The Narendra Modi government's demonetisation move, which turned around 86 per cent of cash in circulation illegal tender overnight on November 8, 2016, led to a significant decline in cash, which lowered India's economic growth and led to a reduction in jobs by at least 2-3 percentage points in the quarter of the note ban, a new study has found. The study shows that Indian districts that experienced more "severe demonetisation shocks" had much larger contractions in ATM withdrawals, and highlights its effects on the Indian economy. It also talks about the rise of alternative forms of payment options, including mobile wallets, after demonetisation.

The paper, 'Cash and the Economy: Evidence from India's Demonetisation', written by Gabriel Chodorow-Reich, an associate professor of economics at Harvard; Gita Gopinath, the Economic Counsellor and Director of the Research Department of the IMF; and Prachi Mishra of Goldman Sachs and RBI's Abhinav Narayanan, was done to highlight "the consequences of demonetisation in the cross-section of Indian districts".

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Talking about the effects on economic activity, the paper says the economic activity declined by 2.2 percentage in November and December 2016. "To reach this number, we first cumulate the cross-sectional effects on employment and nightlights over districts. Next, we argue that this calculation provides a lower bound for the aggregate consequences of the cash decline. Such a lower bound arises in our model due to cross-district trade. Combining these two results yields a decline in nightlights-based economic activity and of employment of 3 pp or more in November and December of 2016 relative to the counterfactual path, which translates into a decline in the quarterly growth rate of 2 pp or more," it said.

The paper also says there was around 2 percentage points or more decline in credit in Q4 of 2016. Talking about the poor implementation of the note ban, the report said both the RBI and government maintained secrecy prior to the policy's announcement and the RBI "did not print and distribute a large quantity of new notes before the announcement", which led to an immediate shortage of cash. "Printing press constraints then prevented the government from quickly replacing more than a fraction of this total with new notes. Thus, the total currency declined overnight by 75 per cent and recovered only slowly over the next several months," said the report.

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The study said while the slow replacement of notes led to a decline in the currency, it did not affect the overall size of the RBI's balance sheet. "The immediate consequence was to increase deposits at commercial banks as households deposited old notes but could not freely withdraw new notes due to the cash shortage," it said.

The RBI initially required banks to hold these deposits as reserves at the central bank by increasing the cash reserve ratio to 100 per cent on all incremental deposits received between September 16 and November 11, said the report. "Since these reserves paid no interest while banks continued to pay positive interest on their deposits, on December 6 the RBI withdrew the increase in the reserve ratio and instead absorbed the deposits by issuing short-term Market Stabilization Bonds (MSB)," it maintained.

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"We conclude that in modern India cash continues to serve an essential role in facilitating economic activity," said the report.

On November 8, 2016, at 8:15 pm, Prime Minister Modi had announced in an unscheduled national televised address that the two largest denomination notes, the 500 and Rs 1000 rupee, would "cease to be legal tender", and that they would be replaced by new Rs 500 and Rs 2,000 notes. The Centre said the decision was taken to target black money, reduce corruption, and remove fake currency notes.

Edited by Manoj Sharma

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