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What is demonetization?

Demonetization is a process by which a currency loses its status as legal tender, meaning that it can no longer be used as a medium of exchange for goods and services. This usually occurs when a government decides to replace an old currency with a new one or to combat illegal activities such as corruption, counterfeiting, or money laundering.

In the context of India, demonetization in 2016 involved the government's decision to ban the use of all 500 and 1,000 rupee notes, which accounted for the majority of the currency in circulation at the time. The old notes were replaced with new 500 and 2,000 rupee notes, and people were given a limited time to exchange their old currency for the new one. This move was aimed at combating black money, counterfeiting, and corruption, among other things.

Objective of demonetization

Curbing corruption and black money

Demonetization was aimed at curbing the circulation of unaccounted cash, preventing the generation of black money, and making it difficult for corrupt individuals to store and use their illegal wealth.

Increasing tax revenues

By bringing more people into the formal financial system and promoting a shift towards digital transactions, the government expected to increase tax compliance and boost tax revenues.

Promoting digital payments

: The demonetization move was expected to encourage people to shift towards digital transactions, which would help to reduce the use of cash in the economy, promote transparency, and reduce the incidence of tax evasion.

Boosting economic growth

The government expected demonetization to have a positive impact on the economy by promoting transparency and accountability, reducing the informal economy, and increasing financial inclusion.

Impact of demonetization on Indian economy

Short term impact in which demonetization impacted the economy

Cash crunch: Demonetization involved the sudden withdrawal of high-value currency notes, which led to a shortage of cash in the economy. This led to reduced demand and consumption, which in turn slowed down economic activity.
Disruption of informal sector: A significant portion of the Indian economy is made up of the informal sector, which largely operates on cash transactions. Demonetization disrupted this sector, leading to job losses and reduced economic activity
Reduced investment: The slowdown in economic activity and uncertainty caused by demonetization led to reduced investment by businesses and individuals, further dampening economic growth.
Negative impact on agriculture: : Demonetization coincided with the Rabi crop season, which led to a shortage of cash for farmers to purchase inputs such as seeds and fertilizers. This had a negative impact on agricultural production and rural incomes, which in turn affected overall economic growth.

Potential long-term impacts of demonetization on India's growth trajectory:

Promotion of digital payments: Demonetization led to a significant shift towards digital payments in India, as people had to rely on alternative payment methods during the cash crunch. This could have a long-term positive impact on the economy by reducing the reliance on cash, promoting financial inclusion, and increasing the efficiency of payment systems.
Formalization of the economy: Demonetization aimed to formalize the informal sector of the economy by bringing more transactions into the formal economy and reducing the amount of undeclared income. This could increase tax revenues, reduce corruption, and promote a more sustainable growth trajectory.
Reduction in black money: Demonetization aimed to reduce the amount of black money in the economy by targeting cash-based transactions and encouraging people to declare their income. This could have long-term positive effects on the economy by reducing the amount of unaccounted money, promoting transparency, and increasing confidence in the economy

Effects on GDP

Demonetization had a negative impact on the Indian economy in the short term, as it led to a slowdown in economic growth. This was due to reduced demand, lower consumer spending, and disruptions in the informal sector, which accounts for a significant part of the Indian economy. However, over the long term, demonetization is expected to have a positive impact on the economy by promoting transparency, accountability, and financial inclusion, and reducing the informal economy.

Will demonetization slow down India’s growth?


Moreover, demonetization had a mixed impact on the demand, prices, and GDP of the Indian economy, with negative effects in the short term and potential positive effects in the long term. In the future, it is important for policymakers to consider the potential consequences of such policies on different segments of society and the economy as a whole, and to implement them in a way that minimizes the negative effects and maximizes the positive effects.