Waging a war against the black economy, Prime Minister Narendra Modi announced the demonetisation of high-denomination notes on November 8. But, this has created a massive liquidity crisis across the country. That’s because, as Chart 1 shows, Indian economy uses cash far more than other countries. Chart 2 shows two related things. One, as of 2011-12, cash was used in a high proportion (almost 87 per cent) of transactions in India. Two, this proportion has been coming down over the years.
Chart 3 shows that cash is the least preferred instrument for storing undeclared assets. It is real estate, followed by precious metals and jewellery, that is used to launder most of the black money. Demonetisation is likely to bring down real estate prices across the board but as Chart 4 shows, real estate accounts for over 90 per cent of household wealth and this, too, might come down. Moreover, all sectors, such as the cement industry, that are heavily dependent on real estate development will be adversely affected. Demonetisation is also likely to shrink the informal sector, which not only provides employment to 80 per cent of India’s labour force but also, as Chart 5 shows, accounts for 48 per cent of India’s total output. This share might go down to 20 per cent between Q3FY17 and Q4FY19.
As such, the growth rate of India’s gross domestic product (GDP) in FY17 is expected to nosedive — as shown in Chart 6. Most other estimates suggest a reduction, though not as sharp. But, retail inflation will fall further, as shown in Chart 7, and the other big benefit of demonetisation will be the bump-up in white savings ratio, at the cost of black savings ratio, over the next few years, as shown in Chart 8.