How will the ban of Rs 500 and Rs 1000 notes affect Indian economy?

The ban on Rs 500 and Rs 1000 notes, implemented on November 8, 2016, had significant short-term and long-term impacts on the Indian economy. Here are some key effects:

Short-Term Impacts

1. Liquidity Crisis:

   • The immediate effect was a severe liquidity crisis, as households and businesses faced difficulties in exchanging the banned notes and withdrawing cash from banks. This led to a disruption in commodity transactions and general cash market activities345.

2. Impact on Unorganized Sector:

   • The unorganized sector, including small traders, roadside vendors, and daily wage workers, was severely affected due to their high dependence on cash transactions. This resulted in significant volatility in small trade market activities and immediate liquidity issues for a large portion of the Indian workforce345.

3. Decline in Economic Activity:

   • The demonetization led to a decline in economic activity, particularly in sectors that rely heavily on cash transactions such as retail, agriculture, construction, and real estate. This was evident from the fall in attendance rates in factories, production cuts, and a decline in demand for goods and services145.

4. Impact on Specific Sectors:

   • The retail sector was significantly impacted due to its high dependency on cash transactions, leading to low consumer demand and a fall in sales. Other affected sectors included agriculture, construction, real estate, media & entertainment, gems & jewellery, tourism & hospitality, and labour-intensive sectors like leather and textiles134.

5. Employment and GDP Growth:

   • There was a significant layoff in the unorganized sector, and daily wage earners lost their jobs immediately after the demonetization. This contributed to a decline in GDP growth, with estimates suggesting a contraction of around 0.5% to 2% in GDP growth due to the fall in economic activity145.

Long-Term Impacts

1. Financial Inclusion and Tax Compliance:

   • The demonetization led to a shift from cash to banking transactions, resulting in better tax compliance and an increase in savings and term deposits. The government recorded a noticeable rise in the tax-to-GDP ratio15.

2. Reduction in Black Money and Corruption:

   • The move aimed to reduce black money, terrorism, and corruption. It led to a cleansing of the real estate sector, which was a major hub for shadow economy transactions. This made housing more affordable for the middle and lower sections of society15.

3. Fiscal Balance and Inflation:

   • In the long term, the demonetization was expected to improve fiscal balance and lower inflation, contributing to sustained economic growth. However, the immediate transition phase posed significant challenges12.

4. Structural Changes:

   • The demonetization drove the Indian economy towards greater formalization and digitization, although the process was painful in the short term. It encouraged the use of digital payment systems and reduced the reliance on cash transactions125.

In summary, while the ban on Rs 500 and Rs 1000 notes caused significant short-term disruptions and economic pain, it was anticipated to bring long-term benefits such as improved tax compliance, reduced black money, and a more formalized economy. However, the immediate impact was marked by a liquidity crisis, job losses, and a decline in economic activity across various sectors.