Effect of Demonetization on Financial Inclusion in India

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EFFECT OF DEMONETIZATION ON FINANCIAL
INCLUSION IN INDIA
Parul Mahajan1, Anju Singla2
1 Research Scholar, 2Assistant Professor, Centre for Management and Humanities (CMH),
PEC University of Technology, Chandigarh (India)
ABSTRACT
Financial inclusion has come up as a key measure for achieving inclusive growth. The government of India has
taken up several measures for financial inclusion. Although the degree of financial inclusion has improved still
India has a long way to go to become digitally financially included. Indian government adopted demonetization
in November 2016 to tackle with black money and make India a cashless digital economy. With the
implementation of demonetization and considering the country’s agenda to improve financial inclusion, this
paper makes an attempt to study the effect of demonetization on financial inclusion. The effect of demonetization
has been studied on various participants of financial inclusion drive such as ordinary individuals, informal
sector, rural population, MSMEs, NBFC MFIs and E-wallet companies. The findings of the study reveal that
ordinary individuals were the most adversely affected. The new type of deposits called benami deposits have
also come up with demonetization. With the aim of achieving financial inclusion along with making India a
cashless and digital economy, efforts are required to make technology reach the bottom of the pyramid.
Keywords: Cashless Economy, Demonetization, Digital Economy, Financial Inclusion.
1. INTRODUCTION
The concept of inclusive growth has gained a lot of momentum in India. It means that all sections of society
contribute to benefit from economic growth of the country. Financial inclusion has come up as a key measure
for achieving inclusive growth. Financial inclusion is defined as “the process of ensuring access to appropriate
financial products and services needed by all sections of the society in general and vulnerable groups such as
weaker sections and low income groups in particular, at an affordable cost in a fair and transparent manner by
regulated mainstream institutional players” [1]. It aims to take banking services to the doorstep of everyone to
meet their entire savings, credit and remittance needs initially, and needs for all other financial products and
services subsequently [2]. When the poorest of the poor have access to credit and savings facilities, this
translates to their financial security. They can grow larger businesses, manage consumption and household
expenses better and plan for shocks. The standard of living improves and poverty falls, allowing people to
contribute more to the economy as well [3].

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2. FINANCIAL INCLUSION IN INDIA
The government of India has taken various measures for financial inclusion. The proportion of adult population
with a bank account has increased to 65 percent with the financial inclusion reforms in India over the last 5
years. However, a substantial 23 percent of those accounts remain dormant, indicating that it will take a lot more
than just opening formal bank accounts for the financially excluded to be truly included [4]. Table 1 shows the
degree of financial inclusion in India in comparison to other emerging and advanced economies of the world.
Table 1: Degree of Financial Inclusion (in 2014)
Indicators of Financial Inclusion
Advanced Economies
Emerging Economies
India
Account at a financial institution (% age 15+)
95.85
67.88
52.75
Commercial bank branches
(per 100,000 adults)
33.57
19.41
11.38
Automated teller machines
(per 100,000 adults)
136.45
86.38
11.21
Debit card (% age 15+)
84.50
49.48
22.07
Source: cited in [5]
The above table reveals that as on 2014, 96 percent of the population above 15 years of age holds account at a
financial institution in advanced economies while only 53 percent of the same age group have an account at a
financial institution in India. It was also found that the number of commercial bank branches catering per
100,000 population in advanced economies is 3 times higher than in India whereas the number of ATMs
available to per 100,000 population is more than 11 times higher in advanced economies and 8 times higher in
other emerging economies than in India. While 22 percent of the population above age 15 holds debit card in
India, the corresponding number for emerging economies and advanced economies are 49 percent and 84
percent respectively.
Keeping this in view, government launched a financial inclusion scheme called Pradhan Mantri Jan Dhan
Yojana on 28 August 28 2014. The purpose of the scheme was to open zero balance saving account for every
unbanked Indian household, providing access to financial literacy, credit and pension. Under this scheme, as on
28 October 2015, 19.02 crore accounts have been opened, out of which 11.58 crore accounts are in rural areas
and 7.44 crore in urban areas [5]. With this scheme, the bank account penetration increased from 35 percent to
53 percent during last three years, however, 74 percent of these new accounts remained non-operational with
zero balances [6].
With the introduction of digital financial services i.e. access to financial services through numerous electronic
platforms, the concept of digital financial inclusion has also gained a lot of importance in recent years. People
who are digitally financially included transact digitally using debit/credit cards, point of sale (POS) machines,
online banking, and mobile financial services. As per the latest Financial Inclusion Insights survey, 49
percent of Indian adults are digitally included. However, usage of these digital accounts remains debatable [4].

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3. DEMONETIZATION IN INDIA
Indian currencies with denomination 500 and 1000 have ceased to be the medium of exchange from the
midnight of 8th November 2016. This demonetisation move is implemented as a tool to measure the stock of
black money hoarded in these high denomination currencies, and to curb terrorist activities in the country. The
government aims to bring the unaccounted money back to the formal banking sector by allowing limited
exchange and unlimited deposit of old notes in bank accounts till the end of 2016 [5]. However, the biggest
problem is that the distinction between unaccounted cash and black money is lost. Money that is derived from
illegal activity is harmful, but money circulated in small businesses only adds to economic activity. Indian
economy is heavily dependent on cash. Inadequacy of bank branches is one primary reason why cash dominates
especially among small businesses. Every bank branch in a rural and semi-urban centre caters to more than
double the number of people in an urban and metropolitan centre. According to December 2015 Reserve Bank
of India Report, each rural and semi-urban bank branch serves 12,863 people compared with an urban and
metropolitan branch which serves just 5,351 people. There were 7.8 branches for one lakh people in rural India,
but 18.7 branches in urban India. The spread of ATMs too is skewed in favour of urban centres [7].
4. NEED AND OBJECTIVE OF THE STUDY
With the recent implementation of demonetization and considering the country‟s agenda to improve financial
inclusion, it becomes imperative to study the effect demonetization on the financial inclusion drive of the
county. Therefore, the broad objective of the study is to examine the effect of demonetization on financial
inclusion.
5. EFFECTS OF DEMONETIZATION ON FINANCIAL INCLUSION IN INDIA
The demonetization has created a tremendous impetus toward greater financial inclusion. It has operationalized
the Jan-Dhan bank accounts, with around 210 billion rupees ($3 billion) in deposits [6]. However, it brought in a
new concept called Benami Deposits. The Jan Dhan bank accounts opened for the poorest of poor are now
swelling with cash since demonetization. This implies that these accounts have become holders of somebody‟s
account i.e. the poor have been used by those with hordes of unaccounted for money to park their funds [8]. In
detail, the effect of demonetization on the process of financial inclusion has been studied on various sections of
the society which are the participants in the financial inclusion drive.
5.1 ORDINARY INDIVIDUAL
The common man has had to bear the economic hardship as 90 percent of all transactions are paid in cash [6].
Millions of people are crowding the banks and queuing outside ATM centers to deposit their cash, revealing that
India has a long way to go before it fully transitions into a digital financial economy. In spite of expanded digital
access to bank accounts, a very small percentage of the population has been able to operate without withdrawing
cash or visiting the bank regularly. This is due to lower level of digital financial literacy [4].
5.2 INFORMAL ECONOMIC SECTOR
India‟s massive informal economic sector comprising of domestic help, contract labourers, daily wage workers,
farmers, fishermen, micro-entrepreneurs etc. runs almost entirely on cash. These groups of people typically do

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not have a formal bank account. Cash is their only means of receiving income and making payments. The
demonetization has led to a situation of cash crunch in the economy which has created a huge disruption on
work and daily lives of these people with severe adverse impacts on their livelihoods and well-being [4]. The
small service providers like auto-rikshaws, road-side eateries, local kirana stores etc. are being abandoned for
cab aggregators, online food home delivery, online grocery respectively. These informal services providers
although being very large in numbers, are not part of the digital economy and are losing business. The
demonetization has led them to compromise on their work and stand in long queues outside banks for their own
hard-earned cash. However, through demonetization, the wealth produced and saved by the poor can be brought
into the formal banking system [3]. The „dead capital‟ which was not available in the formal economy is now
being turned into „live capital‟.
5.3 RURAL POPULATION
The effects of demonetization have been even more worrying in the rural parts of the country which are
even more dominated by cash and which have limited physical accessibility to banks and other financial
institutions. Visiting physical bank branches in rural areas still remains a time consuming and costly
exercise for many. Other digital financial services like ATMs and POS machines at shops are limited in
number and crippled with infrastructural issues. Ordinary rural residents are placed in great stress with
nowhere to go [4].
5.4 RURAL MSMES
The data on MSMEs, as per the latest available Fourth Census of MSME, 2006-07, reveal that there are
200.18 lakh unregistered rural sector units, and they make up over 55 per cent of such enterprises in India
while urban MSMEs are 161.58 lakh. The bulk of the MSMEs in India have turnover in just a few lakhs of
rupees [7] and maximum of MSMEs are dominated by the micro enterprises. Majority of their transactions
are on cash. With uneven spread of bank branches and ATMs among rural and urban regions, the micro and
small enterprises operating in rural areas are adversely affected. The demonetization made impossible for
them to get cash in lower denominations for their daily operations.
5.5 NBFC MFIS AND THEIR CUSTOMERS
There are a large number of micro financing institutions (MFIs) in India, catering to the financing needs of
rural and semi-urban Indian population. Customers, typically individuals (women, daily wage workers,
farmers), small traders and retailers, mainly operate on a cash basis due to informal and trifling nature of the
amounts involved in such transactions. Loan instalments from some such customers are usually collected on
a weekly and sometimes on daily basis. Demonetization has halted, albeit temporarily, business transactions
of these individuals which are now running on a daily credit basis, and more importantly has led to a
domino effect on employees/daily wage workers and other customers of non-banking financial companies-
micro financial institutions (NBFC-MFIs) whose livelihood is based on cash payments. Such customers do
not have bank accounts and/or sufficient means to either exchange currency in their possession into notes of
acceptable denomination, or make a transition to cashless means of finance. This is adversely affecting their
daily businesses/lives which in turn is affecting the timely repayment of loans taken by them from NBFC-
MFIs. These loan defaults have lead to temporary increase in non-performing assets of NBFC-MFIs which
generally rely on borrowing from banks for further lending. The adverse affect on the overall asset quality

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of NBFC-MFIs will eventually trickle down to banks and other financial institutions and may subsequently,
affect the Indian economy as a whole [9].
5.6 E-WALLET COMPANIES
The demonetization promotes cash-less economy and increase in use of digital financial services. The e-
wallet companies have seen a rapid surge in the number of transactions and traffic on their web and app-
based platforms which are mostly driven by urban and metropolitan parts of the country [4].
6. CONCLUSION
RBI statistics shows that 80 percent of monetary circulation in India consisted of Rs. 500 and Rs. 1000 notes
[3]. This demonetization is putting more than 80 percent of the country‟s monetary economy under suspicion of
black money. This creates confusion between „unaccounted money‟ and „black money‟. The government‟s
move towards demonetization aims to convert black money into white money but inclusive growth can be
achieved only if this money is used for development purposes. However, the government is withdrawing
subsidies, and reducing expenditure on development sectors. The development contemplated is in the sense of
smart cities and cashless economy. But for India to be a cashless and digital economy, sufficient time and efforts
are required. The process cannot be completed over night or fortnight or within months.
This demonetization is much different from the 1978 demonetization which never really affected ordinary
people. The 1978 demonetization covered notes of Rs 500 and Rs 1000 and those denominations were hardly
used by the common man. The hundred rupee note was what most people used [3]. However, in comparison to
present scenario, the effect has been largely upon the ordinary man than on the ones who are the main
contributors to the black money. With the aim of achieving financial inclusion along with making India a cash-
less and digital economy, efforts are required to make technology reach the bottom of the pyramid. For this
purpose, the young generation should be leveraged upon to educate and support the poor, rural and elderly with
digital literacy and transactions.
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