An Year after Demo

Truth is that the positives outweigh the negatives of demonetization

On November 09th, India completed a full one year since demonetization was implemented. While the ostensible reason for demonetization was the eradication of black money from the economy, the jury is still out on the subject. There have been negatives but there have been some bigger positives from demonetization. For the time being, we need to put the politics aside and purely focus on the economics…

Yes, there was a cash crunch…

To be fair, there is no denying this reality. The GDP growth took a hit of nearly 150 bps and the SME sector bore the brunt of it. Sectors like cement, construction, microfinance, and consumer goods were the worst hit due to the cash crunch. The cash crunch did force factories to go slow on their inventory plans and that had a negative impact on the IIP numbers and the manufacturing PMI. The cause-effect relationship was quite clear. Working capital cycles of corporates got adversely impacted due to delays in collections. At the same time, the treasurers also became more cautious of committing too much of their funds into inventories. The cash crunch played on the manufacturing growth and that in turn played on the liquidity. The net effect was a clear compression in growth for around 2-3 quarters. However, the first green shoots of a recovery are already visible. The Q2 GDP data could be the key going ahead!

Digitization did get triggered…

While the stated purpose of the note ban was to crunch the black money in the system, it had another positive impact altogether. The near ban on cash transactions led to rapid adoption of digital transactions like the use of credit cards, use of net banking and of course the use of mobile wallets like Paytm. One can argue that the cash economy will return as a result of remonetization but that is missing the point. The combination of financial inclusion and digital spread has created the right platform for digitization of money. We can see that explode in the next few years and that will be the big takeaway from the demonetization.

The big boost to banking…

But the real boost was for banking, especially PSU banks. The note ban resulted in a surge in deposits with banks to the tune of nearly Rs.5 trillion. With a surfeit of liquidity, banks were forced to cut lending rates sharply resulting in 100% transmission of rate cuts undertaken by the RBI since 2015. This huge stash has had another effect. The massive deposit base has created the right environment for the much-needed recapitalization of bonds. The Rs.2.35 trillion bank recapitalization is being driven by recap bonds. That would not have been possible without demonetization. That may the biggest positive spill-off from the note ban! ©

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