The impact of demonetisation is immense and it is bound to have positive impact in the long run via different channels of transmission. The different transmission channels are explained below in detail.
The more cash in the coffers of bank and financial institutions would lead to lower lending rate of interest which can boost investment and hence the growth of Indian GDP. The easy availability of loan will bring many unbanked and poor section of the society under the umbrella of organised financial institutions. Whether it be agricultural sector or MSME in the manufacturing sector lack of availability of credit is a major constraint in their growth and development. Reliance on moneylender for credit at a very high rate of interest reduce the productivity of these sectors and jeopardize their prospects of expansion. The tyranny of moneylenders through which small land holding farmers and landless labourers have to go is not unknown. Easy disbursal of loans to them can script the revival of the plunging agricultural growth rate. MSMEs with accessible formal financial credit has huge potential for employment creation which can generate better organised sector jobs for the unskilled and semi-skilled labourers.
Demonetisation is a broader structural reforms which have larger implications and is not limited to uprooting black money. Most of the unorganised sector will transform into organised sector having better life prospect for the poor people who were earlier forced to work in unhygienic condition in the sweat shops. This transition may come with some cost to small traders, but we know that capitalist system is based on creative destruction, where a new form takes over the old form. The old form has to reinvent themselves to remain in the market.
The black money which was lying unproductive in the economy will be channelized into the productive and efficient formal economy would help in achieving the aspiration of India of becoming a developed econmy.
Old 500 and 1000 rupees currency notes which do not come back to the banking system will lead to increased revenue for the government which can be used for the benefit of the deprived section in society. This will again boost the overall fiscal consolidation of the government. It may help in achieving a stable macroeconomic environment which increases the attractiveness of FDI and Capital Inflow.
Demonetization along with GST incentivize small and medium businessman to pay tax. They will get benefits and would be able to reduce the cascading effect of taxations. This will help in augmented indirect tax revenue generation for the government. As indirect tax are regressive in nature, the government being a welfare state may reduce the tax rate and this will help in easing of inflation in the economy.
Lesser tax evasion will help in higher tax to GDP ratio which for long time is hovering around 10 % of GDP in India. The higher direct tax revenue will give more fund at the disposal of government which it can prioritise according to the need either in the infrastructure sector or in reviving the social security measures. This will lead to fiscal consolidation by center.
Mobilisation of savings towards the formal financial sector will augment domestic private investment. This is possible with the underlying assumption that the financial institutions will deliver proper allocation of these financial resources to the promising projects.
The transition from a cash dependent economy to a less cash economy will help in the curtailment of expenditure in printing money. The transition to online and digital transaction is easy to monitor with the advent in data analytics, IT and communication. This will help in invigorated payment of taxes and lesser scope for bribe and corruption.
Demonetisation will help in curbing the menace of counterfeit currency and tackle problem of insurgency and terrorism which can be easily explained.
Generally when debate arises on how to tackle the issue of black money we focus mainly on the black money stashed in foreign account while black money in domestic economy is not given importance. Demonetization has changed the scenario and it gave due importance to domestic black money which is equally if not less problematic for the economy.
The prospect of poor people reaping the benefit of demonetisation will depend to certain extent on the redistribution mechanism employed by the government. Assuming the government to be a benevolent social planner and believer in progressive taxation, will lead the funds to flow from the rich to the poor and help in bridging the inequality gap.
An issue may arise due to frequent use of Income Declaration Scheme which goes against the principle of time consistency. The frequent income declaration scheme by the government will give disincentive to honest people paying taxes. It would incentivize the dishonest as they will feel the words of the government to be hollow and would not pay taxes timely. The government hence need to be cautious in its approach and must not frequently have an income declaration scheme in one form or another.
There may be compression in demand in few sectors in the very short run. But in medium and long run it depends on the way the sector move forward and the support they get from the government and administration. If the government relaxes the norm and help during the transition into an organised sector then the firm is going to gain in long run by raising their productivity and efficiency.
Many other initiatives by government like ease in tax reforms, benami property law, GST, availability of banking correspondents, and ease of digital transaction along with high band-with internet need to go hand in hand for demonetization to be a success. The onus lies with the youth, the corporate, CSR and the NGOs to train and impart digital and financial literacy to people and help India in transitioning to a bright future.
Overall demonetization will have a positive impact on the economy through the transmission channels described above.
