Demonetization's Impact on India's Financial Markets

DEMONETIZATION: IMPACT ON THE FINANCIAL MARKET
Submitted By:
Keshin Pandit
(A30506416027)
Guided By:
Dr. Vivek Sapru & Dr. Aniruddh Durafe
Summer Project submitted in lieu of partial fulfillment of the degree
BBA + GDBA (2016-19)
August, 2017

CERTIFICATE
I hereby certify that the Summer Project entitled DEMONETIZATION: IMPACT
ON THE FINANCIAL MARKET, submitted by Mr. Keshin Pandit (Enrollment
No. A30506416027) in lieu of partial fulfillment of the degree BBA + GDBA offered
by Amity Global Business School (Indore) during the academic year 2017-18, has
been completed under my supervision.
Date: Dr. Vivek Sapru
Dr. Aniruddh Durafe
2

ACKNOWLEDGMENT
I express my sincere thanks to Dr. Rajeev Samuel, Principal, for providing me with all
the necessary support and facilities for the research.
I am also grateful to my project guides, Dr. Vivek Sapru & Dr. Aniruddh Durafe. I am
extremely thankful and indebted to them for sharing their expertise and sincere &
valuable guidance and encouragement extended to me.
I sincerely express gratitude to all of the Department faculty members for their help and
support. I also thank my parents for the unceasing encouragement, support and
attention.
I also place on record, my sense of gratitude to one and all, who directly or indirectly,
have lent their hand in this venture.
Keshin Pandit
(A30506416027)
3

ABSTRACT
The primary aim of this project is to research the impact of demonetization in India,
based on the secondary data gathered from the Government of India and financial
institutions.
The project starts with an introduction to demonetization. The history of
demonetization in the modern world is scrutinized. The move to demonetize the Indian
Rupee was a major announcement. Hence, the timeline since the announcement on
November 8, 2016, is elaborated on.
The impact of demonetization on the financial market is the core subject of the project.
The following components of the financial market are considered for analysis – money
market, securities market, equity market, mutual funds, venture funds, investment
bonds, insurance, banks, non-banking financial companies, forex market.
Based on the findings, it was established that demonetization was a successful and
important decision. Its impact on the financial market is summarized and the merits &
demerits listed in the conclusion.
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TABLE OF CONTENTS
1. CERTIFICATE 2
2. ACKNOWLEDGMENT 3
3. ABSTRACT 4
4. LIST OF ABBREVIATIONS 6
5. INTRODUCTION 8
I. Introduction
II. What is Demonetization?
III. Why Demonetization?
IV. Importance of Research
V. History of Demonetization
VI. Timeline of Demonetization in India (2016)
VII. The Indian Financial Market
VIII. Project Structure
6. EMPIRICAL RESEARCH STRATEGY AND METHODOLOGY 23
I. Introduction
II. Aims and Objectives
III. Methodology
IV. Validity and Reliability
V. Limitations
7. ANALYSES 27
I. Money Market
II. Government Securities Market
III. Equity Market
IV. Mutual Funds, Venture Funds, Investment Bonds
V. Insurance: Life / General
VI. Banks
VII. Non-Banking Financial Companies (NBFCs)
VIII. Forex Market
8. SUMMARY AND CONCLUSION 50
I. Introduction
II. Summary
III. Conclusion
IV. Limitations
V. Future Prospects
9. APPENDICES 56
I. Research Terms
II. Financial Terms
10. REFERENCES 63
5

LIST OF ABBREVIATIONS
Abbreviation Description
AFC Asset Finance Company
APR Annual Percentage Rate
ATM Automated Teller Machine
bps Basis Points
BSE Bombay Stock Exchange
CASA Current Account and Saving Account
CDs Certificate of Deposits
CMB Cash Management Bill
CP Commercial Paper
CPG Consumer Packaged Goods
CRR Cash Reserve Ratio
EM Emerging Market
EME Emerging Market Economies
FCNR Foreign Currency Non-Resident
FCNR(B) Foreign Currency Non-Resident (Bank) Deposits
FMCG Fast Moving Consumer Goods
FPI Foreign Portfolio Investment
FY Financial Year
GDP Gross Domestic Product
G-Sec Government Securities
HFC Housing Finance Company
ICRR Incremental Cash Reserve Ratio
IOU I Owe You
IRDAI Insurance Regulatory and Development Authority of India
LAF Liquidity Adjustment Facility
LC Loan Company
MCLR Marginal Cost of Funds based Lending Rate
6

LIST OF ABBREVIATIONS
Abbreviation Description
MFC Micro Finance Company
MFI Micro Finance Institution
MFIN Micro Finance Institutions Network
MPC Monetary Policy Committee
MSS Market Stabilization Scheme
NBFC Non-Banking Finance Company
NDTL Net Demand and Time Liabilities
NPA Non-Performing Assets
NRI Non-Resident Indian
OTC Over the Counter
PFRDA Pension Fund Regulatory and Development Authority
PMJDY Pradhan Mantri Jan Dhan Yojana
Q1 Quarter One of FY
Q2 Quarter Two of FY
Q3 Quarter Three of FY
Q4 Quarter Four of FY
RBI Reserve Bank of India
RRB Regional Rural Bank
SBI State Bank of India
SBN Sustainable Banking Network
SCB Scheduled Commercial Bank
SEBI Securities and Exchange Board of India
WACR Weighted Average Call Rate
WALR Weighted Average Lending Rate
*Other abbreviations, not stated here, bear their usual meaning.
7

INTRODUCTION
I. Introduction
The present chapter provides an introduction to the topic under investigation i.e.,
Demonetization and Its Impact on the Financial Market. It starts with an explanation of
about demonetization. The importance of the topic at hand are described.
Background information on the demonetization and the financial market is introduced
in the following sections.
The final part of the introduction consists of a brief guide to subsequent chapters of the
project.
9

INTRODUCTION
II. What is Demonetization?
Demonetization is the act of stripping a currency unit of its status as legal tender. It
occurs whenever there is a change of national currency: The current form or forms of
money is pulled from circulation and retired, often to be replaced with new notes or
coins. Sometimes, a country completely replaces the old currency with new currency.
The opposite of demonetization is remonetization, in which a form of payment is
restored as legal tender.
III. Why Demonetization?
A few major reasons why nations demonetize their local units of currency are:
• to combat inflation
• to contain corruption and crime (counterfeiting, tax evasion)
• to discourage a cash-dependent economy
• to facilitate trade
10

INTRODUCTION
IV. Importance of Research
On November 8 2016, the Government of India announced that the high denomination
notes (Rs. 500 and Rs. 1000), then in circulation would cease to be legal tenders. With
this effort, 86.9% of India’s currency1
was nullified that aimed to wash the stock of
“black market’s cash supply” and counterfeit notes out of the economy and convert it
into the licit, bankable and taxable, part of the economy.
Cash is the preferred mode of transaction in India and only less than half the population
uses banking system for monetary transactions. An immediate public anger appeared
against the mismanaged and unprepared banking system. The banks didn’t have enough
of the newly designed banknotes (Rs. 500 and Rs. 2000) to distribute in exchange for
the canceled notes. The move also led to a shortage of lower denomination notes such
as Rs. 50 and Rs. 100 that were and still are still legal tenders, as people had taken to
conserving whatever cash they had in hand.
While the immediate impact on the daily lives of the populace was prominently visible,
an in-depth research into the impact on the financial markets is needed to determine the
exact level of impact.
The research is based on the analysis of secondary data as released by the Government
of India and financial institutions.
1 RBI (2017), “Macroeconomic Impact of Demonetization- A Preliminary Assessment”
11

INTRODUCTION
V. History of Demonetization
The following countries have tried demonetization before:
• India: The Government had demonetized bank notes on two prior occasions
– once in 1946 and then in 1978—and on both occasions, the goal was to
combat tax evasion by "black money" held outside the formal economic
system. In 1946, the pre-independence Government hoped demonetization
would penalize Indian businesses that were concealing the fortunes amassed,
supplying the Allies in World War II. In 1978, the Janata Party coalition
government demonetized banknotes of 1000, 5000 and 10,000 rupees, again
in the hopes of curbing counterfeit money and black money.
• Britain: Before 1971, pound sterling and pence currency was in circulation
in Britain but to bring uniformity in currency, the Government stopped
circulation of the old currency (pounds, pence and shillings) in 1971, and
brought in coins of 0.5p, 1p, 2p, 5p, 10p and 50p. This helped in
decimalization of the currency.
• Ghana: In 1982, Ghana ditched their 50 cedis note to tackle tax evasion and
empty excess liquidity. As a result, support for the black market and
preference towards investing in physical assets increased leading to the
weakening of the economy.
• Nigeria: During the Government of Muhammad Buhari in 1984, Nigeria
introduced new currency and banned the old notes. However, the debt-ridden
and inflation hit country didn’t take the change well and the economy
collapsed.
• Myanmar: In 1987, Myanmar’s military invalidated around 80% value of
money to curb the black market. But this led to political dispute in the
country leading to thousands of deaths.
• Australia: Australia became the first country to release polymer notes in
1988, to stop widespread counterfeiting. Since the purpose was to replace
paper with plastic and only the material changed, there were no side-effects
on the economy.
• Soviet Union: In 1991, the Mikhail Gorbachev Government banned the
currency notes of Ruble 50 and 100 to end the black money in the country.
The Government expected that it would decrease the market of black money
and give a proper life to common people. But, the move didn’t go well with
the citizens resulting in a coup attempt, which ultimately led to the Soviet
breakup.
• Congo: Director Mobuto Sese made changes to the currency of Congo for
smooth running of the economy during the 90s. However, the changes didn’t
12

INTRODUCTION
give any better results. Resultant prices of necessity goods increased and
share market saw a heavy downfall.
• Zimbabwe: Zimbabwe used to have a $100,000,000,000,000 note. The then
President Robert Mugabe issued edicts to ban inflation by demonetizing the
trillion dollars to $0.5.
• North Korea: The demonetization in North Korea happened in 2010, which
left people with no food and shelter. Kim-Jong II introduced a reform that
knocked off two zeroes from the face value of the old currency in order to
banish black market.
• Pakistan: From December 2016, Pakistan phased out the old notes as new
designs were brought in. The tender was legally issued a year and a half prior
to that and therefore, the citizens had the time to exchange the old notes and
get new notes.
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INTRODUCTION
VI. Timeline of Demonetization in India (2016)
• Nov. 8, 2016: Prime Minister Narendra Modi announces the demonetization
in an unscheduled live televised address to the nation at 20:15 IST.
• Nov. 9, 2016: Banks and ATMs remain closed to the public. Any amount
deposited above Rs. 2.5 lakhs was declared tax chargeable. Highway tolls
suspended till Nov. 11, 2016.
• Nov. 10, 2016: Banks across the country witnessed long queues for
exchanging and depositing annulled notes, whilst ATMs still remained shut.
• Nov. 11-12, 2016: ATMs open for the first time after the demonetization
announcement. But, after opening, most ATMs went empty in a few hours
with people drawing the maximum possible amount; long queues beginning
to be seen across the country, in selected places like Government hospitals
and petrol pumps. Toll waiver on national highways extended till Nov. 14
midnight by the Government.
• Nov. 13, 2016: Currency exchange limit increased from Rs. 4000 to Rs.
4500. ATM withdrawal limit increased from Rs. 2000 to Rs. 2500. The
weekly limit of Rs. 20,000 for withdrawal from bank counters was increased
to Rs. 24,000. The maximum limit of Rs.10,000 per day on such withdrawals
was removed.
• Nov. 14, 2016: Government extended acceptance of Rs. 500 and Rs. 1,000
notes for public utility and fuel payment till Nov. 24. Cash withdrawal for
current account holders increased to Rs. 50,000 per week. Charges on ATM
transactions waived till Dec. 30.
• Nov. 15-16, 2016: No relief from long queues at banks, ATMs. Government
asked banks to put indelible ink on the right hand finger of those exchanging
banned Rs. 500 and Rs. 1000 notes. SBI collected Rs. 1,14,139 crore in
deposits during the week.
• Nov. 17, 2016: Government lowered the exchange limit for now defunct Rs.
500 and Rs. 1000 notes to Rs. 2,000 from the existing of Rs. 4,500. Cash
withdrawals of Rs. 2.5 lakhs from bank account were allowed for wedding
ceremonies. Government eased cash withdrawal limit for farmers by
allowing them to withdraw up to Rs. 50,000 cash per week from bank.
Government extended toll exemption on national highways till Nov. 24
midnight.
• Nov. 18-20, 2016: ATMs still fight cash shortage. Congress alleged 55 dead
due to demonetization, sought PM’s apology.
• Nov. 21, 2016: Farmers allowed to use Rs. 500 notes for buying seeds. Banks
received Rs. 5.12 lakh crore of deposits and exchanged Rs. 33,006 crore.
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INTRODUCTION
• Nov. 22, 2016: 82,500 ATMs out of 2.2 lakh ATMs recalibrated to dispense
new notes. Relief for public as around 40% of the total ATMs started
dispensing new notes.
• Nov. 24, 2016: Government extended national highway toll exemption till
Dec. 2 midnight. Withdrawal of exchange facility of old currency notes and
extension of deadline for exemption of using Rs. 500 notes upto Dec. 15
midnight.
• Nov. 25, 2016: RBI announced that, the facility to exchange old Rs. 500 and
Rs. 1000 would continue to be available at its counters. Bank queues thin
down, but branches still face cash shortage.
• Nov. 26-30, 2016: Deposits in Jan Dhan accounts rises sharply by around Rs.
27,200 crore to Rs. 72,834.72 crore in just 14 days after the announcement of
the ban on old Rs. 500 and Rs. 1000 currency notes. Rs. 32,361 crore
deposited in post offices since demonetization. Banks get about Rs. 8.45 lakh
crore worth of scrapped notes.
• Dec. 1-3, 2016: Government announced that, Rs. 500 notes would be valid
till Dec. 2 for fuel, air ticket purchase instead of Dec. 15 as announced
earlier. 80 lakh ATMs recalibrated to dispense Rs. 500 and Rs. 2000 notes.
• Dec. 6-7, 2016: Tax department seized Rs. 130 crore cash, jewellery and Rs.
2000 crore of undisclosed wealth was admitted by taxpayers post
demonetization. Rs. 11.55 lakh crore or 76% of junked notes went back into
the system.
As of Dec. 30, 2016, Rs. 14.97 trillion (97% of the Rs. 15.4 trillion demonetized2
) was
deposited into the banks. This was against the Government’s initial estimate that Rs. 3
trillion would not return to the banking system. Of the Rs. 15.4 trillion demonetized,
Rs. 9.2 trillion in the form of new Rs. 500 and Rs. 2000 notes was recirculated as of
Jan. 10, 2017.
2 RBI (2017), “Macroeconomic Impact of Demonetization- A Preliminary Assessment”
15

INTRODUCTION
VII. The Indian Financial Market
The Financial System of any country consists of financial markets, financial inter-
mediation and financial instruments or financial products. It is categorized in India as
shown in the figure below.
A financial market is a broad term describing any marketplace where buyers and
sellers participate in the trade of assets such as equities, bonds, currencies and
derivatives. Financial markets are typically defined by having transparent pricing, basic
regulations on trading, costs and fees, and market forces determining the prices of
securities that trade. A financial market can be classified into the following types:
• Capital markets which consist of:
• Stock markets, which provide financing through the issuance of shares or
common stock, and enable the subsequent trading thereof.
16

INTRODUCTION
• Bond markets, which provide financing through the issuance of bonds,
and enable the subsequent trading thereof.
• Commodity markets, which facilitate the trading of commodities.
• Money markets, which provide short term debt financing and investment.
• Derivatives markets, which provide instruments for the management of
financial risk.
• Futures markets, which provide standardized forward contracts for trading
products at some future date; see also forward market.
• Foreign exchange markets, which facilitate the trading of foreign exchange.
• Spot market.
• Inter-bank lending market.
In India, the financial system is regulated with the help of independent regulators,
associated with the field of insurance, banking, commodity market, and capital
market and also the field of pension funds. Some of them are as follows:
• RBI (Reserve Bank of India): It is the apex monetary Institution of India. It
is also called as the central bank of the country. The Reserve Bank of India
was established on April 1, 1935 in accordance with the provisions of the
Reserve Bank of India Act, 1934. The Central Office of the Reserve Bank
17

INTRODUCTION
was initially established in Kolkata but was permanently moved to Mumbai
in 1937. The Central Office is where the Governor sits and where policies are
formulated. Though originally privately owned, since nationalization in 1949,
the Reserve Bank is fully owned by the Government of India.
• SEBI (Securities and Exchange Board of India): Apart from RBI, SEBI
also forms a major part under the financial body of India. It is a regulator
associated with the security markets in Indian Territory. Established in the
year 1988, the SEBI Act came into power on 12th April, 1992. There are
three groups, which fall under this category, and those are the investors, the
security issuers and market intermediaries.
• IRDA (Insurance Regulatory and Development Authority): It is based in
Hyderabad (Andhra Pradesh). It was formed by an Act of the Indian
Parliament known as the IRDA Act 1999, which was amended in 2002 to
incorporate some emerging requirements. The mission of IRDA as stated in
the act is "to protect the interests of the policyholders, to regulate, promote
and ensure orderly growth of the insurance industry and for matters
connected therewith or incidental thereto."
• PFRDA (Pension Fund Regulatory and Development Authority): It is a
pension related authority, which was established in the year 2003 by the
Indian Government. It is authorized by the Finance Ministry, and it helps in
promoting income security of old age by regulating and also developing
pension funds. On the other hand, this group can also help in protecting the
interest rate of the subscribers, associated with the schemes of pension
money along with the related matters.
When the borrower of funds approaches the financial market to raise funds, mere issue
of securities will not suffice. Adequate information of the issue, issuer and the security
should be passed on to take place. There should be a proper channel within the financial
system to ensure such transfer. To serve this purpose, Financial intermediaries came
into existence. Financial inter-mediation in the organized sector is conducted by a wide-
range of institutions functioning under the overall surveillance of the Reserve Bank of
India.
18

INTRODUCTION
Intermediary Market Role
Stock Exchange Capital Market
Secondary Market to
securities
Investment Bankers
Capital Market, Credit
Market
Corporate advisory services,
Issue of securities
Underwriters
Capital Market, Money
Market
Subscribe to unsubscribed
portion of securities
Registrars, Depositories,
Custodians
Capital Market
Issue securities to the
investors on behalf of the
company and handle share
transfer activity
Primary Dealers Satellite
Dealers
Money Market
Market making in
government securities
Forex Dealers Forex Market
Ensure exchange ink
currencies
Financial Instruments
Money Market Instruments
The money market can be defined as a market for short-term money and financial
assets that are near substitutes for money. The term “short-term” means generally a
period of upto one year and near substitutes to money is used to denote any financial
asset which can be quickly converted into money with minimum transaction cost.
Some of the important money market instruments are briefly discussed below:
19

INTRODUCTION
1. Call / Notice-Money Market
Call / Notice money is the money borrowed or lent on demand for a very short period.
When money is borrowed or lent for a day, it is known as Call (Overnight) Money.
Intervening holidays and / or Sunday are excluded for this purpose. Thus money,
borrowed on a day and repaid on the next working day, (irrespective of the number of
intervening holidays) is "Call Money". When money is borrowed or lent for more than
a day and up to 14 days, it is "Notice Money". No collateral security is required to
cover these transactions.
2. Inter-Bank Term Money
Inter-bank market for deposits of maturity beyond 14 days is referred to as the term
money market. The entry restrictions are the same as those for Call / Notice Money
except that, as per existing regulations, the specified entities are not allowed to lend
beyond 14 days.
3. Treasury Bills.
Treasury Bills are short term (up to one year) borrowing instruments of the union
government. It is an IOU (I Owe You) document of the Government. It is a promise by
the Government to pay a stated sum after expiry of the stated period from the date of
issue (14/91/182/364 days i.e., less than one year). They are issued at a discount to the
face value, and on maturity the face value is paid to the holder. The rate of discount and
the corresponding issue price are determined at each auction.
4. Certificate of Deposits
Certificates of Deposit (CDs) is a negotiable money market instrument and issued in
dematerialized form or as a Usance Promissory Note, for funds deposited at a bank or
other eligible financial institution for a specified time period. Guidelines for issue of
CDs are presently governed by various directives issued by the Reserve Bank of India,
as amended from time to time. CDs can be issued by (i) scheduled commercial banks
excluding Regional Rural Banks (RRBs) and Local Area Banks (LABs); and (ii) select
all-India Financial Institutions that have been permitted by RBI to raise short-term
resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs
depending on their requirements. A FI may issue CDs within the overall umbrella limit
fixed by RBI, i.e., issue of CD together with other instruments viz., term money, term
deposits, commercial papers and inter-corporate deposits should not exceed 100 % of
its net owned funds, as per the latest audited balance sheet.
20

INTRODUCTION
5. Commercial Paper (CP)
CP is a note in evidence of the debt obligation of the issuer. On issuing commercial
paper the debt obligation is transformed into an instrument. CP is thus an unsecured
promissory note privately placed with investors at a discount rate to face value
determined by market forces. CP is freely negotiable by endorsement and delivery. A
company shall be eligible to issue CP provided - (a) the tangible net worth of the
company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the
working capital (fund-based) limit of the company from the banking system is not less
than Rs.4 crore and (c) the borrow account of the company is classified as a Standard
Asset by the financing bank/s. The minimum maturity period of CP is 7 days. The
minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other
agencies.
Capital Market Instruments
The capital market generally consists of the following long term period i.e., more than
one year period, financial instruments; In the equity segment Equity shares, preference
shares, convertible preference shares, non-convertible preference shares etc and in the
debt segment debentures, zero coupon bonds, deep discount bonds etc.
Hybrid Instruments
Hybrid instruments have both the features of equity and debenture. This kind of
instruments is called as hybrid instruments. Examples are convertible debentures,
warrants etc.
For this project, the financial market is the primary focus and thus, other segments of
the financial system will not be considered for analysis.
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INTRODUCTION
VIII. Project Structure
The project consists of four chapters.
The first chapter consists of an introduction about the topic under investigation, entails
the history of demonetization, the timeline of demonetization in India and a brief
overview of the Indian financial market.
The second chapter relates to the methodology used. Secondary data was gathered from
various sources across the Internet.
The third chapter analyzes and discusses the data gathered.
The last chapter propounds a summary and conclusion of the findings.
22

2. EMPIRICAL RESEARCH STRATEGY AND METHODOLOGY
23

EMPIRICAL RESEARCH STRATEGY AND METHODOLOGY
I. Introduction
The previous chapter was the first research stage which consisted of a systematic
review of literature on demonetization and the financial market. The search was
undertaken in online libraries / databases (such as EBSCO Host) and internet search
engines (such as www.google.com). The search terms used were:
• Demonetization,
• Demonetization in India,
• Demonetization timeline in India,
• History of demonetization in the modern world,
• Indian financial system,
• Financial market statistics post demonetization,
• Impact of demonetization on various sectors of the financial market.
Furthermore, specific financial newspapers and websites were used as well. The
outcomes of the literature review and the associated aims and objectives will be
explained in the following sections. Lastly, a summary of the systematic approach is
given.
24

II. Aims and Objectives
The aim of the present research is to analyze the financial market on the basis of the
data available for the duration of process while the implementation of demonetization
was in progress.
The objective is to determine the impact of demonetization, its merits and demerits.
III. Methodology
Since the research focuses on the analysis of secondary data, a basic comparative model
is to be used in order to determine the magnitude of the effects. The comparison will
consider, the performance of the sectors of the financial market during demonetization
as well as during the same time in the previous year.
25

IV. Validity and Reliability
Validity describes to what extent findings from research accurately represent what is
really happening in the situation. Faulty research procedures, incorrect data undermine
the validity.
The validity of the project is determined from the data which has been gathered. From
the numerous sources that were referred, the data was corroborated against that gained
from Government websites and publications related to the topic in question. Thus, the
present research is valid only till the data collected supports the research.
Reliability deals with the credibility of the research. If anyone can repeat the research
and obtains similar results, a research is reliable.
Reports and publications released by RBI, SEBI, IRDAI & various other financial
institutions, discuss the impact of demonetization on various parts of the economy. The
observations in the present research are backed by the results presented in the
aforementioned sources making the research reliable.
V. Limitations
Since the research is based on secondary data instead of primary, the results are bound
by the data available. This in turn, limits the scope of future research based on the same
topic and topics that can be derived.
26

ANALYSES
I. Money Market
Despite large surplus liquidity, active liquidity management by the Reserve Bank
ensured that the weighted average call money rate (WACR) – the operating target of
monetary policy – traded around the repo rate (during November 8 to November 25),
but with a softening bias (23 bps on an average). With the announcement of the
incremental CRR of 100% on November 26, banks borrowed aggressively on
November 28 (November 26 and 27 being holidays) from both the Reserve Bank and
money markets to meet the additional reserve requirement. This pushed up the WACR
above the repo rate on November 28. However, this impact was short-lived and the
WACR started trading again with an easing bias (21 bps on an average) from December
1, reflecting the persisting surplus liquidity conditions.
Other overnight money market rates have tracked the WACR. In line with the overnight
money market rates, other short-term rates also eased. Post demonetization, 3-month
CD and 91-day T-bill rates softened by about 22 and 45 basis points (bps) respectively,
while the 3-month CP rate declined by 9 bps.
28

ANALYSES
II. Government- Securities Market
The 10-year gilt yield softened from 6.80% (November 8, 2016) to as low as 6.18%
(November 24, 2016). It rose to 6.33% on November 28 with the announcement of the
incremental CRR effective November 26, which helped maintain integrity of the yield
curve. Following the MPC’s decision to pause on December 7, the 10-year benchmark
yield hardened by 21 bps and traded in a range-bound manner but with a hardening bias
up to end-December. This was also supported by global developments, including US
monetary policy tightening and subsequent hardening of US yields driving FPI
outflows from EMEs, including India, and higher crude prices. Between end-December
2016 and early February 2017, however, the benchmark yield traded with a softening
bias on continuing surplus liquidity conditions and the reduction in the government
borrowing programme for January-February 2017. Bond yields firmed up significantly
over two successive days after the announcement of the change in the monetary policy
stance from accommodative to neutral on February 8, 2017 by the Monetary Policy
Committee (MPC). Yields have remained firm thereafter. The spread between 30-year
and 10-year yields declined from 41 bps on November 8, 2016 to 35 bps on November
30 and further to 23 bps on March 7, 2017.
Long-term bonds saw the highest price appreciation due to the drop in yields. Debt
mutual funds holding long-term bonds shot up 2.8%. This is what the category
normally earns in 3-4 months. Some long-term gilt funds rose more than 3% absolute
returns during this period.
30

ANALYSES
III. Equity Market
Although the equity market was affected by both domestic and global factors, the
impact of demonetization alone can be gauged from the movement in indices of cash
sensitive sectors such as FMCG, consumer durables, auto and realty vis-à-vis the
overall index. As against the decline of 3.5 % in the BSE Sensex (from November 9 to
December 30), the BSE realty index declined by 14.4 %, followed by consumer
durables (-9.9 %), auto (-9.0 %) and FMCG (-5.3 %) indicating market expectation of a
sharp fall in demand for these products, as they were disproportionately driven by cash
transactions. However, the impact on sectoral indices was transitory as they have since
recovered most of the lost ground. As against the overall increase of 8.9 % in the BSE
Sensex between March 7, 2017 and December 30, 2016, the BSE consumer durables
index increased by 23.0 %, followed by realty (18.8 %), FMCG (8.7 %) and auto (7.2
%) during this period. On the whole, while consumer durables, FMCG and realty
indices are now higher than their pre-demonetization levels, the auto sector is
marginally lower.
Equity portfolio flows cumulatively declined by Rs. 24,988.275 crores during
November 9-December 30, 2016. The overall foreign portfolio outflows were Rs.
62795.95 crores during this period. This may be on account of international
developments also as the US presidential election results raised expectations of
tightening of monetary policy by the US Fed. In this regard, it is significant that most of
the EMEs also witnessed capital outflows during the same period. Beginning the
second half of January 2017, net equity foreign portfolio flows turned positive again.
32

ANALYSES
The equity market was buoyed by the encouraging corporate sector results for Q3. The
results of the listed companies for Q3 of 2016-17 suggest that the corporate sector
remained resilient as sales and net profits improved at an aggregate level as also for
manufacturing companies.
Within manufacturing, sales of cash intensive sectors such as FMCG and motor vehicle
companies got impacted in Q3 vis-à-vis the previous quarter. However, the companies
in the real estate sector registered positive sales growth in Q3 in contrast to the sharp
contraction in the previous quarter.
The share prices of most of the large listed NBFCs also registered a significant decline
between November 8, 2016 and December 30, 2016 mainly due to the cash intensive
nature of their businesses and delayed repayments. However, the share prices of most of
such companies have recovered fully / partially after December 2016.
33

ANALYSES
IV. Mutual Funds, Venture Funds, Investment Bonds
Reduction in deposit interest rates by banks after demonetization enhanced the
relative attractiveness of debt oriented mutual funds. As a result, there were net
inflows in income / debt schemes during November 2016-January 2017 in contrast to
net outflows during November 2015-January 2016. This was reflected in a sharp
increase in the overall resources mobilized by mutual funds during November 2016-
January 2017 in contrast to outflows in the same span of last year.
35
NET INFLOWS/OUTFLOWS IN MUTUALFUNDS
(Rs.Billion)
Category Nov.2015-Jan. 2016 Nov.2016-Jan. 2017
Aprilto January
2015-16 2016-17 Y-o-y growth %
Income/Debt Schemes -535.5 520.4 880.2 2673.1 203.7
Equity Schemes 129.4 240.6 728.7 556.9 -23.6
Balanced Schemes 63.8 108.8 187.2 261 39.4
Exchange Traded Fund 31.2 138.8 50.1 188.8 276.6
Fund to Fund Investing Oversea -0.9 -0.2 -3.6 -3.1 0
Total -311.9 1007.6 1842.7 3676.6 99.5

ANALYSES
V. Insurance: Life / General
According to the monthly numbers of life insurance companies released by IRDAI, the
individual single premiums collected in November for all life insurance subscriptions
were Rs 6,692 crore. This was 507% more than what was collected in November 2015.
In fact, even on a monthly basis, the insurance segment grew by 170% from Rs. 2,481
crore collected in October. The total amount of first-year premiums (both regular and
single premium) grew 113% on a year-on-year basis, and 45% compared to the
collections in October 2016. The insurance industry, which was growing at a decent
28% on a month-on-month basis, grew more than 40% in November.
Traditionally, Indians have held a preference towards real estate and gold as the means
to invest their money. Due to demonetization, these two options became less viable as
compared to the insurance sector, which lead to an exponential growth in the sector
within a couple of months.
India’s life insurance market is currently valued at Rs. 3,84,930 crores and growing at
12% per year while, the general insurance market is valued at Rs. 73,393.32 crores and
growing at 17% per year.
36

ANALYSES
Further growth is anticipated with the push towards a cashless economy, which
would’ve decreased operating expenses. These savings would be passed on to the
customers through discounts on the premiums, better products, and improved services.
37

ANALYSES
VI. Banks
• Balance Sheet Effects
Decline in the currency in circulation on account of demonetization led to a
surge in bank deposits. The demonetized notes were accepted at bank
counters till December 30, 2016. Between October 28, 2016 and January 6,
2017 (i.e., days immediately prior to and after demonetization for which
fortnightly banking system data are available), total currency in circulation
declined by about Rs. 8,800 billion. This, in turn, was largely reflected in
sharp increase of about Rs. 6,720 billion in aggregate deposits of the banking
system even after outflows in NRI deposits during the period.
Remonetization progressed at a fast pace. Between end-December 2016 and
early March 2017, there was a net increase in currency in circulation by
about Rs. 2,600 billion. During this period, deposits with banks also declined
moderately.
Banks furnish data on their major assets and liabilities on a fortnightly basis.
As per data available for the reporting Fridays of October 28, 2016 (prior to
demonetization) and February 17, 2017 (post-demonetization), aggregate
deposits of SCBs increased by Rs. 5,549 billion during the period.
38

ANALYSES
Bulk of the deposits so mobilized by SCBs were deployed in:
(I) reverse repos of various tenors with the RBI
(ii) cash management bills (CMBs) issued under the Market Stabilization
Scheme (which is a part of investment in government securities in the
balance sheet of banks). Loans and advances extended by banks increased by
Rs. 1,008 billion. The incremental credit deposit ratio for the period was only
18.2 %.
Additional deposits mobilized by commercial banks were largely deployed in
liquid assets. This may be due to the expected transitory nature of the bulk of
such deposits and weak demand as reflected in the subdued growth of credit.
• Profitability of Banks
Banks’ net profits essentially reflect the difference between interest earned on
loans, advances and investments, & interest paid on deposits and borrowings,
adjusted for operating costs and provisions. Loans, advances and
investments, which are the main sources of interest income, together
constitute more than 85% (61% accounted for by loans and advances & 25%
by investments) of banks’ consolidated balance sheet. Post-demonetization,
there has been a surge in the current account and saving account (CASA)
deposits of banks. The sharp increase of 4.1 percentage points in the share of
CASA deposits in aggregate deposits to 39.3% (up to February 17, 2017),
resulted in a reduction in the cost of aggregate deposits. The cost of CASA at
3.2% was significantly lower than the weighted average term deposit rate at
7.1%. Banks also lowered their term deposit rates; the median term deposit
rate declined by 38 bps during November 2016-February 2017.
The decline in the cost of funding resulted in decline in the 1-year median
marginal cost of funds based lending rate (MCLR) by as much as 70 bps
post-demonetization (November 2016-February 2017).
39
Changes in Major Assets and Liabilities of SCBs (Oct. 28, 2016 and Feb. 17, 2017)
LIABILITIES ASSETS
1 Aggregate Deposits 5549 1 Bank Credit 1008
2 Borrowings -56 2 Investment in Govt. Securities 4560
3 Net OtherAssets -75
Total 5493 Total 5493

ANALYSES
Banks earned return of around 6.23-6.33% under reverse repos and market
stabilization scheme (MSS) as against the cost of CASA deposits of around
3.2 %. Accordingly, for an average deployment of about Rs. 6 trillion in a
quarter under reverse repos and MSS securities, banks’ net interest income
from increased deposits was estimated at about Rs. 45 billion in a quarter
after demonetization. Banks continue to enjoy the increased share of low cost
CASA deposits, although it has gradually declined with the increase in
currency in circulation. The increase in net interest income would need to be
adjusted for the cost of managing withdrawal of SBNs and injection of new
bank notes (such as calibration of ATMs, staff overtime, security
arrangements, lower fees / waiver of fees on digital modes of payments), the
exact details of which were not available at that stage.
• Liquidity Conditions
With the return of SBNs to the banking system, while currency in circulation
contracted, deposits in the banking system surged. The sudden increase in
deposits (given the gradual replacement of SBNs by new notes) created large
surplus liquidity conditions in the banking system, which could be divided
into four distinct phases in terms of how liquidity was managed by the
Reserve Bank using different instruments. The active liquidity management
was necessitated to ensure that the operating target remained aligned to the
policy repo rate.
In the first phase (November 10 to November 25), the Reserve Bank
absorbed the excess liquidity through variable rate reverse repos of tenors
ranging from overnight to 91 days under its Liquidity Adjustment Facility
(LAF). The outstanding amount of surplus liquidity absorbed through reverse
repos (both variable rate and fixed rate auctions) reached a peak of Rs. 5,242
billion on November 25.
In the second phase (November 26 to December 9), the liquidity surplus
was managed through a mix of reverse repos and the application of the
incremental cash reserve ratio (ICRR) of 100% on the increase in net demand
and time liabilities between September 16 and November 11, 2016. The
ICRR helped drain excess liquidity in the system to the extent of about Rs.
4,000 billion during the fortnight ended December 9, 2016.
In the third phase (December 10 to January 13), surplus liquidity
conditions were managed through a mix of reverse repos and issuance of
cash management bills (CMBs) under the MSS. With the enhancement of the
limit on issuance of securities under the MSS from Rs. 300 billion to Rs.
6,000 billion on December 2, 2016 by the Government of India, the Reserve
40

ANALYSES
Bank withdrew the ICRR effective the fortnight beginning December 10,
2016.
Between December 10, 2016 and January 13, 2017, surplus liquidity in the
system was managed by a mix of fine-tuning reverse repo operations and
auctions under the MSS. The peak liquidity absorbed was Rs. 7,956 billion
on January 4, 2017 (Rs. 2,568 billion absorbed through reverse repos and Rs.
5,466 billion through CMBs). Subsequent to the advance tax payment in
mid-December, a part of the excess liquidity was offset by the build-up in
cash balances. The surplus liquidity in the system declined to Rs. 7,269
billion on January 13, 2017.
The peak liquidity absorbed was Rs. 7,956 billion on January 4, 2017 (Rs.
2,568 billion absorbed through reverse repos and Rs. 5,466 billion through
CMBs). Subsequent to the advance tax payment in mid-December, a part of
the excess liquidity was offset by the build-up in government cash balances.
The surplus liquidity in the system declined to Rs. 7,269 billion on January
13, 2017.
In the fourth phase (since January 14), the Reserve Bank has increasingly
used reverse repo operations to absorb surplus liquidity, particularly the
liquidity released through the maturing CMBs, as the magnitude of surplus
liquidity has been moderating in sync with remonetization. Of the total
surplus liquidity (net of injection under the LAF) in the system of Rs. 5,537
billion on March 7, 2017, Rs. 500 billion was absorbed through CMBs under
the MSS and the remaining through variable rate reverse repo auctions under
the LAF. The surplus liquidity is expected to decline going forward as
remonetization progresses further, which will result in decline in deposits
with the banking system.
The surplus liquidity is expected to decline going forward as remonetization
progresses further, which will result in decline in deposits with the banking
system. Despite this however, surplus liquidity conditions are likely to persist
for some more time.
41

ANALYSES
• Monetary Policy Transmission to Lending Rates
Surplus liquidity conditions have helped facilitate the transmission of
monetary policy to market interest rates. Post demonetization, several banks
lowered their domestic term deposit rates and lending rates. The median term
deposit rates of SCBs declined by 38 bps during November 2016-February
2017, while the weighted average term deposit rate of banks declined by 24
bps (up to January 2017). Combined with the sharp increase in low cost
CASA deposits, the overall cost of borrowings declined, allowing banks to
reduce their lending rates. The weighted average lending rate (WALR) of
banks in respect of fresh rupee loans declined by 56 bps during November
2016-January 2017. During January 2017, 25 public sector banks reduced
their 1-year MCLR in the range of 15 to 90 bps, while 17 private sector
banks reduced it in the range of 10 to 148 bps. The 1-year median MCLR of
SCBs declined by 55 bps during January 2017. During February 2017, six
public sector banks lowered their 1-year MCLR in the range of 15 to 65 bps,
while six private sector banks reduced in the range of 10 to 50 bps. During
March 1-7, 2017, two private sector banks reduced their 1-year MCLR in the
range of 5 bps and 20 bps.
42

ANALYSES
The 1-year median MCLR declined by a cumulative 70 bps since November
2016 even when the policy repo rate was not changed. 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. The WALR on outstanding rupee loans declined by 8 bps
during November 2016-January 2017 as against the decline of 11 bps during
the preceding seven months (April-October 2016).
• Jan Dhan Accounts
Post-demonetization, 23.3 million new accounts were opened under the
Pradhan Mantri Jan Dhan Yojana (PMJDY), the bulk of which (80%) were
with public sector banks. Of the new Jan Dhan accounts opened, 53.6 % were
in urban areas and 46.4 % in rural areas.
Deposits under PMJDY accounts increased significantly post demonetization.
The total balance in PMJDY deposit accounts peaked at Rs. 746 billion as on
December 7, 2016 from Rs. 456 billion as on November 9, 2016- an increase
of 63.6%. As there were reports regarding the use of these accounts to
convert black money into white, the Government issued a warning against
the misuse of such accounts.
43
Monetary Transmission: Reduction in Deposit and Lending Rates – Post demonetization (upto March 7, 2017)
Bank Group
MCLR(Median) Term Deposit Rates (Median)
1Year Upto 1Year 1 to 3Years All Tenors
Public Sector Banks 85 26 35 28
Private Sector banks 65 50 48 50
Foreign 40 8 34 6
Scheduled Commercial Banks 70 31 40 38
Deposits Under PMJDY: Number ofAccounts
(in million)
Bank-Group
As on Nov. 9, 2016 As on Mar. 1, 2017 Variation (Mar. 1, 2017 over Nov. 9, 2016)
Rural Urban Total Rural Urban Total Rural Urban Total
Public-Sector Banks 114.3 89.3 203.6 122.1 100.8 222.9 7.8 11.5 19.3
-6.8 -12.9 -9.5
Regional Rural Banks 37.1 6 43.1 40 6.4 46.4 2.9 0.4 3.3
-7.8 -6.8 -7.7
Private-Sector Banks 5.3 3.1 8.4 5.4 3.6 9 0.1 0.5 0.6
-1.3 -16.8 7
Scheduled Commercial Banks 156.7 98.4 255.1 167.5 110.9 278.4 10.8 12.5 23.3
-6.9 -12.7 -9.1

ANALYSES
The Government also capped deposits into PMJDY accounts at Rs. 50,000 on
November 15, 2016. Although deposits declined to Rs. 643 billion as on
March 1, 2017, they were still higher by 41% over the level of November 9,
2016. Jan Dhan accounts contributed 4.6% in total accretion of aggregate
deposits of SCBs in the post-demonetization period.
44
Deposits Under PMJDY:Amount Mobilized
(` billion)
Bank Group As on Nov. 9, 2016 As on Mar. 1, 2017 Variation (Col. 3 over Col. 2)
1 2 3 4 5 6
Public-Sector Banks 364 502.5 138.5 (38) 2733 (3.9) 5.1
Regional Rural Banks 76.3 118.1 41.8 (55) 616 (18) 6.8
Private-Sector Banks 16 22.3 6.3 (39) 778 (3.5) 0.8
Scheduled Commercial Banks 456.4 642.9 186.5 (41) 4098 (4.1) 4.6
Note: Figuresin parenthesis are percentage variations.
#: The ratio pertainsto Jan Dhan deposits as on Feb.15,2017,asdata on aggregate deposits ofSCBsas on Mar.3,2017 are not available yet.
Variation in aggregate deposits
of scheduled commercial banks
(Feb. 17, 2017 over Nov. 11,
2016)
Accretion in PMJDY
deposits as percentage of
accretion inAggregate
deposits#

ANALYSES
VII. Non-Banking Financial Companies (NBFCs)
Loan disbursals by all categories of NBFCs declined significantly in November 2016
compared with the monthly average disbursals during April-October 2016, especially
for micro finance companies (NBFC-MFIs) whose business is more cash intensive.
NBFCs operating in semi-urban and rural areas rely more on cash and thus got affected.
Fresh loan demand for large truck operators fell with lower freight business. Inability of
borrowers to make down payments slowed consumer loans. The demand from real
estate sector was anecdotally the worst affected as buyers expected prices to decline
sharply. To sum up, demand for credit declined due to customers postponing decisions
on account of uncertainty.
In contrast to loan growth, collections (i.e., repayments of loans due) of loan companies
(LCs) during both November and December 2016 increased over the monthly average
collections during April-October 2016. Although collections by asset finance
companies (AFCs) declined in November, they increased in December 2016.
Collections by NBFC-MFIs declined in both November and December vis-à-vis April-
October 2016, but December figures were better than those of November 2016.
Consumer finance, which is mainly through post-dated cheques was less affected.
Wholesale accounts which use online transfers suffered even less. Some customers of
AFCs, who had failed to pay installments during November 2016, may have paid them
along with the December 2016 installments switching to digital payments in December
2016 leading to an improvement in collections. Collections by HFCs, after marginal
contraction in November, rebounded significantly in December 2016.
The growth of credit extended by banks to NBFCs also appears to have been affected
due to demonetisation. Bank credit growth to NBFCs decelerated from 5.1% on y-o-y
basis in October 2016 to 1.3% in November 2016, which further declined by 0.6% in
January 2017.
45

ANALYSES
As regards the micro finance segment of NBFCs, demonetisation impacted NBFC-
MFIs as their customers depend on cash transactions. Such customers often fall in the
category of small farmers and unskilled labor. Micro-finance institutions were reported
to have faced problems in getting full repayment from clients in some pockets of the
country due to currency shortage. In order to provide relief to this sector, the Reserve
Bank in November 2016 provided an additional 60 days beyond what was applicable
for the concerned regulated entities in this sector for recognition of a loan account as
sub-standard. Subsequently, on December 28, 2016, the Reserve Bank again announced
forbearance of 30 days (in addition to the 60 days provided earlier) for asset
classification for dues payable between November 1 and December 31, 20163
. Data
provided by the Micro Finance Institutions Network (MFIN) suggest that pending
repayments were still high in January 2017.
While total loan amount outstanding declined by 4.1% between end-November and
end-January 2017, loan amount disbursed increased by 9.2% during the same period.
The information sourced from Sa-Dhan4
indicates that cash collections, which initially
witnessed significant reduction, improved subsequently, except for some pockets in the
western region. The latest feedback received by MFIN from their member MFIs
suggests that there has been some improvement in collections since late December
2016. While repayments are mostly made in cash, MFIs are striving to opt for different
cashless ways for disbursements.
3 Latest data available was till the first week of March. Impact of this decision on NPAs is not available yet.
4 It is the Association of Community Development Finance Institutions, est. 1998.
47

ANALYSES
VIII. Forex Market
The foreign exchange market has exhibited some volatility post-demonetization,
reflecting both global and domestic developments. Foreign portfolio investors (FPIs)
made net sales of Rs. 56,360 crores (November 9, 2016 to February 16, 2017) in a
global retrenchment across EMEs as funds re-balanced their emerging market (EM)
exposures after the US presidential elections and the Fed rate hike. The softening of G-
sec yields following surplus liquidity immediately after demonetization may also have
encouraged some FPIs to sell government securities to book profits. The likely fall in
quarterly earnings of cash intensive sectors such as auto and FMCG may have also led
to a sell-off by FPIs, which led to some volatility in the foreign exchange market.
However, equity portfolio flows have been positive at US$ 2.4 billion since January 17,
2017. The Indian rupee, which depreciated by 2.6% during November 8, 2016 to
November 30, 2016 against the US dollar, appreciated in the first week of December
2016.
Considering the factors mentioned above and the peak FCNR(B) deposit redemptions
in November 2016, the exchange rate volatility remained contained. Thereafter, it
exhibited some downward pressure amidst sustained foreign portfolio outflows
especially after the US Fed’s policy rate hike and hawkish guidance, and increased
demand for dollars from importers. Since February 2017, the Indian rupee has
appreciated by 1.8 % mainly due to net equity inflows led by the policy announcements
made in the Union Budget and the change in the monetary policy stance of the Reserve
Bank from accommodative to neutral. Thus, the impact of demonetization on the forex
market appeared to have been transitory.
49

SUMMARY AND CONCLUSION
I. Introduction
The final chapter summarizes the main points from the analyses. It shows the
interpretation of the results as observed in the conclusion. The limitations of the
research are identified. Future prospects are determined.
51

II. Summary
The impact of demonetization on the economy in the long run is still to be determined,
as the data analyzed in the project is of the short term basis i.e., till the end of Q1, 2017.
The results of the analyses are listed as follows:
• WACR operated around the repo rates despite the short term changes.
• The yield traded with a softening bias during November and early December.
It started hardening during the late December to mid February span.
• Due to the cash intensive nature of transactions in relation to consumer
durables, FMCG & auto, they declined in anticipation of a decrease in
demand.
Consumer durables and FMCG recovered and are currently performing at
higher levels than the pre-demonetization period. Auto is still performing at
lower levels.
• Investment in mutual funds increased, as banks decreased fixed deposit rates.
• The insurance industry emerged as a more viable option as compared to real
estate and gold. The industry encountered a growth of nearly 113% on a year-
on-year basis.
• Banks observed increase in deposits leading to fall in cost of funds. The
demand for Government bonds increased. Lending growth of banks is still
less. Jan Dhan Accounts rose in number.
• The exchange rate volatility remained contained. It exhibited some
downward pressure amidst sustained foreign portfolio outflows. Since
February 2017, the Indian rupee has appreciated.
52

III. Conclusion
While the world awaited the results of the US presidential campaign, the Prime
Minister of India Mr. Narendra Modi made an announcement that shocked experts
worldwide. The span while demonetization lasted, brought forth changes in the
economy, the likes of which haven’t been observed in the past century. The move
rendered 86.9% of the cash circulating in the nation, useless.
The immediate effects observed were the long queues outside and inside all the major
banks, as people flocked to the counters in order to exchange old currency for new
currency. ATMs became the most sought after hangout places, as people tried to
withdraw money for everyday expenses.
Overall, the step to demonetize the Indian currency although seemingly a bit lacking in
planning, has been a successful step.
Merits:
• A major portion of the black money in the economy was rendered useless
which became an effective block against the funding of terrorism, gambling
etc.
• Increase in tax revenue.
• A major steps towards creating a digitized economy.
• Improved deposits and savings.
• Helped in appreciation of the Indian Rupee against the US Dollar.
But, it also has its shortcomings.
Demerits:
• Since the move wasn’t completely planned, it led to shortage of cash in the
initial stages.
• Economic growth slowed down.
• Disruption of trade activities.
53

III. Limitations
This research considered the impact of demonetization on the financial market. Since
the data was of secondary form, the outcome was pre-determined. These results were
influenced by the economic conditions of the nation.
The results of this research can’t be used as a reference when analyzing demonetization
in another nation (if and when it’s implemented). This difficulty arises from the fact
that no two nations have similar economic conditions. Which implies that, the situation
in which demonetization may be introduced in the nation, may have quite a different
impact on its financial market.
54

IV. Future Prospects
The present research analyzed the impact of demonetization on the Indian financial
market. While some changes could be observed easily, since the report is based on a
short time span, a lot of changes could not be observed.
Further research needs to be undertaken in order to determine the long term effects and
how these effects result in changes in the monetary policy as well as the strategies
adopted by various financial institutions.
The impact on GDP and tax revenue require in-depth research in order to determine
whether the goal of increasing tax revenue is achieved or not.
The rise of the E-Commerce industry presents a new area for research.
Another aspect that can be researched in more detail, is the current situation of the
parallel economy and the activities funded by black money.
55

APPENDIX I. RESEARCH TERMS
• Empirical Research: It is based on observed and measured phenomena and
derives knowledge from actual experience rather than from theory or belief.
• Primary Data: Primary data is data originated for the first time by the
researcher through direct efforts and experience, specifically for the purpose
of addressing his research problem. Also known as the first hand or raw data.
Primary data collection is quite expensive, as the research is conducted by the
organization or agency itself, which requires resources like investment and
manpower. The data collection is under direct control and supervision of the
investigator.
The data can be collected through various methods like surveys,
observations, physical testing, mailed questionnaires, questionnaire filled and
sent by enumerators, personal interviews, telephonic interviews, focus
groups, case studies, etc.
• Research Methodology: It is the systematic, theoretical analysis of the
methods applied to a field of study. It comprises the theoretical analysis of
the body of methods and principles associated with a branch of knowledge. A
methodology does not set out to provide solutions – it is, therefore, not the
same as a method. Instead, a methodology offers the theoretical underpinning
for understanding which method, set of methods, or best practices can be
applied to specific case, for example, to calculate a specific result.
• Research Strategy: It is a step-by-step plan of action that gives direction to
thoughts and efforts, enabling the research to be conducted systematically
and on schedule to produce quality results and detailed reporting.
• Secondary Data: Secondary data implies second-hand information which is
already collected and recorded by any person other than the user for a
purpose, not relating to the current research problem. It is the readily
available form of data collected from various sources like censuses,
government publications, internal records of the organization, reports, books,
journal articles, websites and so on.
Secondary data offer several advantages as it is easily available, saves time
and cost of the researcher. But there are some disadvantages associated with
this, as the data is gathered for the purposes other than the problem in mind,
so the usefulness of the data may be limited in a number of ways like
relevance and accuracy. Moreover, the objective and the method adopted for
acquiring data may not be suitable to the current situation. Therefore, before
using secondary data, these factors should be kept in mind.
57

APPENDIX II. FINANCIAL TERMS
• Asset: It is an economic resource. Anything tangible or intangible that can be
owned or controlled to produce value and that is held by a company to
produce positive economic value is an asset.
• Basis Point (bps): It refers to a common unit of measure for interest rates
and other percentages in finance. One basis point is equal to 1/100th of 1%,
or 0.01% (0.0001), and is used to denote the percentage change in a financial
instrument. The relationship between percentage changes and basis points
can be summarized as follows: 1% change = 100 basis points, and 0.01% = 1
basis point.
• Black Market: It is a clandestine market or transaction that has some aspect
of illegality or is characterized by some form of non-compliant behavior with
an institutional set of rules. If the rule defines the set of goods and services
whose production and distribution is prohibited by law, non-compliance with
the rule constitutes a black market trade since the transaction itself is illegal.
• Bond: It is a debt security, under which the issuer owes the holders a debt
and (depending on the terms of the bond) is obliged to pay them interest (the
coupon) and/or to repay the principal at a later date, termed the maturity date.
• Bond Yield: It is the amount of return an investor realizes on a bond. Several
types of bond yields exist, including nominal yield which is the interest paid
divided by the face value of the bond, and current yield which equals annual
earnings of the bond divided by its current market price. Additionally,
required yield refers to the amount of yield a bond issuer must offer to attract
investors.
• Cash Reserve Ratio (CRR): It is the amount of funds that the banks have to
keep with the RBI. If the central bank decides to increase the CRR, the
available amount with the banks comes down. The RBI uses the CRR to
drain out excessive money from the system. Commercial banks are required
to maintain with the RBI an average cash balance, the amount of which shall
not be less than 3% of the total of the Net Demand and Time Liabilities
(NDTL), on a fortnightly basis and the RBI is empowered to increase the rate
of CRR till 20% of the NDTL.
• Commodity: It is a marketable item produced to satisfy wants or needs.
Economic commodities comprise goods and services.
• Currency: It in the most specific use of the word refers to money in any
form when in actual use or circulation as a medium of exchange, especially
circulating banknotes and coins.
58

• Debt: It is an amount of money borrowed by one party from another. Debt is
used by many corporations and individuals as a method of making large
purchases that they could not afford under normal circumstances. A debt
arrangement gives the borrowing party permission to borrow money under
the condition that it is to be paid back at a later date, usually with interest.
• Debt Issue: It is a fixed corporate or government obligation, such as a bond
or debenture. A debt issue is a financial obligation that allows the issuer to
raise funds by promising to repay the lender at a certain point in the future
and in accordance with the terms of the contract. Debt issues include notes,
bonds, certificates, mortgages, leases or other agreements between the issuer
(the borrower) and lender.
• Derivative: It is a contract that derives its value from the performance of an
underlying entity. This underlying entity can be an asset, index, or interest
rate, and is often simply called the "underlying". Derivatives can be used for
a number of purposes, including insuring against price movements (hedging),
increasing exposure to price movements for speculation or getting access to
otherwise hard-to-trade assets or markets. Some of the more common
derivatives include forwards, futures, options, swaps, and variations of these
such as synthetic collateralized debt obligations and credit default swaps.
• Edict: It is a decree or announcement of a law, often associated with
monarchism, but it can be under any official authority.
• Emerging Market Economy (EME): It is a nation's economy that is
progressing toward becoming advanced, as shown by some liquidity in local
debt and equity markets and the existence of some form of market exchange
and regulatory body. Emerging markets are not as advanced as developed
countries but maintain economies and infrastructures that are more advanced
than frontier market countries.
• Equity: It is the difference between the value of the assets and the value of
the liabilities of something owed.
• Foreign Currency Non-Resident (FCNR) Account: It is a term deposit
account that can be maintained by NRIs and PIOs in foreign currency. This
account can be a good option for Non Resident Indians (NRIs) looking to
invest in India without worrying about currency risks.
• Foreign Exchange Market: It is a global decentralized or over-the-counter
(OTC) market for the trading of currencies. This includes all aspects of
buying, selling and exchanging currencies at current or determined prices.
59

• Foreign Portfolio Investment (FPI): It consists of securities and other
financial assets passively held by foreign investors. It does not provide the
investor with direct ownership of financial assets and is relatively liquid
depending on the volatility of the market.
• Gilt Fund: It is a mutual fund that invest only in government securities.
They are preferred by risk averse and conservative investors who wish to
invest in the shadow of secure government bonds.
• Inflation: It is a sustained increase in the general price level of goods and
services in an economy, over a period of time. When the price level rises,
each unit of currency buys fewer goods and services; consequently, inflation
reflects a reduction in the purchasing power per unit of money– a loss of real
value in the medium of exchange and unit of account within the economy.
• Insurance: It is a means of protection from financial loss. It is a form of risk
management primarily used to hedge against the risk of a contingent,
uncertain loss.
• Interest Rate: It is the amount charged, expressed as a percentage of
principal, by a lender to a borrower for the use of assets. Interest rates are
typically noted on an annual basis, known as the annual percentage rate
(APR). The assets borrowed could include, cash, consumer goods, large
assets, such as a vehicle or building.
• Legal Tender: It is a medium of payment recognized by a legal system to be
valid for meeting a financial obligation. Paper currency and coins are
common forms of legal tender in many countries.
• Liability: It is defined as the future sacrifices of economic benefits that the
entity is obliged to make to other entities as a result of past transactions or
other past events, the settlement of which may result in the transfer or use of
assets, provision of services or other yielding of economic benefits in the
future.
• Liquidity: Liquidity describes the degree to which an asset or security can be
quickly bought or sold in the market without affecting the asset's price.
• Liquidity Adjustment Facility (LAF): It is a tool used in monetary policy
that allows banks to borrow money through repurchase agreements. This
arrangement allows banks to respond to liquidity pressures and is used by
governments to assure basic stability in the financial markets.
• Marginal Cost of funds based Lending Rate (MCLR): It refers to the
minimum interest rate of a bank below which it cannot lend, except in some
60

cases allowed by the RBI. It is an internal benchmark or reference rate for the
bank. MCLR actually describes the method by which the minimum interest
rate for loans is determined by a bank – on the basis of marginal cost or the
additional or incremental cost of arranging one more rupee to the prospective
borrower.
• Market Stabilization Scheme: It is a monetary policy intervention by the
RBI to withdraw excess liquidity (or money supply) by selling government
securities in the economy. The MSS was introduced in April 2004.
• Monetary Policy Committee (MPC): It is a committee of the RBI that is
responsible for fixing the benchmark interest rate in India. The meetings of
the Monetary Policy Committee are held at least 4 times a year and it
publishes its decisions after each such meeting. The committee comprises of
six members – three officials of the RBI and three external members
nominated by the Government.
• Mutual Fund: It is an investment vehicle made up of a pool of funds
collected from many investors for the purpose of investing in securities such
as stocks, bonds, money market instruments and similar assets. Mutual funds
are operated by money managers, who invest the fund's capital and attempt to
produce capital gains and income for the fund's investors.
• Non-Performing Asset (NPA): It is defined as a credit facility in respect of
which the interest and / or installment of principal has remained ‘past due’ for
a specified period of time. In simple terms, an asset is tagged as non
performing when it ceases to generate income for the lender.
• Portfolio: It is a grouping of financial assets such as stocks, bonds and cash
equivalents, as well as their funds counterparts, including mutual, exchange-
traded and closed funds. Portfolios are held directly by investors and / or
managed by financial professionals.
• Repo Rate: It is the rate at which the RBI lends money to commercial banks.
It is an instrument of monetary policy. Whenever banks have any shortage of
funds they can borrow from the RBI. A reduction in the repo rate helps banks
get money at a cheaper rate and vice versa.
• Reverse Repo Rate: It is the rate at which the RBI borrows money from
commercial banks. Banks are always happy to lend money to the RBI since
their money are in safe hands with a good interest. An increase in reverse
repo rate can prompt banks to park more funds with the RBI to earn higher
returns on idle cash. It is also a tool which can be used by the RBI to drain
excess money out of the banking system.
61

• Security: It is a tradable financial asset. The term commonly refers to any
form of financial instrument, but its legal definition varies by jurisdiction.
• Stock: The stock of a corporation is constituted of the equity stock of its
owners. A single share of the stock represents fractional ownership of the
corporation in proportion to the total number of shares. In liquidation, the
stock represents the residual assets of the company that would be due to
stockholders after discharge of all senior claims such as secured and
unsecured debt.
• Stock Exchange: It is an exchange where stock brokers and traders can buy
and sell stocks (also called shares), bonds, and other securities. Stock
exchanges may also provide facilities for issue and redemption of securities
and other financial instruments and capital events including the payment of
income and dividends. Securities traded on a stock exchange include stock
issued by listed companies, unit trusts, derivatives, pooled investment
products and bonds.
• Sustainable Banking Network (SBN): It is a unique community of financial
sector regulatory agencies and banking associations from emerging markets
committed to advancing sustainable finance in line with international good
practice. The Network facilitates the collective learning of members and
supports them in policy development and related initiatives to create drivers
for sustainable finance in their home countries.
• Weighted Average Call Rate (WACR): It is The declared operating target
of the RBI is the overnight call money rate. It has to be averaged across what
can be quite wild swings even in the course of any single trading day.
62

REFERENCES
2016 Indian banknote demonetisation (2016), Retrieved from wikipedia.org:
https://en.wikipedia.org/wiki/2016_Indian_banknote_demonetisation
Borkar N. (2016), Retrieved from indiatimes.com:
http://www.indiatimes.com/news/world/here-s-a-list-of-countries-that-have-tried-
demonetisation-before-india-265743.html
Demonetization Impact on Life Insurance Industry (2017), Retrieved from
bemoneyaware.com: https://www.bemoneyaware.com/blog/demonetization-impact-life-
insurance/
Finken S. (2012), Private Banking Consumer Perception and the Influence of
Acquisition.5
Kumari J. (2017), Retrieved from moderndiplomacy.eu:
http://moderndiplomacy.eu/index.php?
option=com_k2&view=item&id=2253:demonetization-and-its-impact-on-indian-
economy&Itemid=137
Nathan N. (2016), Retrieved from economictimes.indiatimes.com:
http://economictimes.indiatimes.com/wealth/invest/demonetisation-what-should-debt-
fund-investors-do-now/articleshow/55508165.cms
RBI (2017), Macroeconomic Impact of Demonetization- A Preliminary Assessment.
Singh N. (2017), Retrieved from blog.hrblock.in:
https://blog.hrblock.in/demonetization/advantages-disadvantages-demonetisation/
Types of Financial Markets and their Roles (2017), Retrieved from investopedia.com:
http://www.investopedia.com/walkthrough/corporate-finance/1/financial-markets.aspx
What is CRR, repo and reverse repo rate?, Retrieved from indiainfoline.com:
http://www.indiainfoline.com/article/news/what-is-crr-repo-and-reverse-repo-rate-
4891655230_1.html
5 Used as a reference for the format and language of the project.
64

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