De Monetization & Inflation - II

It has been one week since my last post, Demonetization has gone to next phase where 2000 notes are now available from ATMs (Metros cities at least) and lines have started reducing in certain places - saw Bhopal in one of the news channel yesterday.

News of blacks money caught in various states are coming everyday and experts are commenting that there could be 2 Lakh crore rupees which may not come to market at all, leading to substantial reduction in M0 and then M3. Inflation is definitely going to come down and there are other changes that we may soon start to notice -

• Pick up in Non Cash Transactions - E-Wallet/Debit/Credit/On line payments will see jump and more business.
• Banks will have more cash which will lead to reduction in interest rates/deposit rates.
• Reduced inflation will also make good case for reduction in interest rates.
• Credit off take will pick up since Banks have to lend to make up for the increased cost by way of interest that they have to pay on deposits.
• Tax compliance shall improve as people will fear further such moves by Govt. Increased tax collection may reduce  tax rates and will also improve overall balance sheet of Govt.

One major disadvantage will be impact on business for next 2 months or so since there will be liquidity crunch in the market however there are lot of business who have started accepting Online/E-Wallet Payments.

De Monetization & Inflation

Recent move by GOI on 500 and 1000 notes, how is it going to impact the inflation?

Before we go on to understand the impact of above, let us first go through money supply

Money Supply equation gets defined by MV = PT where

M Money supply
V velocity of money
P Price of Goods
T Transactions

As established by many researchers,money supply has direct relation with Price of goods hence inflation.

In Indian context, money supply is defined as total circulation of notes and time/savings deposit in the banking system, Number for Oct28,2016 is INR 124 Lakh Crore - https://www.rbi.org.in/scripts/BS_PressReleaseDisplay.aspx?prid=38538

Total Currency is 17 Lakh Crore and Deposits are close to 107 Lakh crore, making the overall money supply in the market to be 124Lakh Crore. With cash reserve ratio of 4% - total currency of 17 Lakh Crore can in fact create money supply of 1000 Lakh crore but SLR keeps this in check.

Now if GOI reduces the currency notes in circulation, i don't think this will have much impact until unless they reduce the amount by big margin and don't change SLR & CRR.

We will need to wait until RBI publishes the next data !!