegally and is not disclosed in order to avoid taxes. So, should we say that a business of a kirana store which runs wholly on cash is an illegal business? No it is not, but if he does not disclose his income then it is black money as he trying to avoid tax. A normal day to day business requires cash transactions but that does not mean that the money used in it is illegal. Also, be it an ordinary business of black business both use money and invest it further to make more money. So, it’s pretty difficult to segregate white from black and the government should make the decision of going behind black money or undisclosed business.


Second, this step of demonization will bring in more innovation in the minds of black money hoarders. For e.g.; people will start exchanging their Rs.1000 and Rs.500 notes for a lesser amount. The black money hoarders will start find ways to convert their money into white through the accounts of their workers. And hey! Do not underestimate the magic skills of our CA’s who can turn things around. This would not only be done by the people having black money but also by the people having white in case of certain emergencies, as all keep some money at home for different purposes. There are incidences reported where the employers have given month’s salaries in advance to their employees in order to get rid of the black money.

Opportunity Cost

Third, the opportunity cost factor. As we are already witnessing that people are standing in long queues outside the banks ATMs and are still not able to get money. It has an opportunity cost attached to it, the hour or day lost standing in the queue is equal to the wage that person could have earned by working somewhere. And so the vicious circle is created, not only is the wage been lost but the business is also loosing as neither they have the labor nor they have the adequate amount of cash to run the business. In the retail and whole sale markets there will price rise due to shortage and hoarding, which will impact the common man.


Fourth, the reduced liquidity will impact the aggregate demand. The good harvest in this season and the 7th pay commission boost of which we were expecting an increase in consumer spending has put the people in a jeopardized state, as they don’t have the money to spend in spite of having money!. Also there will be negative wealth effect as the rates of property (the physical saving instrument) will go deep down. That’s because the major channel to invest black money is through investing in property and this will have a multiplier effect. The infra activity will reduce and this will impact the industries related to it. Therefore, the zeal to reach the 8% growth rate will need to be sacrificed for some time now. While in the long run in order gain back the speed of growth the government should focus on the fiscal spending.

Banking Industry

Fifth, the banking industry. The current scenario gave us a reality check, the banking infrastructure is really poor and should be worked upon ASAP. While on the other side, the banks will see a splurge in liquidity which would improve their profitability. The gains would be transferred to the common man through the reduced lending rates. Also, as the real estate sector is impacted the loan business of the banks may see a decline.

Informal Sector

Sixth, the informal sector works on cash. Even the saving is done in cash majorly through informal financial mechanisms as the penetration of bank branches is low. So, the informal financial sector operating will feel the jolt of the move as we move towards cash less economy and may have to face long term effects.

Counterfeited Currency and some Black Money

Seventh, this step has curbed the counterfeited currency and some black money but it couldn’t reaching the money which has been converted into assets and one moved to the foreign banks. This move has also shaken the terrorist organization which are operating and using counterfeited currency. But we need to keep an eye on fake currency and this can be done if we become more techno freak.

Though the move was taken in at most interest of the people but it required much more planning so that the complete dream of financial inclusion could have been realized. Currently the COMMON MAN is going through a lot of suffering, but most are enduring it with proud.