Macro Shocks and Micro Woes: Short-Term Effects of India's Demonetization on the Poor

Abstract

This study analyses and estimates the impact of demonetisation on the welfare of poor households in the Sundarbans region of India. Using a unique high frequency (weekly) data set collected during the process of demonetisation, we estimate that household welfare is reduced by INR 1,414 (US $ 20.8), equivalent to about 15.6% of income over the two months post demonetisation. Short-term welfare reductions happen through increased unemployment, losses to income and savings, and the opportunity costs of exchange. Our analysis shows that immediately after demonetisation, households adopted a range of strategies to rid themselves of unwanted currency notes, including increased consumption-related purchases, a reduction in borrowing and increased instances of loans. We find evidence that consumption levels and borrowing fall continuously, but consumption expenditures remain stubbornly high two months after the shock. Local income and remittances are affected heterogeneously by the shock, with households experiencing unemployment and female-headed households losing out more. The results shed light on how low income households use the limited tools at their disposal to deal with shocks, as well as the need to carefully consider how national monetary policy, however well intentioned, may adversely affect the welfare of vulnerable households. Our findings have important policy implications not only in the context of India but for governments in other developing countries thinking of adopting similar policies.