Did demonetisation hit the right notes? Evaluating its impact 8 years later

Eight years ago, on November 8, a televised address by Prime Minister Narendra Modi changed the way India looked at currency notes. That evening, he announced that Rs 500 and Rs 1,000 bills would no longer be valid, effectively rendering nearly 86 per cent of the cash supply invalid overnight.

 

The demonetisation was intended to vanquish black money, reduce counterfeit currency, curb corruption, boost digital payments, and counter terrorism. The Prime Minister emphasised that high cash circulation fostered corruption, and, obtained through corrupt means, it fuelled inflation and illicit activities. In his address to the nation, Modi said: “High circulation of cash also strengthens the hawala trade, which is directly connected to black money and illegal trade in weapons.”

 

So, eight years on, how do things look?

 

What happened to cash

 

Cash remains integral to the economy and continues to circulate widely. From around Rs 16.63 trillion in 2015-16 (FY16) before demonetisation, it initially fell to Rs 13.35 trillion in FY17, but in subsequent years rose to touch approximately Rs 35 trillion in FY24.

 

The cash-to-GDP ratio fell from 11.9 per cent in FY16 to 8.5 per cent the following year, then rose to 14.2 per cent in FY 21 before falling to nearly 12 per cent in FY24. GDP is short for gross domestic product, which is the monetary value of all goods and services produced in a country during a specified period.

 

Arun Kumar, former professor of economics at Jawaharlal Nehru University in New Delhi, says an economy can never be truly cashless, because people hold it for numerous reasons. During uncertain times, they tend to hoard even more. “To say that more cash means an economy is generating more black money is not correct,” he says.

 

Bharatiya Janata Party (BJP) national spokesperson Gopal Krishna Agarwal, however, opines that cash- to-GDP ratio is not an important factor. More important point is the number of digital transactions, according to him.   

 

Kumar says cash-to-GDP ratio does not directly indicate the extent of black money in the system. “In Japan, the cash-to-GDP ratio was 18 per cent in 2016, much higher than our 12 per cent at that time, but you can't say Japan is more corrupt. In Nigeria, it was 1.4 per cent, and corruption is very high there,” says Kumar, and emphasises that cash constitutes less than 1 per cent of black money, most of which is parked in other assets. 

 

A recent report corroborates this, indicating that 90 per cent of Indians still reportedly believe black money is prevalent in the real estate sector. The government’s efforts to centralise property records have a long way to go. 

 

Impact on digital payments

 

Digital payments have grown lightning fast, reaching Rs 36.59 trillion in FY24 from Rs 19.62 trillion in FY18, achieving a compound annual growth rate (CAGR) of about 44 per cent. This increase aligns with one of the government’s stated objectives. The mainstay of this growth is UPI, or Unified Payments Interface, which has surged from Rs 1 trillion in transaction value in FY18 to Rs 200 trillion in FY24, recording a CAGR of 138 per cent over seven years.

 

Agarwal says demonetisation has a strong impact on digital payments. India now has one of the highest penetration of digital payments. India's digital penetration is far better than many of the developed countries, he points out.

 

"UPI, Google Pay are the favoured mode of payment here in India, including rural areas. Bank accounts with ease of financial transactions through UPI have helped financial inclusion of a very large section of the population," Agarwal says.

 

Sunil Sinha, professor of economics at the Institute for Development and Communication, Chandigarh, points out digital payments saw an immediate uptick following the demonetisation, largely because of the shortage of physical currency. "The sustained growth in digital payments has been due to the ease and convenience they offer," he explains. "The digital push by banks and the Reserve Bank of India has been a significant driver of its continued increase."

 

However, Pronab Sen, former Chief Statistician of India, believes demonetisation is not the primary driver of digital payments. “Digital payments have been on the rise since before the demonetisation was announced and have been growing steadily since 2010,” he notes. 

 

The annual growth rate of digital payments was around 26.5 per cent in FY19 and has eased to 9.06 per cent in FY24, touching a low of 0.07 per cent in FY22, a period marked by the second wave of the Covid-19 pandemic. 

 

Counterfeit currency 

 

The year of the demonetisation saw a sudden increase in the number of counterfeit notes, rising from around 630,000 units in FY16 to 760,000 next year. However, since then, the number has been on a downward trajectory, dropping to 220,000 in FY24.

 

The primary driver of counterfeit currency has been the increased circulation of Rs 2,000 and Rs 500 notes, which now constitute more than half the total counterfeit currency in circulation.  

 

In FY24, the number of fake Rs 2,000 notes seized rose to 26,035 units from 9,806 the previous year, despite withdrawal of even original currency notes of this denomination from circulation. 

 

Similarly, fake Rs 500 notes have seen an increase even as there is a fall in their number in FY24 from the previous year. For instance, counterfeit Rs 500 notes surged from 9,892 in FY19 to 91,110 in FY23, but dropped to 85,711 in FY24. 

 

The value of counterfeit notes has declined as well, from Rs 43.5 crore in the year of the demonetisation to about Rs 10 crore in FY24, although there has been a small increase from the Rs 7.3 crore in FY23.

 

“The demonetisation did nothing to curb the circulation of counterfeit currency,” Sen says.

 

Kumar argues that demonetisation was not the right approach to tackle counterfeit currency. "Wiping out 86 per cent of the currency to counter something that forms a very minuscule share of the total currency is not the right move," he says. He emphasises that inconveniencing the entire nation to address such a small issue was disproportionate.

 

Counterfeit notes have always constituted a very small portion of the total currency in circulation. Volume-wise, they made up approximately 0.0007011 per cent in FY16, rising to 0.0007598 per cent in FY17. This share further decreased to 0.0001515 per cent in FY24.

 

Countering terrorism  Data compiled by the South Asia Terrorism Portal shows a downward trend in terrorist activities in India. In 2016, there were 2,394 terrorist incidents, which fell to 2,126 next year, and subsequently dropping to 1,323 in 2024. 

 

Agarwal says digital transactions have also helped in establishing the audit trail of financial transactions. "Liquid cash without audit trails easily finds its way into funding terrorist activities. Reduced funding options have contributed to choking terrorisim," he asserts.  

 

Also, audit trail helps in reducing corruption, Agarwal notes. 

 

Sen argues that there is no direct link between terrorism and demonetisation. He asserts that the decline in terrorism is unrelated to demonetisation and could be more attributed to Pakistan's internal challenges and struggles.