Rs 2,000 notes withdrawal: Why RBI's move can cause ripples in some sectors of the economy

Killing by hanging or injecting a lethal dose has the same effect!”

A former senior official of the Reserve Bank of India provided the insightful analogy in a LinkedIn post. This aptly describes the future of the Rs 2,000 notes. RBI recently set in motion a policy to completely take out these currency notes from the system. “They were issued as a stop-gap measure,” says Vimal Kumar, Associate Professor at IIT Kanpur, who has written research papers on black money. In fact, the signs of the impending decision were visible much earlier. For instance, their numbers had started falling within two years of their introduction.

Per RBI’s annual report, the number of Rs 2,000 notes fell from 3.36 billion pieces in March 2018 to 1.81 billion pieces in March 2023. (See box). In value terms too, it has almost halved from Rs 6.51 lakh crore to Rs 3.62 lakh crore in six years. “This approach represents a well-structured method of implementing such a measure while minimising disruptions to both the general public and the industry,” says a private banker on condition of anonymity.

The numbers in the RBI annual report also indicate their gradual disappearance from the banking system, with ATMs rarely dispensing them, and even banks struggling to acquire them. “This denomination did not have major use cases. Though unusual uses, such as in stacking unaccounted cash, cannot be denied,” says Manas Paul, Professor of Economics, Environment and Policy at IMT, Ghaziabad.

But why were such high denomination notes issued in the first place? It was a critical requirement when Rs 500 and Rs 1,000 notes were demonetised in November 2016 as they constituted almost 86 per cent of the currency in circulation at that time. And RBI’s capacity to print new currency notes was limited. Although not a natural choice, the Rs 2,000 notes helped push more liquidity into the system. Per RBI, when the market had sufficient new Rs 500 notes, the liquidity objective was achieved.

Vimal Nadar, Head of Research at real estate services firm Colliers India, says that recalling the Rs 2,000 notes “will have an impact on high-value real estate transactions.” It will also impact sectors like gems & jewellery, MSMEs, the movie business, agriculture, and other informal sectors. But will it stop the generation of black money? “Black money cannot be stopped or managed by changing denominations. There are ways to shift into other denominations or forms of assets. It was proved in 2016,” says Paul. The hoarding of currency will now shift to Rs 500 notes, suggest many experts.

The RBI had presumably been waiting for the proper level of Rs 2,000 notes in the economy before announcing the current recall. The Rs 3.62 lakh crore present in the economy today constitutes only 10.8 per cent of the notes in circulation as on March 31, 2023. “They must have targeted 10 per cent as the most suitable level to decide to withdraw the currency,” says an expert. People are unlikely to experience any significant inconvenience as the notes represent only a small fraction of the currency used in day-to-day transactions.

Second, the Unified Payments Interface (UPI) has witnessed substantial growth over the past six years, with almost one-fifth of total retail payments happening through the platform. One of the objectives of issuing new notes was to discourage fake and counterfeit notes. But the market soon had fake notes of Rs 2,000 in circulation despite the additional security features. According to RBI’s data, the total number of counterfeit notes were at 17,020, 8,798 and 13,604 notes, in 2019–20, 2020–21, and 2021–22, respectively.

While the RBI’s current move is not like the demonetisation of currency notes announced in 2016, in the sense that Rs 2,000 notes continue to be legal tender, those holding them in large numbers may have to explain their source when they deposit or exchange them.

The RBI in consultation with the government will have to take a call on the future of such notes post the deadline of September 30, 2023 for exchanging or depositing such notes at banks. If a large quantity remains in the system, it may extend the deadline or revoke the legal-tender status of the notes. “We have given a deadline of September, so that the process will be taken seriously. We can’t leave it open-ended,” said RBI Governor Shaktikanta Das at a media briefing on May 22, adding that people should view the move as part of the central bank’s currency management exercise and that the notes had completed their life cycle.

Another aspect of the recent move is whether it will help the banking system and the economy. Although it is not expected to impact economic activity as the previous demonetisation exercise did, common people might react differently to such moves. Arvind Chari, Chief Investment Officer of Q India (UK), an affiliate of portfolio management firm Quantum Advisors, says repeated activities of this nature create a sense of distrust among people in holding cash. This may lead common people, who do not indulge in black money generation, to choose to not hold cash. That may mean using cash to buy other asset classes like gold.

Anil Gupta, Senior VP at ICRA says the move will marginally aid the deposit growth of the banks as these notes form just 2 per cent of their overall deposit base of more than Rs 184 lakh crore. “This could help the banks calibrate their deposit rate hikes in the near term, as deposit growth has lagged credit growth.”

From a global standpoint, India’s highest denomination currency will be of Rs 500, which is equivalent to around £5 or $6. The commonly used currency in the US or the UK has a denomination of 20. On a purchasing power parity basis, the Rs 500 note works out to around £20 or $23. “This seems okay,” says Chari. The Rs 2,000 note has then, truly, had its run. 

@anandadhikari