Demonetization - Is it Good, Bad or Ugly for India?

Demonetization – Is it Good, Bad or Ugly for India?

Roboadviso     Economy     Posted On, Sun 25th December, 2016     No comments
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Demonetisation demonetization good or bad

Demonetization is not a new concept in India. It has been done in the past but not in such a large scale. For example, the 10,000 rupee note was demonetised in 1978. However, only the very rich had these notes and the general population of the country remained unaffected by this move.

Demonetisation of 500 and 1000 rupee notes on November 8, 2016 by the NDA government has impacted almost everyone. This is because 500 and 1000 rupee notes are in wide circulation and used by about 85 percent of the population. Hence, its effects are widespread and far reaching, unlike the previous instances of demonetisation.

The current government opted for demonetisation to obliterate counterfeit money, end corruption and black money, disrupt terrorist activities, and gradually move towards a cashless society. The move has also however affected not just the daily lives of the populous, but will also result in short-term slowdown of the economy, reduced revenue, and decreased GDP growth. Analysts however believe that demonetisation will result in positive impact over the long term.

Demonetisation thus has its pros and cons. These are listed below.

Pros of Demonetisation

  • Demonetisation is going to be a death blow on corruption. The exchange of hoarded cash by people with black money will end or will be minimized. Hoarders will be afraid to exchange black money as doing so may trigger penal action, monetary penalties, and/or criminal prosecution.
  • The society will gradually move towards a cashless one. Improvement in the banking systems and digitization of money will lead to sharp decrease in cash transactions. Cashless economy will be beneficial for all as it will be marked by financial inclusion and increased and easy access to credit.
  • The interest rates will fall with a fall in inflation caused by demonetisation. Also, higher deposits in banks will lead to increased ability of banks to give loans at lower interest rates, which in turn will decrease the price of commodities, real estate, etc., as well as enhance access to such commodities by those who could not previously afford it.
  • Tax collected via IT department search and seizure activities as well as voluntary disclosure will fill the government coffers. Increased tax revenue can help offset the fiscal deficit. Also, better tax compliance and increased tax collection in a cashless economy will result in a less complex tax system. Such a system will be marked by tax savings which will increase the disposable income of the population. This will result in increased spending by consumers and economical growth of the nation in the long term.

Cons of Demonetisation

  • The banking system is currently flush with huge deposits. All analysis of the positive impact of demonetisation on the banking sector as well as the eventual transition towards a cashless society is based on the fact that banks will have large sums to lend. However, after the government eases the limits on cash withdrawals it remains to be seen whether consumers keep their money in banks or take them out.
  • The cash crunch caused by demonetisation has and will continue to affect sectors that are largely cash based. For example, jewelry, real estate, retailing, logistics, restaurants, luxury brands, consumer durables, and cement, etc. will face short-term downturn and reduced revenue.
  • The transition to a cashless society post demonetisation is going to require a tremendous effort and will be not easy.
  • Most consumers and households in India prefer transacting in cash for purchase of durables as well as essentials. Most Indians also prefer to save cash at home. Also, over fifty percent of the populous does not know how to transact in card or other forms of digital payments.
  • The banking infrastructure in India is way behind other emerging markets. Access to ATMs and point-of-sale terminals is limited and typically available mostly in towns and cities and in organized sector. Rural India has limited access to even banks.
  • Access to internet, especially broadband connection, is limited to urban areas. Also, even if internet connections are available, it is not very reliable.
  • Nearly 80 percent of Indians have mobile phones. However, nearly 65 percent of such mobile phone users do not access the internet from their phones. Also, most of those who do use internet on their smartphones often use it to access WhatsApp, Facebook, etc., and not for shopping or banking.

Investment options post Demonetisation

Before demonetization most of us had invested our savings in FDs, real estate, etc. The situation has now changed.

  • With the steep increase in deposits at banks after demonetisation, banks would not need additional money in the form of FDs, etc. Hence, interest rates for FDs will fall
  • The real estate market is going to go through short-term turmoil post-demonetisation.
  • Mutual funds are a great investment option during this period of short-term volatility. You can opt for equity mutual funds with investments in fundamentally sound stocks. They will provide great benefits in the long term. Due to a currently stagnant stock market, you can invest in good equity mutual funds at low prices.
  • Debt mutual funds tend to do well when the interest rates are falling. Bond prices tend to gain during such times of falling interest rates. It can be historically verified that returns on such bonds are usually quite high.

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