India’s cash crunch situation to deter GDP growth, informal sector likely to be worst hit

The cash crunch situation, owing to the recently announced demonetization scheme, is throttling the Indian economy and is likely to have a downside impact on the country’s gross domestic product (GDP in the last quarter of the year. Besides, the poor and middle-class people are being badly affected by this stance. The informal sector or the more cash-dependent sector of the economy will be the worst hit, among all.

India, the world’s largest democracy remains extremely dependent on cash transactions and borrowing, especially the rural sector, as the availability of banks in remote places are a rare visual, despite efforts by the government to adopt total financial inclusion. Attempts by the ruling Narendra Modi-led BJP government to bring all classes of people under the banner of modern banking system have failed to the core. The Pradhan Mantri Jan Dhan Yojana was aimed to secure the poor class of the money that they hold; however, it did not succeed to incorporate everyone.

Prime Minister Modi announced the demonetization plan on November 8, 2016, to be effective from same day midnight onwards. The 1.25 crore billion Indian population has been suffering since then. Although it meant sleepless nights for the black money hoarders, it attempted to provide a sigh of relief to the working class population.

We foresee that although such a bold move will benefits all Indians, both in short as well as long term, the immediate effects seem dangerous. Firstly, the Q4 economic growth will suffer in the wake of lost money; many big businessmen, gold merchants, real estate builders and others who prefer to hold cash, have either burnt their unaccounted black money or have not deposited them into banks, in exchange of new notes, fearing corruption charges.

A country where 86 percent of the transactions are done via the 'hand-to-hand-mode', a lumpsome amount of cash has gone missing from the economy. Although that money was part of the parallel economy, some portion of it could have entered the white economic system, contributing a significant amount to the country’s GDP. Now that most of it are lost, we really do not think the Q4 growth will be reminiscent of the past.

Lastly, we believe that the informal sector, whose earnings are unaccountable, but not black money will suffer the most. With India being a street food destination, the shopkeepers will face a slump in customer visits either due to complete unavailability of cash, or due to unavailability of small changes on the bigger INR2000 note.