By Lal Singh Governments sometimes take strong monetary steps to deal with deep economic problems. One such step is demonetisation. It is a bold policy move that directly affects money in circulation, daily transactions, businesses, and the overall economy.
Demonetisation became a widely discussed topic in India when high-value currency notes were withdrawn from circulation. The move aimed to tackle issues like black money, fake currency, and corruption. While demonetisation had some clear objectives and benefits, it also created serious short-term challenges.
To understand it properly, let’s look at the advantages and disadvantages of demonetisation.
What Is Demonetisation?
Demonetisation is the process by which a government withdraws the legal tender status of certain currency notes. These notes can no longer be used for transactions and must be exchanged or deposited in banks within a specified time.
The policy is usually implemented by the government in coordination with the central bank, such as the Reserve Bank of India in the Indian context.
Advantages of Demonetisation
1. Control of Black Money
One of the main objectives of demonetisation is to curb black money.
- Unaccounted cash holdings become difficult to use
- People are forced to disclose or deposit money
- Hidden cash outside the banking system reduces
This increases financial transparency.
2. Reduction in Fake Currency
Demonetisation helps eliminate fake notes.
- Old counterfeit currency becomes invalid
- Criminal and anti-national activities lose funding support
This improves national security.
3. Boost to Digital Payments
Cash shortage pushes people toward digital modes.
- Increase in UPI, card, and mobile payments
- More people enter the formal banking system
This accelerates the shift toward a cash-lite economy.
4. Increase in Tax Compliance
More money enters the banking system.
- Deposits are tracked
- Tax evasion becomes harder
- Tax base expands
This improves government revenue in the long run.
5. Encourages Formalisation of the Economy
Demonetisation pushes informal businesses to formal channels.
- More bank accounts are used
- Business transactions become recorded
- Transparency improves
A formal economy is easier to regulate.
6. Temporary Control on Inflation
In the short term, reduced cash availability:
- Lowers demand
- Slows price rise
This can help control inflation temporarily.
7. Strengthens Banking System Liquidity
Large deposits increase bank funds.
- Banks get more money to lend
- Interest rates may soften
This supports credit growth over time.
8. Psychological Impact on Hoarders
Fear of sudden policy actions:
- Discourages cash hoarding
- Promotes lawful financial behavior
This has a long-term deterrent effect.
Disadvantages of Demonetisation
Despite its aims, demonetisation has serious drawbacks.
1. Cash Shortage and Public Hardship
The biggest impact is immediate cash crunch.
- Long queues at banks and ATMs
- Daily wage earners suffer most
- Rural and informal sectors are badly hit
This causes social and economic stress.
2. Negative Impact on Small Businesses
Cash-dependent sectors face disruption.
- Sales drop sharply
- Small traders and vendors struggle
- Informal employment declines
Recovery takes time.
3. Slowdown in Economic Growth
Reduced consumption affects production.
- Demand falls
- Businesses cut output
- GDP growth may slow temporarily
This impacts overall economic momentum.
4. Job Losses in Informal Sector
Many workers are paid in cash.
- Employment opportunities reduce
- Migrant workers suffer income loss
The informal sector bears the biggest burden.
5. Limited Long-Term Impact on Black Money
Most black money is not held in cash.
- It exists in assets like real estate or gold
- Cash demonetisation affects only a small portion
This limits long-term effectiveness.
6. High Implementation Cost
Demonetisation is expensive.
- Printing new currency
- Managing logistics and security
- Administrative burden on banks
These costs are borne by the economy.
7. Disruption to Rural Economy
Rural areas depend heavily on cash.
- Limited digital infrastructure
- Banking access is weaker
This creates inequality in impact.
8. Loss of Trust and Uncertainty
Sudden policy decisions can create fear.
- People worry about future currency stability
- Confidence in cash savings may reduce
Policy uncertainty affects behavior.
When Demonetisation Can Be Effective
Demonetisation works better when:
- Supported by strong digital infrastructure
- Followed by strict tax enforcement
- Implemented with adequate planning
- Focused on long-term reforms
Without follow-up actions, benefits remain limited.
Final Thoughts
Demonetisation is a powerful but disruptive economic tool. Its main strengths lie in promoting transparency, pushing digital payments, reducing fake currency, and increasing tax compliance. In the long run, it can support formalisation of the economy.
However, demonetisation also brings significant short-term pain. Cash shortages, economic slowdown, job losses, and hardship for small businesses and informal workers are serious concerns. Its impact on black money is also limited if not backed by structural reforms.
The real lesson from demonetisation is balance. Such a step should be used rarely, planned carefully, and supported by strong institutions and digital systems. When combined with broader economic reforms, it can contribute to long-term improvement—but by itself, it is not a complete solution.