India’s central bank has announced that the country will be phasing out its highest denomination currency note, the 2000-rupee note. Although the note will still be considered legal tender, citizens have been advised to deposit or exchange these notes by September 30, 2023. This decision to scrap the Rs 2000 note will affect India’s economy.
The recent decision to withdraw the Rs 2000 note from circulation in India has drawn comparisons to a previous significant move in 2016. At that time, under Prime Minister Narendra Modi’s leadership, the government suddenly decided to withdraw 86% of the currency in circulation overnight. This move had a substantial impact on the Indian economy.
Analysts and experts believe that the current decision to withdraw the Rs 2000 note will have less impact than the previous move in 2016. This time, a lower denomination note is being phased out gradually over a longer period. This approach is expected to result in a smoother transition and minimise potential disruptions to the Indian economy.
Why the decision to withdraw 2000 rupee notes?
The government decided to withdraw the 2000-rupee notes for a couple of reasons. Firstly, when these notes were introduced in 2016, their primary purpose was quickly to replenish the currency in circulation after the demonetisation process. However, over the past four years, the central bank has expressed its intention to reduce the number of high-value notes in circulation, and it has already ceased printing the 2000-rupee notes.
Furthermore, the Reserve Bank of India (RBI) has stated that the 2000-rupee denomination is not commonly used for everyday transactions. Considering this, withdrawing these notes aligns with streamlining the currency system and promoting the usage of more widely used denominations.
Why at this time?
The decision to withdraw the 2000-rupee notes, although the government and the RBI did not specify the timing, is believed by analysts to be related to the upcoming state and general elections. Cash usage typically increases during election periods, and withdrawing high-value notes may aim to prevent the misuse of cash and promote transparency in transactions.
Rupa Rege Nitsure, the Group Chief Economist at L&T Finance Holdings, commented that withdrawing the 2000-rupee notes before the general elections is a wise move. She acknowledged that individuals using these notes as a store of value might experience inconvenience due to the withdrawal.
Will this impact economic growth?
The value of 2000-rupee notes in circulation is Rs 3.62 lakh crore ($44.27 billion). This is about 10.8% of the currency in circulation.
According to Rupa Rege Nitsure, withdrawing the 2000-rupee notes is not expected to cause significant disruption since smaller denomination notes are readily available in sufficient quantities. She also highlighted the substantial growth of digital transactions and e-commerce over the past 6-7 years, suggesting that these alternative payment methods can help mitigate any inconvenience caused by the withdrawal of the higher denomination notes.
Yuvika Singhal, Economist at QuantEco Research, noted that small businesses and cash-dependent sectors like agriculture and construction might face inconvenience in the short term due to the withdrawal of the 2000-rupee notes.
Singhal mentioned that if individuals holding the 2000-rupee notes opt to use them for purchases instead of depositing them in bank accounts, discretionary spending may rise, particularly in areas like gold purchases.
How will the banks be affected?
Due to the government’s directive to deposit or exchange the 2000-rupee notes for smaller denominations by September 30, bank deposits are expected to increase. This increase in deposits is occurring at a time when deposit growth is trailing behind bank credit growth.
Karthik Srinivasan, the Group Head of Financial Sector Ratings at ICRA Ltd, expressed that the increased deposits resulting from withdrawing 2000-rupee notes will alleviate the pressure on deposit rate hikes.
Madhavi Arora, an Economist at Emkay Global Financial Services, stated that cash circulation would decrease with all the 2000-rupee notes being returned to the banking system. This reduction in cash circulation is expected to enhance liquidity within the banking system.
What are the implications for bond markets?
Srinivasan highlighted that the enhanced liquidity in the banking system and the influx of deposits could lead to a decrease in short-term interest rates. As these funds are invested in shorter-term government securities, it can have a downward impact on the interest rates in the market.
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