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India as a country, experienced a most staggering change in its economic history in the month of November, 2016. The Prime Minister of India, nullified two of the highest denomination currency notes of Rs.500 and Rs. 1000. The decision came like a surprise as the entire country came to staggering halt, trying to cope up with this decision. What later ensued was a great amount of chaos mainly because of the grave dis-balance, the economy of India was left in. By doing away with these two notes, the government of India withdrew, almost 86% of the currency value that was being circulated in the economy. This was done without replacing the bulk, that was withdrawn and it resulted in a huge gap in terms of the value of currency, because after INR 100 notes, the next currency note available was INR 2000.
While the government and the banks tried to ease the situation, they was very less that they could do. Even today, when a considerable amount of time has elapsed, since the decision, there is still some level of discontent in the society. With very few ATMs recalibrated and the fact that, the new 2000 rupee note with slim utility, the Indian economy and finance are bound to be affected. Demonetization is basically a step taken to give the economy, a liquidity shock. While the very time and method of it ended up highlight more downsides, than it was supposed to. The process was definitely not as big a shock as the banking sector disaster of the year, 2007, but it nonetheless affected the economic activities, in the most grave way possible.
The term liquidity crunch or liquidity shock, basically refers to the fact, that people would not be able to make use of a currency of a certain denomination, in this regard the 500 rupee note, which was regularly used in the daily transactions previously. It ought to be highlighted that, this bold move was taken in order to do away with all of the counterfeit currency rackets, which in turn resulted into supporting terrorism and related activities. While the Indian society will be impacted in a lot of ways in terms of finance, with the economic growth of the country, being highly affected. Apart from that various other negative impacts include, the welfare loss of all those sections of the society, that solely depended on liquid cash. There are quite a few chances that the entire economy will feel a lull, in terms of the momentum and the purchasing power of the consumers.
Although it may seem that the banks would benefit, more than any other sector, it may be so but only in the short term. The many old notes that are being deposited in the banks, in order to get new notes, will be doing absolutely nothing in terms of their cash reserve ratio. The banks would only benefit when people would start depositing, the new notes, which would result in improvement of their cash reserve ratio. While it is yet to be seen, how the sector of investment banking is affected, it seems that these and the corporate finance professionals, would be sought after quite a lot in terms of gaining advice with how to put the new money, to proper use.