Demonetization in India: Impact on the

Informal Sector

Prepared for:
Prof. Montu Bose

Prepared by: Group A

February 6th, 2018

By Team A
Karishma Gupta kg817@snu.edu.in 1710120013
Kunal Sharma ks500@snu.edu.in 1710120015
Sai Kiran sk534@snu.edu.in 1710120021
Shivom Kalra sk671@snu.edu.in 1710120028
Prateek Kumar pk912@snu.edu.in 1710120020
Puja Baruah pb203@snu.edu.in 1710120019
Vishal Wasson vw608@snu.edu.in 1710120037
CONTENTS –

Introduction ................................................................................ Error! Bookmark not defined.

Demonetization in India ............................................................ Error! Bookmark not defined.
Impact in Informal Sector ....................................................................................................... 2
The GDP Dip 2017-17 .............................................................................................................. 3
Informal Economy Thrashed .................................................................................................. 5
The short term & Long term Impact ..................................................................................... 7
Conclusion ................................................................................................................................ 8
References……………………………………………………………………………………..9
Topic: Demonetization in India: Impact on the Informal Sector

Introduction

Demonetization is an act in which government replaces it old currency or coins which are in
circulation with new currency. In this economic policy the currency unit which is prevalent lose
its significance or ceases to be used in legal trade. This steps are necessary to stop inflation which
otherwise may have adverse effect on our economy. It also helps to check against corruption or
crimes which are taking place. Apart from that it helps in trade and commerce sector to flourish.
This approach can be used to transform people from cash based to digital system (cashless system).
Despite of that if not managed well it might cause many hardship and dis balance in the economy.

Demonetization in India

The government enforced a serious amendment within the economic environment by demonetizing
the high worth currency notes – of Rs 500 and Rs 1000 denomination. These ceased to be monetary
system from the midnight of 8th of November 2016. Individuals were given up to December 30th,
2016 to exchange the notes held by them. The proposal by the government involved the elimination
of those existing notes from circulation and a gradual replacement with a brand new set of notes.
Within the short term, it was supposed to considerably squeeze the cash in circulation since there
were limits placed on the amount that people could withdraw.

The explanations offered for termination were two-fold:

1) To manage counterfeit notes that would be contributive to act of terrorism, in different words a
national security concern.

2) To undermine or eliminate the “black economy.

Impact in Informal sector

Demonetization shows that the majority of the economic indicators was badly deteriorated as
compared to that of past. The impact on economy clearly indicated that demonetization might not
have definitely established economic slowdown. The expansion rates were additionally hugely
impacted by demonetization. But there was some revival in our rural economy that was hit by same
natural catastrophe shortly after the implication of demonetization. Even our informal economy
was tormented by demand deflation. Excluding that, merchandise and services tax(GST) is
additionally another part that pierced our informal economy similar to demonetization. The post
demonetization effects of this might be seen in our unorganized or informal sectors that took large
quantity of financial gain to formal sectors. The formal sector was already ready to the way to
tackle the case as they knew regarding the digitalization and tax compliances. With the passage of
time the part of formal sector can increase but at the expense of informal sector. This shows the
difference that prevails in our economy. The informal sector plays a significant role in our growth
processes. It's an integral part of transition to modern economy. Regardless, it plays negligible role
in payment of taxes, however plays necessary role in providing jobs exposure to several. Few
impacts are listed as follows:

1. Cash Economy: Nearly 2/3 of India’s GDP is cash economy which is heavily dominated
by the unorganized sector. Most of the transactions in this sector happen through cash,
some even daily wages. Sudden liquidity crunch hit both employers and merchandise and
wages respectively.
2. Banking Penetration: Most of the employers in the unorganized sector are illiterate they
are not tech savvy and may not be completely aware of banking procedures. Also many
unorganized jobs are in rural areas gives them less access the banks and ATMs.

3. Savings and Trade: Since most of the savings and trade are done in the form of cash,
The new move brought them to a standstill.

4. Future Trade Flow: No cash made them impossible to carry on buying products for next
cycle of selling. This could be clearly evidenced in agriculture sector, where farmers are
not able to buy seeds, fertilizers. Being a sowing season for Rabi crops, it took toll on
farmers. (1)

The GDP Dip 2016-17

Year GDP
2012-13 5.48
2013-14 6.54
2014-15 7.18
2015-16 7.93
2016-17 7.11

Table 1 : - GDP growth rate of India from 2012-2017

Fig 1: - Graph showing GDP growth rate & moving average .

Fig.2- The GDP dip in 2016-17

The GDP of the economy was badly hit due to Demonization as for the financial year
2016-17 the growth rate has been recorded as 7.11 as compared to the 8 previous financial
year. The demonetization effect and the resultant slowdown in household spending and
corporate investment were evident in the fall in GDP growth estimates released by the
government today. The GDP growth for FY17 was reported at 7.1% while the Q4FY17
GDP growth for Q4 FY17 came in at 6.1% .(3)

The demonetization effect which results in slowdown of household spending and

corporate investment were the factors in the fall in GDP growth estimates released by the
government . The GDP growth for the Financial Year 2017 (FY17) was reported at 7.1%
while for the fourth quarter of the Financial Year 2017, the GDP growth stood at 6.1%.
The growth of the farming sector stood at 5.2% for the fourth quarter FY17 while for
manufacturing sector it was 5.3%.
Informal Economy thrashed -

 While agriculture accounts for the largest share of the informal workforce and is highly
cash sensitive, the impact of demonetization on production was expected to be muted and
transient, primarily due to the healthy progress in rabi sowing.

 Demonetization has perhaps “penalized” the entire informal sector and damaged it
permanently”, especially the informal financial sector, which could account for a fourth of
bank lending, or 26 percent of GDP.

 The Economic Survey-II says that demonetization hurt the informal economy. It generated
a rush for the distress labor under MGNREGA. Thanks to the UPA-era scheme for
guaranteed employment, that rural unrest and political backlash was contained, said the
Survey.

 From November 2016, to March 2017, the official report shows that there was a 14-week
stretch in which the demand for work under MGNREGA surged, before stabilizing again.
The survey also shows that the impact of demonetization was stronger in less developed
states like Bihar, where there was 30% hike in the demand for work.

 One way to gauge the impact of demonetization on the informal sector is to look at the
microfinance sector, which is a proxy source of funding for the highly unorganized
informal economy.

 The informal economy includes workers in small and medium industries, grocers, barbers,
maids and others. Roadside vendors, cab drivers, kirana stores and medical stores had
stopped accepting Rs 500 and Rs 1,000 notes.

 People who do not use debit or credit cards, access the internet or use mobile banking and
e-wallets were worst hit. India has about 700 million debit and 25 million credit cards,
 according to this Reserve Bank of India data; about 950 million people (78 percent of the
population), do not have an internet connection.

If we analyze the cost of the said drive on to the informal sector of the economy where all this cash
is used in India and which accounts for about 45% of gross domestic product (GDP) and nearly
80% of employment, disruption of this liquidity for virtually all transactions within the informal
sector can be very costly both in terms of growth and employment generation. Informal firms are
an important supplier of inputs to formal firms. Employment and output in the organized sector
are greater in those states in India that have a greater presence of unorganized suppliers of inputs.
Therefore, with the inability of the informal sector to provide inputs to the organized sector, the
industrial growth slowed down to 4% in Q3FY17, down from 8.6% for Q3FY16.

The Modi led BJP government failed to understand that the informal sector in India occupies a
gray zone of commercial exchange, mainly by offering its labor. The only reason why the informal
economy continues to grow in India is that it subsidizes the economy by keeping labor costs low.
Though it provides employment to many people, their rights are denied. Therefore, something like
demonetization was like a back-stabber in the cash-sensitive informal sector of India. Not just that,
in a double whammy, the social security schemes introduced and implemented for the informal
sector by the previous government remains ignored now.

Realizing the presence of a massive number of workers in the informal sector and unemployment
at the rural level, Congress-led UPA government had implemented MGNREGA with a view to
preventing deprivation. The aim was to assure the individual of a basic minimum income for
himself and his dependents and to protect the individual from any uncertainties. As a result, rural
wages started climbing and reports also pointed towards a decline in migration to urban centers. A
National Council for Applied Economic Research study of 2015 showed that the MGNREGA Act
helped in lowering poverty by almost 32 per cent between 2004-05 to 2011-12 and prevented
almost 14 million people from falling into poverty.

The study shows that the work under the MGNREGA has helped create rural assets and
infrastructure, ranging from Anganwadi, toilets for individual households, crematoria, cyclone
shelters, and playgrounds for children, to drought-proofing, flood protection and control, water
conservation and harvesting, and rural road connectivity.

But the Modi government started reducing funds for MGNREGA and also reduced the minimum
number of working days. Rubbing salt into wounds, the demonetization of Rs 500 and Rs 1,000
notes hurt informal sector workers, comprising around 482 million people who earn cash incomes.
It created an income disparity, deprivation, and unrest among unorganized sector.(2)

Short Term & Long-Term Impact (6): -

Short –Term Impact Long-Term Impact

GDP Growth GDP growth to be negatively With a tax net widening after
impacted by 0.5-1% due to restriction on cash economy,
drop in consumption of GDP in the long-term likely to
individuals. get a boost.
Inflation Inflation likely to come down As the effect of lower demand
due to low demand owing to can have a lagging impact on
liquidity problem. inflation, prices may remain
flat or fall in the long term
Interest Rates With Banks flush with cash, If demonetization boots
interest rates can come down formal banking and more cash
in the short-term. continues to come in the
system, interest rates may fall
further.
Yield Yields likely to fall as Likely to remain flat to
liquidity in the banking positive depending on how
system means interest rates inflation plays out and how's
are likely to fall the country's fiscal situation.
 Fiscal Deficit Unlikely to have much impact With likely increase in the size
as most of the gains (RBI of formal economy, tax
surplus, higher tax collections, collections will be improved
penalties) will accrue after which further helps in
FY2017. improving the country’s fiscal
situation.

Conclusion:

Without adequate and proper planning; the demonetization-driven cash crunch has rendered Indian
economy paralyzed for short duration as the informal sector which comprises of 40 percent share
in GDP has become unviable. Many people do not have bank accounts where they are paid in cash
are facing severe problem. Hours of working time is being wasted in standing in queues for
exchange. For physically frail and senior citizens it is grave problem indeed to obtain new notes.
Number of deaths occurred for want of medicines as the doctors refuted to take denominations of
500 and 1000.To have a relieve from this unnaturally created agony partial roll back of 500
denominations must be taken as; change for 2000 note for small transactions is another big problem
for the common people. Smaller denominations notes must be ensured in bank and ATM’s quite
ahead before so that this acute shortage of notes were not felt as people would already have had in
their pockets. It is clear that the government's priorities do not lie in poverty alleviation or in
making the lives of the disenfranchised better. This is indeed a government that is concerned about
the well-being of a few high net-worth individuals and corporations. However, the effects of
change are emergent from the system itself and cannot be determined beforehand. Hence we can
only speculate future macroeconomic effects of demonetization.

The lesson from demonetization is the need for not only a better understanding of the black
economy but also a better understanding of how the economy works, particularly the informal
sector.
References: -

1. http://www.timesnownews.com/business-economy/economy/article/demonetisation-
impacts-india%E2%80%99s-informal-sector-un-report/91269
2. https://timesofindia.indiatimes.com/india/demonetisation-hit-informal-sector-
survey/articleshow/60369916.cms
3. http://statisticstimes.com/economy/gdp-of-india.php
4. http://www.iosrjournals.org/iosr-jhss/papers/Conf.DAGCBEDE/Volume-2/1.%2001-
11.pdf
5. https://www.inc.in/en/in-focus/how-the-informal-sector-was-paralysed-by-modi-s-
demonetisation-move
6. https:// http://mopsi.nic.in/data