Currency Demonetisation Will Bring Significant Structural Benefits To Indian Economy: ReportIndian rupees

Amid huge uproar over the demonetisation of Rs 500 and Rs 1,000 currency notes, a report prepared by the CRISIL reveals that the move will have a transitory impact on the Gross Domestic Product (GDP) in a short run and will bring structural benefits to the country’s economy in the long run. The report also points towards the fact that cash-intensive sectors of the economy, such as small and medium scale enterprises, will be inconvenienced for a while.

According to the World Bank, India’s shadow economy stood at 23.2 per cent of the GDP in 2007. If the ratio still holds, over $479 billion is unaccounted for. With demonetisation, the government aims to either mainstream or eliminate altogether the cash not in flow.

Demonetisation, according to this report, can benefit the economy by improving government’s fiscal position, ameliorating tax to GDP ratio, treading down inflation and driving jobs and income.

The move will have a direct positive impact on tax revenue collection and will improve government’s ability to spend on infrastructure. The cash, currently unaccounted for, will be brought into the banking system for exchange and will eventually be taxed. Declaration of unaccounted income due to demonetisation will be taxed at a rate of 30 to 120 per cent, depending on the source.

Higher tax collection, in turn, will give the government room to increase spending on infrastructure. Investment in infrastructure will drive job and income in related sectors.

The shortage of cash will negatively affect demand in cash intensive sectors such as housing, food and transport. This will exert downward pressure on inflation in a short run, but an increased government spending will revive demand. Therefore, in a long run, the effect on inflation will be neutral.

With 86 per cent of currency in circulation suddenly becoming non-usable, there will be a significant impact on the overall level of economic activity.

A version of the report is available here.

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