How will Indian GDP be affected from banning 500 and 1000 rupees notes?

The ban on 500 and 1000 rupee notes in India, implemented in November 2016, had significant short-term and some long-term effects on the Indian economy, including its GDP.

Short-Term Effects

• The immediate aftermath of the demonetization led to a sharp decline in economic activity. The sudden removal of 86% of the cash in circulation caused a temporary but severe cash shortage, which reduced economic output, employment, and bank credit. Studies estimate that this reduced economic activity by at least 3 percentage points in November and December 2016145.
• The sectors most affected were those heavily reliant on cash transactions, such as retail, agriculture, construction, and small businesses, particularly those in the informal sector. These sectors experienced significant disruptions, including reduced demand, payment issues for daily wage workers, and shortages in raw materials25.

Impact on GDP Growth

• The quarterly growth rate of GDP was affected, with estimates suggesting a 2 percentage point reduction in the fourth quarter of 2016 compared to what would have been expected without demonetization14.
• The overall GDP growth for the fiscal year 2016-17 was estimated to be 6.9%, which was lower than the pre-demonetization forecast of 7.6% by the Reserve Bank of India5.

Long-Term Effects

• While the short-term effects were severe, the impact began to dissipate by early 2017 as new currency notes were distributed and the cash shortage eased. By March 2017, the new bills in circulation had reached 77% of the value of the old currency, and by June 2017, the shortage was largely resolved1.
• In the longer term, some analysts suggest that the benefits of demonetization, such as improved tax compliance, better fiscal balance, and a reduction in black money and corruption, could contribute to sustained economic growth. There was also an increase in savings and term deposits as a larger part of the informal economy shifted to the banking system23.

In summary, the ban on 500 and 1000 rupee notes led to a significant short-term contraction in economic activity and a reduction in GDP growth, but the effects were largely temporary. The long-term impacts are more nuanced, with potential benefits in terms of financial inclusion and reduced corruption, though these are still subject to ongoing analysis and debate.