Demonetisation: Macroeconomic Implications for Indian Economy

The present paper attempts to explore the macroeconomic implications of the “demonetisation” exercise announced on November 8, 2016, for the Indian economy on three board parameters of growth, distributional consequences, and the challenges it brought in for the Banking Sector. Concomitantly, an attempt has been made to evaluate the extent to which the stated objectives behind this exercise are justified. We found that it is beyond dispute as far as the immediate impact on growth is concerned. Given the size of the informal economy, contraction in output during this fiscal was inevitable. However, at this stage it is too early to predict anything about the future course of output growth. Other than the growth challenge, the demonetisation exercise throws a far more important challenge bearing distributional consequences. The new interest rate regime that emerged during the post-demonetisation period is likely to benefit some while leaving a large chunk of population worse off. Finally, the banks find it very difficult to manage the liquidity surge in the system. With an increase in deposit growth and a decline in credit growth, it would be difficult for banks to manage their liabilities. The evaluation of its stated objectives suggests that it does not justify such a mammoth exercise, which is cost-intensive and bears serious adversarial economic consequences.