DEMONITIZATION AND FINANCIAL SYSTEM

Assignment for the Rural Financial Institution and Services

Submitted to:

(Prof. Pradeep Kumar Mishra)

By

(Vishal Kumar)

(Roll No UR18030), (Class A)

Xavier School of Rural Management (XSRM)

Xavier University Bhubaneswar

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Table of Content

1. Introduction…………………………………………………………………. 2-3
2. History of Demonetization in India and World……………………………… 3-4
3. Need for Financial Inclusion………………………………………………… 4-5
4. State of Financial Inclusion…………………………………………………... 5
5. Rationale of Demonetization…………………………………………………. 5-6
6. Influences of Demonitization..............................................…........................... 6
6.1 Increase in deposits………………………………………………………... 6
6.2 Fall in cost of funds………………………………………………………... 6-7
6.3 Demand for Govt. bonds…………………………………………………… 7
6.4 Opening of Jan Dhan Account……………………………………………... 7
6.5 Push to Digital Banking……………………………………………………. 7
6.6 Higher detection of fake currency notes…………………………………… 7-8
6.7 GDP growth rate…………………………………………………………… 8
7. Challenges of Demonetization…………………………………………………. 8
7.1 Currency Dominated economy……………………………………………... 8
7.2 Limited availability of Point of Sale terminals……………………………... 8
7.3 Mobile internet penetration remains weak in rural India…………………… 8
8. Conclusion……………………………………………………………………… 8-9

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1. INTRODUCTION
In the course of recent years, India has encountered a fast development in the accessibility
and use of formal money related administrations, especially banking, over all portions of
society. Between 2013 and 2015, a singular responsibility of an account at a formal
budgetary foundation expanded from 47 percent to 65 percent of the adult population (over
the age of 15). This change compares to a 34 percent expansion in monetary consideration,
or in excess of 250 million people. The Government of India's arrangements for expanding
budgetary incorporation are a key driver of the development of the managed a banked
population. The administration, through the Financial Inclusion Department at the Ministry
of Financial Services, has presented various national-scale and incorporated strategies went
for expanding the two considerations, by and large, and usage of advanced money related
administrations, particularly. Most eminent among these strategies is Pradhan Mantri Jan
Dhan Yojana or PMJDY. PMJDY is in charge of the financial inclusion of about 300
million Indian adults. Through PMJDY, the Government of India showed that a complete
money related incorporation program, supported by engaged and authorized approaches, can
effectively drive population-wide budgetary consideration. The rate of individual account
ownership among India's adult population was minimal changed somewhere in the range of
2015 and 2016 as indicated by the broad agent studies executed yearly by the FII program.

The demonetization policy enacted by our respected Prime Minister Narendra Modi on Nov
8, 2016, provided a powerful impetus to resume the upward trend towards greater financial
inclusion and engagement. Demonetization started when Prime Minister Modi announced
that at midnight, Nov 9, the government would no longer recognize existing 500- and 1,000-
rupee notes as valid forms of legal tender. This action invalidated approximately 85 percent
of the currency notes in circulation. The Reserve Bank of India reported that between Nov
4, 2016, and Dec 23, 2016, the amount of cash in circulation fell by nearly half. The absence
of money caused huge financial and social interruption. Banks were overwhelmed by the
volume of notes that should have been exchanged. Regardless of withdrawal limits, banks
and ATMs were not set up to take care of the demand for new notes. result was a money
lack where, months after demonetization was reported, trade was still rare out numerous

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 territories. Withdrawal limits were forced until the point until February and some detailed
by means of local news channels that ATMs were all the while confronting supply issues in
March 2017.

While demonetization was mainly intended to curb the prevalence of black, or untaxed
money, it has also been considered as a mechanism to drive financial inclusion and the use
of digital financial services (DFS). Demonetization required virtually all adult Indians to
engage, directly or indirectly, with a formal financial institution since demonetized notes
could only officially be exchanged for valid notes at a bank or Post Office Bank. Within the
month following demonetization, financial service providers reported that the absence of
cash was driving digitization among DFS-ready segments of society.

These events provided a unique opportunity to investigate the effects of policy changes on
financial inclusion and DFS uptake. The exchange of demonetized notes compelled
individuals to interact with formal financial institutions, which would lead to an increase in
financial inclusion if more individuals opened accounts. Coping with the cash shortage may
have promoted the adoption of cashless payments, albeit starting from very low levels.

2. HISTORY OF DEMONITIZATION IN INDIA AND WORLD

It is not the first time in history, that government has taken this kind of step. It has happened
twice in the past. The first currency ban was announced as on 12th January, 1946 (Saturday)
by RBI. At that time currency notes of 1000 and 10,000 were totally removed from
economy. Both the notes were re-introduced in year 1954. At that time people were given
10 days’ time period to exchange the notes. Further that was extended to 15 days, where
people had to give reasons why they had not exchanged it in previous 10 days. It had not
created much effect at that time. By the end of 1947 out of Rs 143.97 crores, notes of only
Rs 134.9 crores were exchanged. Thus, notes worth Rs. 9.07 were perhaps “Demonetized”.

The second currency ban was made on 16th January, 1978(Monday), announced by R.
Janaki Raman a senior official of RBI, and at the time of Morarji Desai led Janata party. At
that time currency ban was taken 1000, 5000 and 10,000 out of circulation. That time the

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 people had given only 3 days to exchange the notes. This time around 73.1 crore was
demonetized.

Finally, the third, the most recent demonetization had been announced as on 8th November,
2016 by Prime Minister Narendra Modi. This time the currency of 500 and 1000 notes are
demonetized from economy. The Government has instructed the hospitals, petrol pumps,
airports etc. to accept the old denomination notes till 11th November, 2016.

Along with India many countries in the world had done demonetization in the history.
Almost countries that had done demonetization had some common objectives of
demonetization which were to curb corruption and black money and their government
decided to demonetize their higher denomination notes to get rid of these problems.
Countries like Nigeria, Soviet Union, Ghana, Myanmar, North Korea, Zimbabwe, Australia,
Britain, Zaire, USA, Pakistan, Germany and Philippines, went for Demonetization at some
point of time to counter these relevant problems in their respective countries. By collecting
the growth rates of the countries, at the time of demonetization show that most of the
countries lost a lot of growth due to that. Nigeria had a negative growth rate during
demonetization and before demonetization year so their economy collapsed at that time but
after the demonetization they grew at higher rate. Other than this Australia was pretty
stagnant in terms of growth rate in pre-and post- demonetization period. United States and
Britain felt a slowdown in the growth rate during demonetization year but after they grew at
higher rate. Many other countries also done the demonetization when they had high negative
growth rates in the following years, so they couldn’t succeed and their economy collapsed.
By this we can understand that it is pretty hard to sustain the growth, and we should be
aware and alert of that fact and should take appropriate actions, otherwise the story would
remain the same for us also.

3. NEED FOR FINANCIAL INCLUSION

In India financial services are used only by a section of the population due to illiteracy and
other reasons. The excluded regions are rural, poor regions and also those living in harsh
climatic conditions where it is difficult to provide these financial services. Hence, financial
exclusion leads to non-accessibility, non-affordability and non-availability of financial

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 products. Limited access to funds in an underdeveloped financial system restricts the
availability of their own funds to individuals and also leads to high cost credit from informal
sources such as moneylenders. Due to lack of access to a bank account and remittance
facilities, the individual pays higher charges for basic financial transactions. Absence of
bank account also leads to security threat and loss of interest by holding cash. All these
impose real costs on individuals. Prolonged and persistent deprivation of banking services to
a large segment of the population leads to a decline in investment and has the potential to
fuel social tensions causing social exclusion. Thus, financial inclusion is essential for
accelerated economic growth of the country.

4. STATE OF FINANCIAL INCLUSION

Compared to the developed world, the coverage of India’s financial services is abysmally
low. According to the information available with the Reserve Bank of India, about 5.89
crores no-frill accounts, with and without value-added features, have been opened until
November 23, 2016 of which about two-third are with the public sector and one-third with
the private sector banks. Though the RBI promoted no-frills savings bank account under Jan
Dhan Yojana, had all the potential to revolutionize India's rural agricultural economy, as
well as usher in the banking habit amongst a large number of the less privileged population.
However, considering to the vast multitude of the Indian population the number of accounts
opened is not encouraging for the cause of complete financial inclusion. After current
demonetization drive the financial inclusion is being carried out in various ways as people
are seeking respite from the currency shortage. People are being forced to use electronic
banking services and digital platforms. Banks have been pushing the cause of complete
financial inclusion.

5. RATIONALE OF DEMONITIZATION
India is swiftly increasing in terms of growth and standing in No.1 position in terms of
growth but ranked 76 in Global Corruption Perception Ranking. It is no secret that the evil
of corruption and black money also have grown beyond the control of the system. In fact,
they are influencing the system and weakening the efforts in financial inclusion. Also,
existence of huge number of high value currency notes has created conducive environment

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 for hoarding black money, corruption in business and politics and funding of terrorism by
hostile countries. Therefore, demonetization was on the anvil as one of the major steps to
make economy free of these evils. The primary steps were already taken during the last two
years viz., Aadhar seeding to gas and other services making PAN compulsory for high value
transactions, Prime Minister’s Jan Dhan Yojana of no-frills accounts and recent Income
Disclosure Scheme. These policies have been adopted under the recommendation and
pressure of the experts and the need to eradicate economic evils. These efforts directly or
indirectly will culminate into complete financial inclusion.

The liquidity boost resulting from the demonetization announcement on November 8, 2016
has stayed with the banking sector a year after the event, helping banks reduce their high-
cost deposits and boosting their current account and savings account (CASA) ratio.

CASA is abbreviation of current Account Savings Account. It is the ratio which indicates
how much of the total deposits with bank in the current account and savings account. In a
simple language, the deposits with the bank are in the current account and savings account.
Banks do not pay interest on the current account deposits and pays a very low percentage of
interest on savings on account deposits. Hence, it is a good measure to get deposits at no or
very low cost.

6. INFLUENCES OF DEMONITIZATION
6.1. INCREASE IN DEPOSITS
Demonetization has increased the deposits in Banks. Unaccounted money in the form of
Rs.500 and Rs.1000 were flowing to the Banks and the sizes of deposits have been
increased. It helped the banks to grab the deposits and increase their deposits. Bulk of the
deposits so mobilized by SCBs have been deployed in Reverse Repos of various tenors
with the RBI; and Cash Management Bills (CMBs) issued under the Market Stabilization
Scheme. Loans and advances extended by banks increased by Rs.1,008 billion. The
incremental credit deposit ratio for the period was only 18.2 per cent. Additional deposits
mobilized by commercial banks have been largely deployed in liquid assets.

6.2. FALL IN COST OF FUNDS

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 Over the past few months, the deposits are increased. It led the banks to keep a major part
of deposits in the form of cash deposits. PSU Banks have a big share (over 70%) of the
deposits and biggest gainers of the rise in deposits, leading to lower cost of funds. 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.

6.3. DEMAND FOR GOVERNMENT BONDS

After sharp rise in deposits on post demonetization, banks started lending such surplus
deposits to the RBI under the reverse repo options. PSU Banks, particularly, deployed
excess funds in government bonds. The return on bond investment is likely to add 15 to 20
per cent increase in the earnings of banks.

6.4. OPENING OF JAN DHAN ACCOUT

Post-demonetization, 23.3 million new accounts were opened under the Pradhan Mantri Jan
Dhan Yojana (PMJDY), bulk of which (80 per cent) were with public sector banks. Of the
new Jan Dhan accounts opened, 53.6 per cent were in urban areas and 46.4 per cent in rural
areas. Deposits under PMJDY accounts increased significantly post demonetization. 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.

6.5. PUSH TO DIGITAL BANKING

A cashless economy is one in the flow of cash within an economy is non-existent and all
transactions have to be through electronic channels such as direct debit, credit and debit
cards, electronic clearing, payment systems such as Immediate Payment Service (IMPS),
National Electronic Funds Transfer and Real Time Gross Settlement in India.

6.6. HIGHER DETECTION OF FAKE INDIAN CURRENCY NOTES

Approximately 7,62,072 pieces of counterfeit notes were detected in the banking system
last fiscal, a 20.4% increase over the previous year. The Reserve Bank said During 2015-

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 16, Approximately 6.32 lakh pieces of fake currency notes had been detected, the central
bank said in its annual report for 2016-17.

6.7. GDP GROWTH RATE

India’s economic growth fell to 6.1 per cent in the fourth quarter of financial year in 2016-
17, primarily because of Demonetization adversely affecting economic activity. Data
released by the Ministry of Statistics show that GDP slowed to 5.7% in the quarter ended
June 30, from 7.9% in the corresponding period a year ago. The data also showed that the
sectors that would have been affected by demonetization were the ones that took the
biggest hit.

7. CHALLENGES OF DEMONITIZATION
7.1. Currency dominated economy:

High level of cash circulation in India. Cash in circulation amounts to around 13 per cent of
India’s GDP.

7.2. Limited availability of Point of Sale terminals:

According to RBI, there are 1.44 million PoS terminals installed by various banks across
locations at the end of July 2016. But most of them remain in urban/ semi-urban areas.

7.3. Mobile internet penetration remains weak in rural India:

For settling transactions digitally, internet connection is needed. But in India, there is poor
connectivity in rural areas. In addition to this, a lower literacy level in poor and rural parts
of the country, make it problematic to push the use of plastic money on a wider scale.

8. CONCLUSION
The cash shortage in India has abated, but the story of demonetization is far from over.
While demonetization as a single policy intervention was relatively narrow in scope, the
motivations for its implementation are part of a broader set of initiatives intended to
increase financial inclusion and transform the economy of India. This study understands
demonetization as but one part of a much wider Government of India initiative to

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increase financial inclusion among the population. Demonetization also drove increases
in the utilization of financial services that overcame longstanding demographic barriers,
with some exceptions. The income gap widened, however, suggesting that poverty will
remain a strong barrier to financial inclusion. Compared to its effects on financial
inclusion, demonetization was less successful at promoting a transition to a cashless
society. New adopters of mobile money services were rare – less than 3 percent. India
remains in the early stages of DFS adoption after demonetization.

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