DEMONETIZATION

On November 8, 2016,
Prime Minister Narendra Modi announced, surprising everyone that the existing
higher denomination currency (Rs. 500 and Rs. 1000) will cease to be legal
tenders. PM mentioned that this would be the government’s biggest push to fight
black money and end corruption.

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This is not
the first time that demonization has been implemented in India. In 1936, Rs.
10000, which was the highest denomination note was introduced but was
demonetised in 1946. It was re-introduced in 1954 which was later again in 1978
declared illegal by the then Prime Minister Morarji Desai in his intensive move
to counter the black money.  

The Reserve Bank of India on August 30, 2017 released its report on
demonetisation. According to the report, 99 per cent of the banned notes came
back into the banking system which trashes all claims of Narendra Modi that the
move will flush out the black money and counterfeit currency.

With 99 per cent currency back in the system, the failure of demonetisation
hints two things: either the black money held in cash was very low or the
government failed to implement the demonetisation efficiently.

The cost incurred by the currency- scrapping exercise was quite severe,
at least in the short term, disrupting ordinary life across the country for
several weeks. The hardest- hit were those in rural areas, where access to
banking and the internet is quite low.

The impact of demonetization on the financial
sector of the country can be summarised below:

1.     
Shift in the demand for currency

Shift has been observed in the income elasticity
of currency demand in the post-demonetization period to 0.9 from 1 in the
pre-demonetisation period, reflecting a reduction in cash intensity in retail
transactions.

2.     
Significant growth in Bank deposits

Bank deposits grew from 3.0 to 4.7 percentage
points post demonetization.

3.     
Greater financial inclusion

50 million new accounts were made under the
Pradhan Mantri Jan Dhan Yojana (PMJDY) by October 2017.

4.     
Improved monetary transmission

In
an environment of a surge in low-cost current account and saving account (CASA)
deposits, banks announced a large cut in their marginal cost of funds based
lending rates (MCLR) with a 100 basis points (bps) reduction in the 1-year
MCLR.

5.     
Increase in mutual fund investments
by households:
A sizeable expansion in the collections of debt/income-oriented mutual funds
occurred after demonetisation i.e. during November 2016 to March 2017. The assets
under management (AUM) by mutual funds increased from about `16 trillion to `21
trillion between end-October 2016 and end-October 2017.

6.     
Higher collections under life
insurance schemes: The cumulative insurance premium collections
during November 2016 to January 2017 increased by 46 per cent over the same period
of the previous year.

7.      Accelerated
digitisation of retail payments: The latest data
reveal that prepaid payment instrument (PPI) volumes increased by 54 per cent
between November 2016 and August 2017, as also mirrored in the significant drop
in the income elasticity of currency demand referred to earlier.

8.     
Higher rate of detection of fake
Indian currency notes (FICNs): In the post demonetisation
period, the rate of detection of FICNs rose to 6 pieces and 12 pieces for 500
and 1000 notes, respectively, for every million pieces of notes processed –
more than twice during the pre-demonetisation period.

 

I.                  
Demonetisation and Currency Demand

Demonetization was followed by decline in CIC growth. The demonetised
notes were      accepted in the banks
till December 30, 2016. Between November 4, 2016 and January 6, 2017 total CIC
declined by about 9 trillion.

Chart 1a: On
October 27, 2017, CIC was lower by 8.0 per
cent on y-o-y (year over year) basis as against an
increase of 17.2 per cent in the previous year.

Chart
1b: On October 27, 2017, CIC stood at 91 per cent of its pre-demonetisation level.       

 

 

 

II.               
Demonetisation
and bank deposit growth

 

The
circulation of notes declined between October 28, 2016 and January 6, 2017 by 9
trillion which was reflected with the increase in the share of CASA deposits (low-cost
deposits) by 4 percentage points of the banking system.

 

 

Demonetization
also increased financial intermediation with 38 percent increase in deposits in
PMJDY accounts, with an addition of 27 million accounts post- demonetisation (November
9, 2016 to March 31, 2017). Around 50 million accounts were opened since demonetization
until October, 2017.

 

 

III.            
Demonetization
and monetary transaction

 

CASA deposits
increased sharply in the post-demonetization period as the banks credited the
accounts with the demonetised bank notes. The share of the low-cost CASA
deposits in total bank deposits increased from 35.2 per cent in October 2016 to
40.6 per cent in March 2017, before declining to 38.6 per cent in June 2017. With
credit demand remaining sluggish, banks reduced their term deposit rates
significantly towards end-December 2016/early January 2017; interest rates on
saving deposit accounts, however, were left unchanged. In an environment of
surplus liquidity, weak credit demand, lower cost of term deposits and a surge in
low cost CASA deposits, banks announced a large cut in their MCLRs in January
2017.

The 1-year
median MCLR has declined by a cumulative 80 bps since November 2016. This is significant,
considering that the 1-year median MCLR declined by only 15 bps during the
preceding seven months (April-October 2016) when the policy repo rate was
reduced by 50 bps. Thus, a large part of the transmission was facilitated by
the surplus liquidity on account of demonetisation.

 

 

IV.             
Demonetisation and Financialization
of Savings

 

Demonetisation
also resulted in gains for the non-banking financial intermediaries such as
debt/ income oriented mutual funds and insurance companies. In fact, the
aggregate balance sheet of the non-banking financial companies (NBFCs) expanded
by 14.5 per cent during 2016-17. Financialization
of Savings can be broken up into three non-banking financial intermediaries:
Mutual funds, Insurance Companies and NBFCs.

1.      Mutual
Funds

Moderation in interest
rates on bank deposits after demonetisation and decline in the price of gold enhanced
the relative attractiveness of both debt and equity oriented mutual funds.

2.      Life
Insurance Companies

Collections of premium by life insurance
companies more than doubled in November 2016. Premium collected by Life
Insurance Corporation (LIC) of India increased by 142 per cent (y-o-y) in
November 2016, whereas collection by private sector life insurance companies
increased by nearly 50 per cent.

 

3.     
Non-Banking Financial Companies
(NBFCs)

Loans disbursed by all categories of
NBFCs declined significantly in November 2016 as compared with the monthly average
disbursals during April- October 2016, especially by micro finance companies (NBFC-MFIs)
whose business is cash intensive. Disbursals turned positive from March 2017
and grew generally at a higher rate than the monthly average disbursals
recorded during April-October 2016. Growth in collections (i.e., repayments of
loans due) of AFCs and LCs during November 2016-June 2017 increased
significantly over the monthly average collections during April-October 2016. Bank credit to NBFCs decelerated from 5.1 per cent (y-o-y) in
October 2016 to 1.3 per cent in November 2016; however, it subsequently
improved to 10.9 per cent in March 2017. In terms of the returns submitted by
the reporting NBFCs, loans and advances by NBFCs increased broadly at the same
rate in the year ending March 2017 (16.4 per cent) as in the year ending March 2016
(16.6 per cent).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

RECAPITALISATION OF
BANKS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1.     
Economic offenders bill

2.     
Recapitalization of banks

3.     
Frdi

 

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