I’m not an economist, or any kind of finance wizard. That said, here are the various angles I see from a more macro-economic point of view. There were two main areas in my opinion that were the target of this currency demonetization.

1. Corruption: India largely thrives on a what is terms as a parallel economy; double account bookkeeping is one of those unwritten ways of managing things. Take the example of real estate, the way to sell or buy property is by division between check payment (i.e., accounted money) and cash (unaccounted and therefore, not taxed). To facilitate this transaction, prices stay inflated. Another example would be wholesale traders who buy (and account for) stock partly officially, partly unofficially. When stock is sold though, traders would want to cover all costs though, so the price will always stay up (cost + tax + profit + cost of unaccounted stock). Sometimes this stock even gets hoarded, causing artificial scarcities which further drives prices up. It is also hard to track this stock since this is kept off book. Tax not paid on these parallel transactions is just one of the problems. What the demonetization has done is invalidate the ‘cash’ aspect of these transactions. Cash collected thus far unaccounted is negated, with further transactions nearly impossible. It also strikes a fear at the heart of these transactions, with murmurs that businessmen and traders are figuring out how to keep their transactions entirely white here on. Even if 20% traders decide this out of those that don’t transact in white, that’s quite a shift.
2. Terrorism. India suffers tremendously through cross-border terrorism, a total of 6,255 jawans have lost their lives (that’s not counting general public). Terrorism is funded primarily through two means — black, unaccounted money or fake currency (termed the Fake Indian currency network, or FICN). By devaluing the currency, a lot of this cash in hand is now useless. By the time the entire outfit resets itself to use the new currency — whether printing, or just getting ahold of cash outside the system — gives India the driving seat, by months at least. Already a near-term impact can be seen, schools reopened in Kashmir a couple of days ago, and a 94%+ attendance in exams after unrest that has lasted a quarter. Additional, news has been coming in on a joint India-China task force to crackdown on fake currency.

There is a secondary string of ‘benefits’ due to demonetization.

1. Bank liquidity: With the requirement to deposit cash back into bank accounts and the limits in place, there is a massive boost to bank liquidity in the past week. In the first two days alone, approximately INR 53,000 crore was deposited, against INR 700 crore withdrawn. Cash consistently outside the banking system — and I mean accounted/white and black — isn’t great for liquidity, and this turns into a tremendous boost to banks.
2. RBI: In hand with (3), there is also a wiping of debt from India’s central bank. An estimated 14 lac crore rupees was out as cash in 500s and 1000s pre-8 Nov. A conservative estimate says 20% of this cash may not return, and since RBI will print new currency against what is accounted, this would mean a reduction in total actual cash that is printed. Using the same estimate, that’s about 2.8 lac crore (in black money) that is wiped out of the economy, and the RBI would only have outstanding currency printed as 11.2 lac crore instead of 14. Again not being an economist I may not be able to fully elucidate every benefit of this but this is definitely a positive. Considering money is being thrown away, and burnt in the aftermath, I do believe this estimate is fairly realistic.
3. Prices: prices will come down. Already reports are coming out that wholesalers are dumping stock to compensate losses and fear of transaction issues. A large percentage of real estate transactions will stop seeing the black side of the transactions altogether; resulting in first a slump in prices as the market grapples with the aftermath, followed by a proper correction in prices to more realistic numbers that I believe will still be lower than pre-8Nov values.
4. Government dues collections: There is a massive rise in Government dues collections since 8 Nov. Since Govts are allowed to collect payments — taxes, fines and electricity — until Nov 24, a lot of people are attempting to clear out their payments and dues using old currency. This has resulting in an instant rise in Government collections. For example, Maharashtra State Governement and local bodies saw a collection of INR 400 crore in outstanding dues within 3 days. That’s a start. Railways and Air travel, which is also accepted old notes, have already said no cash refunds will be provided for large transactions to prevent this being used as a currency switcher.

Move to cashless economy

I want to address this aspect since it is being brought up a lot. It does seem, if you analyze the Government’s moves since 2014, that there is in fact a gradually increasing nudge towards a more cashless economy (not entirely, but significantly higher than it currently is). Between pushing the poor to open zero-balance zero-fee accounts, the RBI building a Unified Payments Interface (UPI) for peer-to-peer fund transfers between institutions and finally demonetization requiring money to be deposited back into banks, various areas are already seeing a rise in cashless transactions (cards, check, etc). That said, I do not believe demonetization single handedly solves this; India is still largely a cashless economy. Once lies reduce, cash starts to find its way bank in the hands of the people, cash transactions will resume, especially since various places do not yet have the ability to accept electronic currency and cash is convenient. There will still be a shift, a percentage of people starting to use more plastic and bank transfers to manage in the interim will continue down this path, and the younger generation is more savvy and open to this as well. Gateway providers like PayTM and others will also look to cash in on the demonetization, so that will nudge the economy further.

What happens next

There’s a lot of talk around ‘this is not enough’, ‘this does not really stop black money’ and ‘how will introducing a higher (2000) denomination solve the problem caused by a lower (1000) denomination’. I think it’s important to remember what this was set out to do: in my opinion, this was to kill black, unaccounted cash out in the economy (and therefore directly attacking existing corruption and terrorism that is elevated by this cash). More has to happen to control further generation, naturally. Remember that simultaneous raids were carried out at 100s of jewelers, various industries around Nov 10 to clarify transfer of cash into these industries in the hope of emptying thus far stashed currency. Other moves such as requiring PAN cards for jewelry transactions above certain amounts are further aimed at limiting new generation. I do believe the real estate sector will be hit next if not already. A crackdown has already been announced against those who have bank deposits not matching their tax returns. These actions will push more and more people to be careful about whether they wish to indulge this route further, and the small percentage that will continue — as they do in every economy — will be far, far smaller than what they were pre-8Nov. The advent of GST expected in FY 2017 will further add to their pain.

Regarding the currency, it was natural that 14 lac crore in currency would not be circulated entirely in 500s. Someone has highlighted how a different higher denomination also curbs a deposit switcharoo, which has some merit, but is not easy to do. That said, there are two places where the new 2000 denomination really helps:

1. By keeping a larger difference between 500 and the next denomination means the general perception will be to use (and therefore stock on) 500s over 2000s. This means that lesser 2000s will be printed in general (this has been stated anyway), and the difference in wipe out of existing currency in circulation will come out of the 2000 account. This would make it harder to stash the same volumes of currency entirely in black; and the next available denomination is straight down to 500, significantly multiplying the amount of currency required.
2. Also remember that getting hold of a 2000 requires some level of routing through the banking system. While an exchange option is available, a citizen is allowed to exchange a maximum of INR4,500 one-time (through filling out a declaration form). Any further 2000s will enter the system through accounted money, via bank withdrawals. This does mean it will be harder to then dispose this currency into the ‘black’ economy, not impossible, but significantly harder. If the tax authorities do their jobs right, unexplained disappearance/inconsistent expenses of currency will be curbed.

Finally, I know and fully understand the micro-economic inconvenience being caused while banks come to terms with handling the onslaught of citizens wanted to exchange, switch and withdraw currency to manage their day-to-day. This post in no way minimizes that burden, and a shoutout must go to bank staff who are working double, triple shifts to help people. Various citizens are also visiting banks to distribute water, tea and even help people fill out forms as they stand in line, while switching to majority cashless transactions so they don’t add to lines. It is a testament to the resolve of the country that this is happening across the nation today.

Onward and upward.