Categorized | General Insurance

Possible Effects of New Currency Change in India

The entire nation was hit by a financial hurricane on November 8, 2016 when the prime minister announced the demonetization of Rs 500 and Rs 1000 currency notes and the same to be replaced by new notes of Rs 500 and Rs 2000. The main reasons cited were to fight against the three main evils inflicting the society: black money, corruption and terrorism.  There are many who have welcomed the bold move of the government, many others have been criticising it as illogical political move lacking planning and direction.

The now “illegal” currency accounts for 86% of the total money that is in circulation, valued at Rs 14 lakh crore and 12% of the country’s GDP. Clearly, with these going out of circulation and new currency coming in the impact will be felt by one and all. To put things into perspective, let us look at the short, medium and long Term view of this decision.

In the short term, the move will hurt all Indians very negatively as transactions in India are mainly carried out in cash. While some are making noise  even if the actual impact of the decision is not so much on them, there are many businesses which are purely run on cash and such a sudden move to push a cash economy to a cashless economy is definitely going to be painful. With the limit on withdrawals from ATM and also currency exchange from bank, the slowdown is expected to continue across all industries for a couple of months. As the ATMs are yet to be calibrated for the new currency and transferring such high amount of currency in each and every branch of all banks is going to take time the amount of currency in the market is going to remain low. The country’s overall spending in the next 1 to 3 months will see a sharp decline as the process of changing the currency continues thus having a negative impact on the country’s GDP. The impact will be the seen the highest in sectors which are majorly dependent on liquid money such as real estate and jewelry.

In the medium term, as the excess supply of cash is eliminated in the market, it will have a positive effect on the inflation. The economy will eventually start picking up and the volume of transactions would increase over time. The legitimate money will be deposited in the banks. The huge amount of deposits with banks will bring about lowering of the interest rate. For those who are sitting with unaccounted money, estimated to be 50% of total money, will either be extinguished or find its way back in the system through income disclosures or money laundering. Given the severity and strictness of the Government the chances of the latter are grim. Each note is a liability of the RBI and hence each note extinguished or which comes to the government by the way of taxes or penalties reduces the liability of RBI. With the current demonetization the government is hopeful to get one-third of such money extinguished which in value terms can take care of fiscal deficit of the country for a year or two. Interestingly, in 1978 when the previous demonetisation was carried out 25% of the unaccounted money was extinguished.

In the short and medium term the impact of this decision will mostly be may have negative on all sectors especially those in the unorganised business, in the long term such a move will have a positive impact on the economy.  The banking sector will be greatly benefited as more money will enter the banking system. Inflation would come down as the circulation of money in the market is reduced. Other sectors such as real estate and jewelry will also stabilise in the long-term, with certain amount of price correction. As the price of physical assets correct, people would relook their investment portfolio and financial planning would be looked at from a whole new perspective. There would be more participation in the equity and bond market by retail investors.

Though there are still few who believe that with Rs 2000 currency note it would be much easier to hoard cash, going forward the government will make it more difficult to spend cash and make it mandatory to produce PAN Card in high value transactions, so people would have little choice to break rules. Also, the current demonetisation will create an everlasting psychological fear in the mind of people.