‘Demon’etization: One step Forward Three steps Back

‘Demon’etization: One step Forward Three steps Back

Demonetization has been the most controversial economic reform carried out by any Indian prime minister after the historic liberalization of 1991. The prime minister in his address to the nation, extolled demonetization as a surgical strike on black money, counterfeit notes, terror financing, and corruption. Surprisingly, the prime minister had never used the words, "formal or informal economy”, "expansion of tax base", "digitalization", and "less-cash economy", anywhere in his speech but were later added on by the Ministry of Finance in its report as an attempt to save face of the government by shifting goalposts. Later on, the policy turned out to be a twin-sided approach in nature as it was not typically aimed at the economic benefit only rather it has a spectrum of social objectives to wipe out corruption and terrorism related activities from the domestic boundary of the nation. The failure of Lok Pal bill to tackle rampant corruption in the system was the background for the initiation of this draconian policy that has undoubtedly caused significant short, medium and long run impact over various sectors of the Indian economy. Moreover, the cross-country experiences of demonetization, viz European Union, United States etc. shows historical evidences for the smooth execution of the policy by ensuring adequate supply of currency in the banking system while in India it was an overnight decision kept very confidential among the top bureaucrats and politicians causing severe hardships in all spheres of life. According to different reports and studies, it is estimated that 62% of the GDP constitute of Black Money and in addition the simultaneous generation of Black and White Money in the aggregate currency circulation stood against its successful implementation.

When we look at the impact of the policy within this short span of 4 years, it was witnessed that, the real losses were considerably larger than the actual estimated results. It was also true to identify the effect of demonetization policy that caused random shock to the economic system over its medium and long run growth prospects. The fallacious assumption followed by Indian policy makers during the time period was of the thought ‘everything about black economy is about cash’. Crash in price of agricultural produces became a major issue resulting to a drop in farmers income by a certain percentage and that could impact the whole chain of activities related with it as there exist greater linkages (both forward and backward) with the sector.

The Aggregate Investments in the economy for the FY 2016-17 plunged to ₹4.25 lakh crore i.e. a massive drop of 60% year on year basis. The Aggregate Investments disclosed prior to FY 2016-17 i.e. it was ₹11.72 lakh crore in the financial year 2010-11 and declined to ₹10.33 lakh crore by the end of FY 2015-16. The unexpected liquidity crisis stemmed from demonetization had negative spill-over effects over all walks of life, where rural and informal economy being hit the most, had seriously affected the consumer spending and rural income due to its negative accelerator effect. Sudden disturbances in aggregate investments generated from a policy surprise like of demonetization shattered the business expectations and dampened the fresh investments at least for a short period. Even though we had witnessed short recovery from the dips made by the policy implications, the ailing global economy along with the fears of an impending recession subdued new investments into the economy. Once it comes to Micro Small and Medium Enterprises (MSMEs) sector, the issues relating with structural unemployment, breakages in supply chains, lower access to formal credit and finance were the key areas of concerns linked with the policy change. Though the demonetization has caused short run liquidity crunch, the recent progress in Information and Communication Technology (ICT) enabled registration processes and digitalization has eventuated the availability of information to the lenders on making credit assessments of the borrowers. The contribution of informal sector is part and parcel of our growth story providing millions of jobs to low skilled workers. Total workforce is estimated to be 392 million, that is around 82% of the nation’s total employed workforce and contributing 40% of India’s GDP. The wrath of an unprepared policy was mostly borne by ordinary folks within the sector as a huge section rely on cash dealings as this is a sector who were paid in cash, spend in cash and saves in cash. The rise in unemployment rates to 6.1%, the highest of about last four and a half decade, was an immediate consequence of twin impact of demonetization and GST on informal sector.

Demonetization has indisputably led to a permanent rise in the use of digital transactions, popularizing the digital modes of payment among masses. The digital economies augmenting the positive network externalities created a platform to boost financial inclusion through different ways and thereby achieving financial deepening and widening of the economy. The recent suggestions put forward by an RBI committee to levy fees for ATM charges of ₹24 on withdrawals above ₹5000 to promote the use of digital payments to formalize the economy is a strategy to reduce the undue cash transactions. From the below chart it is evident that the aggregate currency circulation in the economy bounced back to the pre-demonetization levels as it was 11.6% in 2014-15 witnessing a decline to 8.7% by 2016-17 and climbing back to about 11.2% of GDP.

The expansion of tax base was one of the add-on objectives of the policy but it failed to convert a larger portion of the tax-filers to the purview of tax regime. Though the number of income tax filers in 2016–17 has grown by 5.4 lakhs compared to 2015–16, the average taxable income disclosed by the additional taxpayers is only around ₹2.7 lakh annually, just above the income tax threshold ₹2.5 lakh contributing to mere 0.3% of rise in income tax collections to GDP. That is on one side, the number of tax filers is increasing year-on-year basis whereas the actual number of net tax payers was in fact exhibiting sluggish growth as a result of twin distortionary policies of Demonetization and GST.

The commendable part behind the policy was the ability of the government to take such a courageous decision that could cause serious backlash and criticism from the common public and opposition parties given the risk and uncertainty of the same. But in reality, it became a game of gambling in which the payoffs turned out to be highly negative and unsatisfiable to the large section of the society. At the same time, for some economists, the policy seems to be successful in one way as it was an experiment for educating the masses about the need and benefits of digitalization and e-transactions followed after it. But in reality, the social and economic costs were blindly neglected which were turned out to be strongly more than the benefits accrued. Policy as a whole failed in bringing down the rampant corruption in the country contrary to the assurance given by the Prime Minister. The aim to defeat the black money circulation in the economy through cash is attained keeping all other loopholes remaining intact. Demonetization is similar to a strategy of recycling a plastic bottle in which the cap of the bottle alone gets recycled keeping the entire portion of the bottle untouched. So, in simple words, the unusual strategy aimed at cracking down the black money ended up in creating alternative ways for recycling the same. Surprisingly, the COVID-19 outbreak has accomplished what Demonetization has failed to achieve since the value of transactions on the Unified Payments Interface (UPI’s) reached an all-time high on June 2020 as the people averted the usage of currency notes on the fears of getting infected. The whole story of Demonization in India reveals the true picture that the removal of current stock of unrecorded and tax evaded money does not entail that creation of such money is being permanently stopped rather it had brought a new set of players to replace the existing ones, while the game would continue.


  1. Kumar, Arun: “Economic Consequences of Demonetisation”, Economic and Political Weekly, January 7, 2017.
  2. Ghosh, Soumya Kanti (2016): “Demonetisation and Note Burning”, Business Standard, 1 November.
  3. Rajakumar, J Dennis & Shetty, S L: “Demonetisation 1978, the Present and the Aftermath”, Economic and Political Weekly, November 26, 2016.
  4. Lahiri, Amartya: “The Great Indian Demonetization”, The Journal of Economic Perspectives, Vol. 34, No. 1 (Winter 2020), American Economic Association.
  5. Daya, Hasina & Mader, Philip: “Did Demonetisation Accelerate Financial Inclusion?”, Economic and Political Weekly, November 17, 2018.
  6. Nag, Ashok K: “Lost Due To Demonetisation”, Economic and Political Weekly, November 26, 2016.
  7. Rakshit, Mihir: “Some Analytics of Demonetisation”, Economic and Political Weekly, March 31, 2018.
  8. Shankar, V Kalyan & Sahni Rohini: “How Demonetisation Affected Informal Labour- Waste Chains in a City”, Economic and Political Weekly, June 30, 2018.
  9. Report on Income Tax Reforms for Building New India, September 2018, Taskforce for drafting the new Income Tax law ,Report on Income Tax Reforms (Vol-1).
  10. Assessment of the progress of digitisation from cash to electronic: https://m.rbi.org.in/Scripts/PublicationsView.aspx?id=19417.
  11. More people need to come under tax net: https://www.livemint.com/money/personal-finance/more-people-need-to-come-under-tax-net-11580317734288.html.
  12. Income Tax Department Time Series Data, Financial year 2000-01 to 2018-19 Income Tax Department Report.

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  1. Informative

    But this demonstration policy follows new classical and Keynesian idea of policy surprise! ( Rational Expectation)
    Partly good and partly bad

  2. It was really helpful and also I get to know about some figures I was confused about.👍

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