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  • Nidhi Dutia


Updated: Feb 13

Nidhi Dutia,

Bharati Vidyapeeth, New Law College



In 2016, the Indian government made a significant decision called demonetization to clean up the economy and promote digitization. This was the third such move, with the first two in 1946 and 1978.[i] The decision involved invalidating high-value currency notes of Rs. 1000 and Rs. 500, which made up 86.9% of the total currency in circulation.

[ii] The Prime Minister announced this to curb black money, corruption, terror funding, and expand tax collections.

The reasoning behind demonetization was to address the large and unsustainable amount of currency in circulation, mainly used in real estate and luxury transactions. The government hoped that a substantial portion of the demonetized money wouldn't return to the banking system, reducing the Reserve Bank of India's liability. People had until December 31, 2016, to deposit these notes in their bank accounts. 

Simultaneously, the government introduced a new Income Disclosure Scheme, IDS-II, or Pradhan Mantri Garib Kalyan Yojana. The purpose was to provide those with undisclosed income another chance to declare it, albeit with a higher tax rate of 50%, including a 30% tax, a 33% Pradhan Mantri Garib Kalyan cess, and a 10% penalty.[iii] If people didn't disclose their black income, they faced a higher penalty of 75% and potential prosecution later. The government emphasized that depositing money in a bank account doesn't turn black money into white; individuals must declare the sources and pay taxes on unexplained income.


The government's move to demonetize high-denomination currency notes in 2016 aimed at achieving three major objectives: 

1.  Combatting Fake Currency:

Problem: A significant circulation of fake currency notes, particularly in higher denominations, posed challenges in distinguishing between genuine and counterfeit money. Objective: Eliminate fake currency to mitigate its adverse impact on the economy.

2.  Curbing Black Money:

Problem: High-value bank notes were being used to hoard unaccounted wealth, leading to unearthing instances of large cash recoveries by enforcement agencies.

Objective: Eliminate the storage of unaccounted wealth by rendering high-denomination notes obsolete.

3.  Addressing National Security Concerns:

Problem: Fake currency was being utilized to fund subversive activities such as drug trafficking and terrorism, posing threats to both the economy and national security.

Objective: Control subversive activities by eliminating the use of fake currency for illegal and harmful purposes.


The immediate aftermath of demonetization has ushered in a wave of changes for Medium and Small Enterprises (MSMEs), both in the services and manufacturing sectors. 

1.  Services Sector Stability:

(a) Continued Operations: The services sector within MSMEs appears relatively stable immediately after demonetization. With a significant reduction in cash transactions over the years, the impact on day-to-day operations has been minimal.

(b)  Adaptation to Digital Modes: Departments such as ESI, PF, income tax payments, and others swiftly adapted to the new payment norms, relying on checks, demand drafts, or net banking. This quick transition has ensured continuity in services without significant disruptions.

2.  Manufacturing Sector Challenges:

Temporary Disruptions: Entities within the manufacturing sector, particularly those dependent on cash transactions, have faced immediate disruptions. Weekly labor wage payments and challenges in product demand have posed short-term hurdles for certain MSMEs.

Shift towards Cashless Operations: Despite these challenges, experts highlight a gradual shift towards a cashless system. Manufacturing units with financial discipline and a commitment to electronic transactions are better positioned to weather the immediate storm. 


Demonetization caused a shortage of cash, leading to chaos. People had a hard time depositing or exchanging old banknotes due to long lines at banks and ATMs throughout India. The ATMs remained short of cash for several months after the demonetization.

During this period, police and tax officials seized ₹6.1 billion in unaccounted money, including ₹1.1 billion in new banknotes.[iv] While the public struggled with a severe cash shortage, some individuals managed to accumulate large sums in new banknotes. This led to criticism, with many considering the demonetization effort futile.[v]

In terms of MSMEs, the sudden demonetization significantly affected their cash flow and day-today operations. The shortage of cash made it challenging for these businesses to carry out regular transactions, pay their employees, and manage their operations smoothly.



Demonetization played a significant role in promoting digital transactions and encouraging people to adopt cashless methods of payment. Although the transition to digitalization faced obstacles, newer technology platforms like Paytm, RuPay, and Bhim app have contributed to overcoming these challenges. The demonetization initiative has effectively nudged society towards a cashless future.

Encouraging digital payments was a stated objective of demonetization. The cash shortage in November–December 2016 led to an immediate surge in digital payments. Debit card transactions doubled, exceeding pre-demonetization trends. While credit card transactions increased, the growth was not as pronounced. Mobile wallet transactions experienced a surge post-demonetization, with a temporary dip in mid-2017 due to easing cash shortages. However, there was a sharp rise again, doubling the volume of digital payments by April 2018.

The currency-to-GDP ratio was 12.1% in 2015–16, declining to 8.8% in 2016–17 post demonetization. Despite a marginal increase to 10.9% in 2017–18, the ratio remained lower compared to levels before demonetization.[vi] This indicates a sustained impact on the economy's reliance on physical currency, aligning with the push towards digital transactions.


The government aimed to transition towards a cashless economy and encourage a digital payment culture. On December 15, 2016, it introduced two schemes, Lucky Grahak Yojana and Digi-Dhan Vyapar Yojana, offering cash awards to consumers and merchants utilizing digital payment instruments for personal expenses.[vii] At that time, approximately 95% of personal consumption expenditure transactions in India were cash-based, contributing to a large informal economy and limiting tax collection capabilities.

Since the announcement, there has been a noticeable surge in digital transactions. Ru-Pay card transactions increased from 3.85 lakh on November 8, 2016, to 16 lakh on December 7, 2016. Ewallet transactions rose from 17 lakhs to 63 lakhs, UPI transactions increased from 3721 to 48238, USSD transactions rose from 97 to 1263, and PoS transactions increased from 50.2 lakh to 98.1 lakh.[viii]

Recognizing the significance of the digital economy, it became a central theme for Budget 2017, aiming to establish speed, accountability, and transparency in the system. As part of the plan to expand the digital payments ecosystem and encourage cashless transactions, the government decided to install an additional one million new post terminals by March 31, 2017.

To further facilitate the move towards a cashless economy, the Ministry of Labour & Employment, along with the States’ Administration, organized 2,73,919 camps to open 24.54 lakh bank accounts for unorganized workers.[ix]These initiatives were geared towards promoting financial inclusion and ensuring a smoother transition to a digitalized payment system.



(i)     Short to Medium-Term Impact on MSMEs:

(a)    Working Capital Challenges: MSMEs faced working capital challenges as delayed payments from customers and disruptions in the supply chain affected cash flows. (b) Adaptation to Regulatory Changes: Businesses had to adapt to the changing regulatory landscape, including compliance with the new GST framework.

(ii)   Long-Term Structural Changes:

(a)    Formalization of Economy: Demonetization contributed to the formalization of the economy by bringing more transactions into the formal sector. This had implications for tax compliance and transparency.

(b)   Technology Adoption: MSMEs that invested in technology and digitization saw improved efficiency and competitiveness. E-commerce platforms gained prominence as a channel for reaching a wider customer base.

(iii)Resilience and Innovation:

(aBusiness Model Innovation: MSMEs that innovated their business models and adapted to changing market dynamics demonstrated resilience. Those who that explored new avenues such as e-commerce or diversified their product offerings fared better.

(b)Skill Development: Upskilling the workforce became crucial to meet the demands of a more technology-driven and competitive environment.

(iv) Overall Economic Recovery:

(i)GDP Growth: While there was a temporary dip in GDP growth immediately post demonetization, the economy showed resilience and gradually recovered in subsequent quarters.

(ii)Structural Reforms: The demonetization move was part of a broader agenda for structural reforms. These reforms aimed at curbing corruption, promoting transparency, and fostering a more formalized and digitized economy.


Demonetization in 2016 had a profound impact on MSMEs, triggering both challenges and opportunities. The move aimed to combat fake currency, curb black money, and address national security concerns. The immediate aftermath brought about disruptions in the manufacturing sector, while the services sector showed more stability with a swift transition to digital modes.

Cash flow disruptions were evident, causing challenges for MSMEs in their day-to-day operations. However, the move towards digital transactions gained momentum, with various platforms contributing to a cashless future. The government introduced schemes and initiatives to support MSMEs in adapting to this transition.

Demonetization contributed to the formalization of the economy by bringing more transactions into the formal sector, influencing tax compliance and transparency. The structural changes included technology adoption, business model innovation, and a focus on skill development.

In the short to medium term, MSMEs faced working capital challenges and had to adapt to regulatory changes, particularly with the implementation of the Goods and Services Tax (GST). However, in the long term, businesses that invested in technology and innovation demonstrated resilience and competitiveness. 

Overall economic recovery, including GDP growth, showed resilience after a temporary dip, and structural reforms aimed at curbing corruption and promoting transparency were part of the broader agenda. In essence, demonetization acted as a catalyst for significant changes in the MSME landscape, prompting adaptation, innovation, and a shift towards a more formalized and digitized economy.


[i]Demonetisation: Three times India faced the big move, The Indian Express (Nov. 18, 2016),

[ii]Manish, Sai (9 November 2016), 86% of currency by value in India are of Rs 500 & Rs 1,000 denominations,

[iii]ET Bureau, Government announces new income declaration scheme 'PM Garib Kalyan Yojana'; stringent penalties prescribed, The Economic Times (Dec. 17, 2016),

[iv]Times Of India, 17% Of Cash Seized In Raids During Demonetisation Were In New Notes, Times of India (July 9, 2017),

[vi]How Successful was Demonetisation? Four Takeaways From the RBI’s Annual Report,

[vii]Times Of India, Govt to launch Lucky Grahak and Digi-Dhan Vyapar Yojana, Times of India (Dec. 23, 2016),

[viii]Times Of India, 400-1000% Increase In Digital Transactions After Demonetisation, Says Government, Times of

[ix]Digital and Cashless Economy : A New Way of Life after demonetization,

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