Aim – Digital Payment and Causality – Inflation and Gold Prices: Evidence from India’s Demonetization Policy

The Government of India unexpectedly enforced demonetization in the night 08 November 2016 and declared around 86% of existing currency notes of Rs. 500 and 1000 denomination in the circulation as illegal.[1] According to official sources key goal demonetization policy were manyfold such as curb corruption, counterfeiting, terrorist activities, to target the black money accumulated mostly by high net worth group individuals (HNI) and emphasizing the digital payment.[2] In other words, indirect aim was to eventually make everyone part of the non-cash digital economy. Because of the surprise nature of the announcement of November 8, 2016 demonetization which targeted fairly high-value notes that made up the vast amount of currency (86 %) in circulation.[3-5] Pre-demonetization, government targeted on the ―Aadhar‖ scheme, the ―Jan Dhan‖ initiative, ―PAN‖ card, and mobile banking.[6,7] According to some reports, it was belief that only 10 people were aware of plan of demonetization policy.[8] The announcement of new INR 2,000 note months before November 2016[9] appears to be pre-indication of demonetization plan. The Indian has experienced demonetization on two occasions in past - once in 1946 and then in 1978. In the initial weeks, no clarity on ‗why‘ and ‗how‘ of demonetization. From the anecdotal news reports, middle class and lower middle class was the worst affected because they conducted almost 98% their transactions in cash to facilitate the daily activities. Long queue outside banks and ATM machines for days resulted in over 100 cases of death across India. Reserve Bank of India was mere a mute spectator. Using the currency chest data form the RBI resources, it was found that that 69% of the notes were returned to the banks from circulation by the end of November; 87% of notes were returned by December 15; and 97% of notes were returned by the end of December 2016 thus negating the

23.8 billion pieces of bank notes between November 09 to December 31, 2016 into circulation aggregating Rs. 5,540 billion in value [10] (pp. 124). However, the availability of new currency notes varied geographically causing huge hardships to common people and bank staff in service.[11-13] As per 2016-17 annual report of RBI[14], the reason for this geographically and heterogenous distribution was acknowledged to ―the logistical difficulties in supplying banknotes to all currency chests in a short span‖.

(Source: RBI annual report 2016-17, pp. 34, https://rbi.org.in/scripts/AnnualReportPublications.aspx)

However, the liabilities of RBI or target interest rate remain unchanged as can be seen in Figure2.

(Source: RBI annual report 2016-17, https://rbi.org.in/scripts/AnnualReportPublications.aspx)

various gateways of the digital payment and total number of transaction made within the study duration. Results shows a moderate increase in digital payment gateway using cards (credit cards, debit card, ATM, POS etc.) in following month of demonetization. But a significant decrease was evident in the month of November 2019 which can be credited to the paucity of available money with common public. A marginal increase was observed in Retail Electronic Clearing including - Electronic Clearing Service (ECS), National Electronic Funds Transfer (NEFT), Immediate Payment Service (IMPS), National Automated Clearing House (NACH). Also, a moderate increase was noticed Prepaid Payment Instruments (PPIs) including - m-Wallet, PPI Cards, Paper Vouchers. In nutshell, the sum of all modes of digital payments altogether represents trend of immediate fall in digital payment in November 2016 and then got some pace until March 2017. Hereafter, the total digital payment gateway seems almost stationary. The concept of cashless economy in case of India, as per the New Keynesian synthesis[15] which outlines that outcomes should depend only on the interest rate not on actual availability of cash money, might not be applicable. After investigating one of the aim of demonetization, authors studies its ripple effects on the inflation and changes in the gold-prices. Because these two sectors are assumed to be highly affected. Regarding to the price situation, inflation eased to its lowest level in the new consumer price index (CPI) series that came into existence in June 2017.

(Source: RBI 2106-17Annual Report, pp. 26, published 30 Aug 2017 https://www.rbi.org.in/Scripts/AnnualReportMainDisplay.aspx

hence gold-prices was a vivid indicator to measure the post-demonetization volatility in this segment because gold is considered as reserved and emergency resource of money.

(Source: RBI 2016-17Annual Report, pp. 57, published 30 Aug 2017 https://www.rbi.org.in/Scripts/AnnualReportMainDisplay.aspx

A few of earlier studies used descriptive statistics[14,16-18] to dissection the causality of demonetization on Indian economy. Rogoff investigated the societal costs of cash and facilitating illegal activity and tax evasion, and cautioned that huge participation of public is necessary to phase-out of the cash-based economy.[19] Rao et. al. discussed that growth in public expenditure, a fall in aggregate real supplies, wrong mix of anti- inflationary policies, economically impractical controls and black money leading were the key reasons the inflation problem of the Indian economy around 1972-73.[20] Rangarajan and Arif explained the interrelationship between money, output and prices using an econometric model in context to Indian economy and concluded that price effects of an increase in money supply are relatively stronger than output effects.[21] Ghoshal’s finding says that both the demand pull, and cost push factors fueled a cumulative price rise of around 25.7% during 1990-92.[22] In his book Brahmadanda P.R. argued that the inflation is outcome of imbalance between the rate of growth of commodities (essential for production) and the rate of growth in money demonetization, RBI has revised the growth forecast from 7.6% to 7.1% for 2016–17. Asper RBI view there will be short run disruption in the economic activity, but the impact will ―ebb with progressive increase in the circulation of new currency notes and greater usage of non-cash-based payment instruments in the economy‖. However, overall, there is a concern, as mentioned by RBI, to maintain the inflation rate at 5% in Q4 of 2016–17.[24] Kishore and Poornima examined other demonetization attempts occurred in Russia, Zimbabwe, and Australia, and compared them with the pros and cons in Indian situation. The purpose was to do a survey of macroeconomic situation after demonetization. Their comparative findings were - at the outset, one can argue that Australian situation was well managed, Russian situation was dictatorial, and Zimbabwe case was chaotic.[25] Mukherjee and Tripathi discussed the various aspects which triggers an increase in inflation in the Indian economy since 2012 and further discusses the inescapable causes of increase in general price level.[26] Narain and Patnaik studied the purpose, the process and the impact of this mega exercise on service sector through a natural experiment.[27] Mukherjee and Ahuja identified the overall impact of demonetization in the Indian Economy with special reference to price level, i.e., inflation.[28] Kumar et. al. studied the impact of demonetization On Inflation, and Interest Rate in Indian Economy.[29] News report by Tim Worst opined that India's post-demonetization caused the flood of cash being deposited which in turn lowered Interest Rates and Also Inflation. This is an interesting and welcome macroeconomic effect and summarized as - A lower budget deficit, lower interest rates and also lower inflation.[30] For example, the largest public sector bank in India, State Bank of India (SBI) reduced rates on deposits from one year to 455 days to 6.90%, down 15 basis points, while keeping the 7% rate for deposits between 211 days to one year unchanged. Also, the then SBI Chairman Arundhati Bhattacharya said, "All rates will fall," because "The bank has seen huge inflow of deposits but demand for credit has slowed down. Therefore, lending rates too will fall but after a gap." Another news report on 24 November 2016 by Shamika Ravi and Eswar Prasad commented That given the magnitude of black money, and the way business is done in this India, tax evasion is a way of life, and transforming a cash economy into a formal, mobile, electronic payment economy into a modern financial economy will require a lot of moves.[31] Dr. Prasad expressed his view that in the short run, clearly it is not a big positive but a significant negative in many ways. But in the long run, this is going to be good for India. This involves (i) taking government out of the economy where it does not really have a place; and (ii) trying to change the basic incentives that many public servants face,

central bank is worried about inflation” in CNBC on 08 Feb. 2017 by Leslie Shaffer said that Economists may have fretted over how demonetization would hit India‘s economic growth, but the subcontinent‘s central bank is focused more on its old foe, inflation.[32] Another reports read Demonetization impact: Retail inflation hit two-year low in December.[33]

The daily historical stock prices index data (S&P BSE 100) was obtained from the Bombay Stock Exchange (BSE) and NIFTY100 index data was obtained from the National Stock Exchange (NSE) for the duration of 03 October 2016- 29 September 2017. The weekend data was missing in both the stocks. Consumer price index (CPI) monthly data was obtained from the Federal Reserve Bank of St. LOUIS, USA[34] for INDIA. Wherein the year 2015-16 was marked as baser year (Index 2015=100) for estimation of the CPI data. Therefore, author obtained the CPI data for the year 2015-16 and the year 2016-17 and then estimated the Inflation (in percentage). The traded value of Bullion GOLD price historical data (Rupees in Lakhs) was retrieved from Multi Commodity Exchange (MCX).[35] And the monthly price (in INR) of 10 grams Gold was obtained from the RBI source.[36] Finally, monthly data of various digital payment gateways was procured from the RBI database as well.[36] In addition to that, the RBI annual report for the year 2016-17 was studied to derive a conclusion on the cross-sectional effects of the demonetization. Some of the graphs were also taken from the aforesaid annual reports (reference were cited properly wherever required). The study was carried out with the help of simple data analysis, without using any economic model, and findings were derived and discussed in this paper

Sensex was the first cross-sectional metric to identify the India‘s demonetization policy shock because it reflects the overall economic health status of any country on account of any significant dynamic change occurring both at national and International level, which is well understood and synchronizes with real-world entrepreneurial theory. Figure 5 shows the BSE100 and NIFTY100 stock-market index variation.

The daily closing share-price value of BSE100 and NIFTY 100 overlaps well on each other. The logic of presenting two stock-market index here is to show the index-return (right column), it is very much evident the volatility clustering around the month of November 2016. In other words, the market index is the direct reflection of shock of any significant policy change or sudden event happening at national level. Out of several objectives of the India‘s 08 November 2016 demonetization policy, transitioning to digital payment was one of them. To explore the influence on various digital payment gateways, we analyzed the data which is shown in Figure 6. It is clear from the figure that Prepaid Payment Instruments including - m-Wallet, PPI Cards, Paper Vouchers; and finally, Mobile Banking; Retail Electronic Clearing including - Electronic Clearing Service (ECS), National Electronic Funds Transfer (NEFT), Immediate Payment Service (IMPS), National Automated Clearing House (NACH) and payment through Cards including - Credit Cards, Debit Cards have experienced moderate rise after the demonetization.

To study the causality of the demonstration policy, authors have chosen the inflation and gold-price because of these two commodities were deemed to be highly affected aftermath the policy came into force. The effect on inflation is reasoned because, in the shortage of new currency notes was experienced demographically. However, as can be seen from Figure 7 below that inflation rate keep on decreasing from October 2016 onwards which reached to its negative peak in the month of January 2017. The inflation trough around January 2017 is credited to the implication of the demonization policy.

Another causality was studied on the precious metal Gold prices. Till today, gold is considered the ‗safe haven‘ in India to meet the demand for any unforeseen emergent situations. The demonetization policy can be regarded as a short-term financial emergency and therefore, trading in gold is highly imminent. With this reason, the total traded value of Bullion gold price data (daily) was obtained from the Multi Commodity Exchange (MCX) database as shown in Figure 8 (left column). The data-tip in Figure 8 (left column) shows the maximum volatility around the demonization and subsequently the traded value of gold-price keep in declining because there was lack of new currency notes and restriction imposed to buy-selling provide the PAN card if buying and selling amount exceed to the Rs. 2 Lakhs to tack the investment of unaccounted money in market which was in the line of objectives of policy implementation. The prices shoot-up in the month of February when there was relatively good amount to new currency notes were back into circulation. The very same trend is evident from 10 grams gold price data (monthly) obtained from the RBI as shown in Figure 8 (right column).

Source: RBI, https://dbie.rbi.org.in/DBIE/dbie.rbi?site=statistics

duration. Similarly, high volatility in gold-prices (INR/10 grams) was evident around the month of December 2016 which keeps on increasing monotonically from January 2017 until May 217. The reason for this increase can be argued that once new currency notes were arrived sufficiently in circulation, the trade in gold might have regained back to the normal business level. The study presents a holistic perspective on the implications of demonstration on most prone areas.

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