What a War on Cash Means For India’s Economy

18.11.2016 • Emerging Markets

By Vivek Kaul – The Vivek Kaul Letter (India) –

There is a cottage industry that has emerged in trying to analyse the impact of the demonetisation of Rs 500 and Rs 1,000 notes.

Your truly is a part of this industry as well. Though often I tend to look at things a little differently than most professional economists do.

This for the simple reason that I am neither an institutional economist working for a bank or a stock brokerage, which has an agenda of its own, nor do I work for one of the many policy institutes based out of Delhi, which are funded by the government.

I work for you, dear reader. And that is what matters the most. One of the points being made by the professional economists on the good impact the demonetisation decision is expected to have, goes somewhat like this: The demonetised notes need to deposited with banks and post offices.

Only Rs 2,000 of demonetised notes can be exchanged in the form of notes which continue to be legal tender.

This amount was first set at Rs 4,000 and then at Rs 4,500.

This essentially means that a large part of the demonetised notes will be deposited into banks as well as post offices.

The demonetised notes amount to around Rs 14.2 lakh crore or around 86 per cent of the currency that was outstanding in the financial system, by value.

As these demonetised notes are deposited into banks, banks will be flush with deposits, leading to a cut in both the deposit rates as well as the lending rates. And this will bring cheer to the moribund Indian economy.

There are limitations to the total amount of money that has been deposited and can be withdrawn. Hence, a large part of these deposits will continue to be with banks. This will mean an overflow of deposits, and that will eventually lead to interest rate cuts.

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