Demonetisation of Indian Currency – A Detailed Study Part 2

In this series called “Demonetisation of Indian Currency – A Detailed Study” we shall conduct a detailed examination of the so-called demonetization ( currency-swap) announced by Indian Prime Minister Narendra Modi on 8th Nov 2016, and assess its impact on Indian economy. In the previous part of this series we had talked about the initial announcement and the reason behind this drastic and sudden economic move. In this part we shall explore this in further details based on Shri S Gurumurthy’s analysis.

Read Part 1.

A Quick Recap

On 8-Nov-2016, the Government of India announced the demonetization of all ₹500 and ₹1,000 banknotes. Prime Minister Narendra Modi in his special address to the nation on the evening of 8th Nov 2016 announced that that Rs 500 and Rs 1000 banknotes would be withdrawn from the financial system “to tackle counterfeiting Indian banknotes, to effectively nullify black money hoarded in cash and curb funding of terrorism with fake notes”. (1) There were stringent oppositions from some small groups of people – notable among them were some Delhi/ foreign based economists, politicians of opposition parties and media personnel. However in general the announcement was greeted with whole-hearted support by most Indians.

Gurumurthy on Demonetisation

Noted political & economic analyst and black-money crusader S Gurumurthy, who describes demonetisation as a “deliberate contraction forced on the economy”, in his various lucid and clear interviews on Doordarshan and private newspapers, talks about the necessity of demonetisation and how it would shape the India economy in the years ahead.

The below points are quotes and paraphrases of Shri Swaminathan Gurumurthy’s views on demonetisation.

Informal Cash Economy

According to Shri Gurumurthy, cash economy is an integral part of the Indian economy. He says that, “studies show 50 per cent of Indian economy is in cash. Cash economy does not mean it is illicit economy, it’s unorganised economy. Ninety per cent of employment is attributed to economy driven largely by cash.”

This has resulted in huge cash hoardings, transactions between real estate. The growth of cash economy in proportion to the gross domestic product (GDP) – was less than 10 per percent until 2001, now it is almost 12 per cent of GDP. Consequently from 2004 onwards, Indian economy witnesses a fake growth in terms of asset appreciation — land, gold and stocks — without growth in jobs.
Lending rates to small and micro businesses became usurious leading to decreased profitability.

If the high denomination notes constituted 34% of the total economy in 2004, it went up to 79% in the next six years and touched 86% in 2014. This is what has propelled the spike in asset prices. Once unofficial cash drove this spiral, the official money too started going into these sectors leaving little monies for the production sectors. The cash to GDP ratio must go down, it has increased. This has also been facilitated by growth in high denomination currency (as high as 87 per cent).

Shri Gurumurthy explains in details: ” During 2004-10, average money supply grew annually 18 per cent (15.3 per cent under the NDA). But asset prices rose by several multiples of it. The moderate rise in money supply over the NDA’s number does not explain the huge asset inflation. The clue hides in the rising unmonitored HDN cash stock with the public which made black money deals easy. In 1999, the cash with the public was 9.4 per cent of nominal GDP. By 2007-08, instead of falling due to rising bank and digital payments, it jumped to 13 per cent of nominal GDP. Later it began hovering around 12 per cent. More critically, the HDNs with the public more than doubled from 34 per cent in 2004 to 79 per cent in 2010. On November 8, 2016, it was 87 per cent. The average annual rise in HDNs was 51 per cent between 2004 and 2010 and the annual rise was 63 per cent by 2013-14. The Reserve Bank of India noted that two-thirds of the Rs.1,000 notes and one-third of the Rs.500 notes — that is over Rs. 6 lakh crore now — never returned to banks after they were issued. The unmonitored HDNs roaming outside banks began driving up the gold and land prices by black cash and the stock prices through Participatory Notes (PNs) — which are largely hawala transfers out of India — that came back pretending as foreign investment in stocks. The PNs rose from Rs.68,000 crore in 2004 to Rs.3.81 lakh crore in 2007.”

Demonetisation of Indian Currency - A Detailed Study Part 2 - Jobless Growth UPA

Jobless Growth and Asset Inflation

During the NDA rule (1999-2004) real GDP grew by 27.8 per cent annually 5.5 percentage points. Annual money supply, that fuels inflation, by 15.3 per cent. Prices by 23 per cent, annually 4.6 per cent. Asset prices rose only moderately in those five years. Stocks rose by 32 per cent; gold by 38 per cent. Taking Chennai as an illustration, land prices by 32 per cent. Jobs rose phenomenally, by almost 60 million.

“In the first and best six years of the UPA (2004-05 to 2009-10), before it was hit by scams, real GDP grew by 50.8 per cent, annually 8.4 percentage points — one-and-a-half times NDA’s. The world celebrated Dr. Singh. The UPA was intoxicated by the “high growth” story. But how many jobs did UPA’s high growth produce? Believe it or not, just 27 lakhs against 600 lakhs during NDA’s five years, according to NSSO data. UPA achieved one-and-a-half times NDA’s GDP growth, but just 5 per cent of its job growth. Dr. Singh now bemoans that Mr. Modi’s demonetisation will stifle jobs!”

“Why was the UPA’s high growth jobless? The well-kept secret is that huge asset price inflation, not production, passed off as high growth. In the first six years of the UPA, stock and gold prices jumped by three times — annually by 60 per cent. Property prices doubled every two-three years. In Gurgaon, not on the property map in 1999, land prices rose by 10-20 times. Asset inflation in six years was three times the annual nominal GDP growth. The asset inflation not the result but the cause of the UPA’s “high growth”! How? Modern economics deducts the non-asset price inflation from nominal growth to know the real growth. But it sees asset price rise as wealth and prosperity and adds it to GDP. See how this economics worked for the UPA.”

Why was Demonetisation Needed?

#1 Demonetisation as a hedge agsinst future crises
Gurumurthy says: “what we have seen thus far is not real growth. One can argue that we could have continued with this — essentially do a holding operation. What has grown from Rs 1.4 lakh crore (HDNs) in 2000 to Rs 14.6 lakh crore now would have increased to Rs 30 lakh crore in the next five years, by which time no government could have intervened unless it is willing to pull down the economy. Even otherwise, the economy would have collapsed on its own eventually. So demonetisation is a hedge against a crisis which might collapse the economy eventually.”

#2 Black money within India
“Two-thirds of Rs 1,000 note and one-third of the Rs 500 note which went out of the bank never came back to the system. This means that over Rs 5 lakh crore was in operation outside the banking system. So, the government felt this was approximately the quantum of black money that existed in the system and it has to be caught.”

Hence demonetisation was an inevitable decision.

Demonetisation of Indian Currency - A Detailed Study Part 2 - Survey



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A Few Last Words

Before making any investment decision, please contact your financial adviser.

I have provided this article for educational purpose only.

I hope you found this article on Demonetisation of Indian Currency – A Detailed Study Part 2 useful. If you have something to add please leave a comment in the post. Please feel free to contact me.

Subhodeep Mukhopadhyay

I am a Management Consultant in the Education Sector. In my previous corporate career, I have worked in Banking, Private Equity and Software industry. I am an MBA in Finance/ Computer Engineer and enjoy doing equity research and financial analysis in my free time.

2 thoughts on “Demonetisation of Indian Currency – A Detailed Study Part 2

  • February 13, 2017 at 11:23 am

    You are doing a great job collating all this research in this series.

    • March 4, 2017 at 12:12 am

      Thanks. We need to collate all the Indic responses – we’ve had too many of Western and Sepoy responses to demonetization so far.


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