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Is Demonetization Playing A ‘Silent Role’ In India’s Recent Inflationary Spiral?

Guest Article

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This article focuses on how Demonetisation is showing silently its true colours as an enemy in India’s declining economic growth and how Demonetisation and Inflation have become “Frenemies” with each other in these five and a half years, swallowing up India’s growing economy and taking away from its target of becoming the third largest economy in the world after USA and China. Could India, at present, have been in a better situation if Demonetisation had not been brought into action?

In recent times, our country is fighting the invisible robbery of inflation. Thus, India’s growth rate is declining and is expected to further decline this year as per the reports of the International Monetary Fund(IMF) and World Bank. According to IMF’s economic forecasts, India’s economy will grow by 7.4% in the financial year 2022-23, as opposed to 9.27% estimated by our Finance Ministry during the Budget Session of the Indian Parliament. This leads to a very strange question of utmost importance which needs to be critically evaluated- “Could India have been in a better situation if Demonetisation, which happened almost five and a half years ago, had not been implemented?” Some might argue that it is utter stupidity to even consider such situations and circumstances which do not correlate with the present-day economic slowdown. Inflation in recent times has occurred due to unforeseen circumstances and not because of internal economic issues. Thus, to consider Demonetization as one of the “invisible” factors of such rising inflation is a farce according to these advocates of economic policy. But, this question cannot be completely ignored.

We need to acknowledge the fact that popular narratives lie above the wishes of the economists and policymakers such that these narratives are more myth-oriented than inclined toward reality, be it the Great Depression of the 1930s or the Hyperinflation that occurred in Latin American countries in the late 1970s-1990s. Along similar lines, Demonetisation was also depicted as a narrative, to inculcate into the minds of the population, that it will eliminate black money, and corruption, and most importantly will raise tax revenue, which in turn will reduce the fiscal deficit and the debt to GDP ratio will improve positively.

The biggest flaw with such economic policies is that they don’t clearly mention their main objectives as well as how to identify the implications of such policies over some time. How can an avid learner, deeply interested in economics, analyze the nature of implications in different time frames, whether it is providing benefits within a short time or those benefits will become visible slowly and gradually with time? These questions are very difficult to answer because there are varied opinions and one cannot reach a single conclusion. Though all the economists worldwide unanimously do not differentiate these two periods, their studies generally reveal that they consider three periods and their duration while analyzing such implications- A short-run period of approximately six months or slightly more, a Medium-run period from six months to six years and Long-run period which measures above the duration of six years. Since the entire article is written before the completion of six years, it will be in the category of Medium-run period.

Firstly, we, as avid learners, need to be clear of the universal notion that all the concepts of economics are interrelated to each other directly and indirectly and no one concept is alienated from one another. Thus, this proves that Demonetisation is indirectly related to the present rising inflation, which is hidden inside the narrative of “India is facing inflation due to International Contexts”. It is incorrect to say that international events are not responsible, but at the same time, to say that domestic economic decisions are not responsible for this is not at all true as well. The untimely and unevaluated economic policies lie very much ahead of international events for India’s rising inflation and Demonetisation is one such kind.

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One such objective of the Indian government to implement Demonetisation was to build a “cashless economy”. It’s true that India now possesses a huge market for digital transactions, where the players like Paytm, PhonePe, and BharatPe are playing a major role to ensure such change by introducing newer modes of payments in the form of Unified Payments Interface(UPI) and Quick Response(QR) codes, and that holding of bigger denominated-currency notes is no longer a major issue. But, what about 93% of the working population involved in the unorganized sector of the economy where even today digital banking has not become their “Friend in need” yet? (Source: Ministry of Labour and Employment Website,2021). Their major source of transactions is still in the form of currency and some in the form of kinds. Thus, the official data proves this point and shows that there hasn’t been any significant impact of Demonetization when it comes to currency circulation in the economy.

Source: 2022).


The currency(in circulation) to GDP ratio, which was 8.7% in 2016-17, climbed steadily to 14.5% in 2020-21, despite a 3% contraction in GDP, that too, in nominal terms. The biggest obstacle that came in front of Demonetisation’s gradual path to slow success, not for the economy, but for the government to prove itself, was Covid-19 Pandemic. This pandemic made currency an utmost necessity for every Indian to hold to run their households and sustain their daily lives. To explain this further, I would like to bring a little bit of theoretical, but general economics into play. John Maynard Keynes, who is regarded as the “Father of Macroeconomics”, mentioned the “Precautionary Motive” as one of the primary reasons for holding currency by the public. What does this motive mean? Keynes explained that besides meeting day-to-day transactions, people withhold currency for some emergencies of life which cannot be anticipated. Thus, the pandemic was such a situation which forced people to hold currency and therefore, the figures are synonymous with this motive.

Even before the pandemic, this ratio kept on rising steadily and did not show any signs of decline for Demonetisation to be proud of itself. It is not that digital banking did not rise, it did rise exponentially in the economy but comparing it with the magnitude of the country’s demographics in terms of its size and population, it still cannot be called a success. Here, I want to take my readers to a flashback, where in 2016, our Indian government called Demonetisation a key to the flow of tax collections in the government’s treasury. But sadly, the gross tax revenue declined sharply as per Budget Estimates, from 105.21% in 2016-17 to 78.4% in 2021-22.

Ever since Demonetisation has taken place, the major change that has taken place is the continuous rise in fuel prices. Since there was not much tax revenue generated by the government after Demonetisation and GST(in 2017), excise and value-added (VAT) taxes on fuel formed a major part of their revenue. For example, the Central government has increased its central excise duties from just Rs 3 per litre of petrol to Rs 30 per litre of petrol in the majority of the states. And since fuel commodities form an important part of various important indicators like the Consumer Price Index(CPI) and Wholesale Price Index(WPI), inflation cannot be stopped to be inflated and thus, the prices of almost all the commodities in the economy increased sharply, and the production in the economy contracted sharply.

Thus, if we go as per narrative, then inflation started after the Russia-Ukraine crisis, but in bitter reality, inflation was going on even before the pandemic but was never told to us nor were we