DEMONETIZATIONOn November 8, 2016,Prime Minister Narendra Modi announced, surprising everyone that the existinghigher denomination currency (Rs. 500 and Rs. 1000) will cease to be legaltenders. PM mentioned that this would be the government’s biggest push to fightblack money and end corruption.
This is notthe first time that demonization has been implemented in India. In 1936, Rs.10000, which was the highest denomination note was introduced but wasdemonetised in 1946. It was re-introduced in 1954 which was later again in 1978declared illegal by the then Prime Minister Morarji Desai in his intensive moveto counter the black money. The Reserve Bank of India on August 30, 2017 released its report ondemonetisation. According to the report, 99 per cent of the banned notes cameback into the banking system which trashes all claims of Narendra Modi that themove will flush out the black money and counterfeit currency.
With 99 per cent currency back in the system, the failure of demonetisationhints two things: either the black money held in cash was very low or thegovernment failed to implement the demonetisation efficiently.The cost incurred by the currency- scrapping exercise was quite severe,at least in the short term, disrupting ordinary life across the country forseveral weeks. The hardest- hit were those in rural areas, where access tobanking and the internet is quite low. The impact of demonetization on the financialsector of the country can be summarised below:1.
Shift in the demand for currencyShift has been observed in the income elasticityof currency demand in the post-demonetization period to 0.9 from 1 in thepre-demonetisation period, reflecting a reduction in cash intensity in retailtransactions. 2. Significant growth in Bank depositsBank deposits grew from 3.0 to 4.7 percentagepoints post demonetization.
3. Greater financial inclusion50 million new accounts were made under thePradhan Mantri Jan Dhan Yojana (PMJDY) by October 2017.4. Improved monetary transmissionInan environment of a surge in low-cost current account and saving account (CASA)deposits, banks announced a large cut in their marginal cost of funds basedlending rates (MCLR) with a 100 basis points (bps) reduction in the 1-yearMCLR. 5. Increase in mutual fund investmentsby households:A sizeable expansion in the collections of debt/income-oriented mutual fundsoccurred after demonetisation i.e.
during November 2016 to March 2017. The assetsunder management (AUM) by mutual funds increased from about `16 trillion to `21trillion between end-October 2016 and end-October 2017.6.
Higher collections under lifeinsurance schemes: The cumulative insurance premium collectionsduring November 2016 to January 2017 increased by 46 per cent over the same periodof the previous year.7. Accelerateddigitisation of retail payments: The latest datareveal that prepaid payment instrument (PPI) volumes increased by 54 per centbetween November 2016 and August 2017, as also mirrored in the significant dropin the income elasticity of currency demand referred to earlier.
8. Higher rate of detection of fakeIndian currency notes (FICNs): In the post demonetisationperiod, the rate of detection of FICNs rose to 6 pieces and 12 pieces for 500and 1000 notes, respectively, for every million pieces of notes processed –more than twice during the pre-demonetisation period. I. Demonetisation and Currency DemandDemonetization was followed by decline in CIC growth. The demonetisednotes were accepted in the bankstill December 30, 2016.
Between November 4, 2016 and January 6, 2017 total CICdeclined by about 9 trillion. Chart 1a: OnOctober 27, 2017, CIC was lower by 8.0 percent on y-o-y (year over year) basis as against anincrease of 17.2 per cent in the previous year.Chart1b: On October 27, 2017, CIC stood at 91 per cent of its pre-demonetisation level. II. Demonetisationand bank deposit growth Thecirculation of notes declined between October 28, 2016 and January 6, 2017 by 9trillion which was reflected with the increase in the share of CASA deposits (low-costdeposits) by 4 percentage points of the banking system. Demonetizationalso increased financial intermediation with 38 percent increase in deposits inPMJDY accounts, with an addition of 27 million accounts post- demonetisation (November9, 2016 to March 31, 2017).
Around 50 million accounts were opened since demonetizationuntil October, 2017. III. Demonetizationand monetary transaction CASA depositsincreased sharply in the post-demonetization period as the banks credited theaccounts with the demonetised bank notes.
The share of the low-cost CASAdeposits in total bank deposits increased from 35.2 per cent in October 2016 to40.6 per cent in March 2017, before declining to 38.6 per cent in June 2017. Withcredit demand remaining sluggish, banks reduced their term deposit ratessignificantly towards end-December 2016/early January 2017; interest rates onsaving deposit accounts, however, were left unchanged. In an environment ofsurplus liquidity, weak credit demand, lower cost of term deposits and a surge inlow cost CASA deposits, banks announced a large cut in their MCLRs in January2017.
The 1-yearmedian MCLR has declined by a cumulative 80 bps since November 2016. This is significant,considering that the 1-year median MCLR declined by only 15 bps during thepreceding seven months (April-October 2016) when the policy repo rate wasreduced by 50 bps. Thus, a large part of the transmission was facilitated bythe surplus liquidity on account of demonetisation. IV. Demonetisation and Financializationof Savings Demonetisationalso resulted in gains for the non-banking financial intermediaries such asdebt/ income oriented mutual funds and insurance companies. In fact, theaggregate balance sheet of the non-banking financial companies (NBFCs) expandedby 14.5 per cent during 2016-17.
Financializationof Savings can be broken up into three non-banking financial intermediaries:Mutual funds, Insurance Companies and NBFCs.1. MutualFundsModeration in interestrates on bank deposits after demonetisation and decline in the price of gold enhancedthe relative attractiveness of both debt and equity oriented mutual funds.2. LifeInsurance CompaniesCollections of premium by life insurancecompanies more than doubled in November 2016.
Premium collected by LifeInsurance Corporation (LIC) of India increased by 142 per cent (y-o-y) inNovember 2016, whereas collection by private sector life insurance companiesincreased by nearly 50 per cent. 3. Non-Banking Financial Companies(NBFCs)Loans disbursed by all categories ofNBFCs declined significantly in November 2016 as compared with the monthly averagedisbursals during April- October 2016, especially by micro finance companies (NBFC-MFIs)whose business is cash intensive.
Disbursals turned positive from March 2017and grew generally at a higher rate than the monthly average disbursalsrecorded during April-October 2016. Growth in collections (i.e., repayments ofloans due) of AFCs and LCs during November 2016-June 2017 increasedsignificantly over the monthly average collections during April-October 2016. Bank credit to NBFCs decelerated from 5.
1 per cent (y-o-y) inOctober 2016 to 1.3 per cent in November 2016; however, it subsequentlyimproved to 10.9 per cent in March 2017. In terms of the returns submitted bythe reporting NBFCs, loans and advances by NBFCs increased broadly at the samerate in the year ending March 2017 (16.4 per cent) as in the year ending March 2016(16.
6 per cent). RECAPITALISATION OFBANKS 1. Economic offenders bill2. Recapitalization of banks3.