India will withdraw its highest denomination currency note 2000 Rupee from circulation, according to an announcement made by the central bank on Friday. The 2000 rupee note, which was introduced into circulation in 2016, will remain legal tender, but citizens have been asked to deposit or exchange these notes by September 30, 2023. This decision bears similarities to the shock move in 2016 when the Narendra Modi-led government withdrew 86% of the economy’s currency overnight. However, the current withdrawal is expected to be less disruptive as a lower value of notes will be phased out gradually over a longer period, as highlighted by analysts and economists.
Why Did the Government Withdraw 2000 Rupee Notes?
When the 2000 rupee notes were introduced in 2016, their purpose was to replenish the Indian economy’s currency in circulation swiftly after demonetization. However, the central bank has consistently expressed its intention to reduce high-value notes in circulation, ceasing the printing of 2000 rupee notes over the past four years. The Reserve Bank of India stated, “This denomination is not commonly used for transactions,” in its communication while explaining the decision to withdraw these notes.
Why Now?
Although the government and the central bank did not specify the exact reason for the timing of this move, analysts believe it aligns with the upcoming state and general elections in India, when cash usage typically surges. Rupa Rege Nitsure, the group chief economist at L&T Finance Holdings, views this decision as wise, stating, “Making such a move ahead of the general elections is a wise decision.” She also pointed out that individuals who have been using these notes as a store of value may face inconvenience.
Will This Withdrawal Affect Economic Growth?
The value of 2000 rupee notes currently in circulation is 3.62 trillion Indian rupees ($44.27 billion), accounting for approximately 10.8% of the currency in circulation. According to Nitsure, this withdrawal will not create significant disruption since notes of smaller denominations are available in sufficient quantities. Additionally, the scope of digital transactions and e-commerce has expanded significantly in the past 6-7 years. However, small businesses and cash-oriented sectors such as agriculture and construction might experience inconvenience in the near term.
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Yuvika Singhal, an economist at QuantEco Research, suggests that if individuals holding these notes choose to make purchases rather than deposit them in bank accounts, there could be a surge in discretionary purchases like gold.
How Will It Affect Banks?
As per the government’s directive, people are required to deposit or exchange the 2000 rupee notes for smaller denominations by September 30. This will lead to a rise in bank deposits at a time when deposit growth is lagging behind bank credit growth. The pressure on deposit rate hikes will be alleviated, according to Karthik Srinivasan, the group head of financial sector ratings at rating agency ICRA Ltd. Furthermore, the withdrawal of these notes will enhance banking system liquidity.
Madhavi Arora, an economist at Emkay Global Financial Services, explains that since all the 2000 rupee notes will come back into the banking system, there will be a reduction in cash in circulation, thereby improving banking system liquidity.
What Are the Implications for Bond Markets?
The improved liquidity in the banking system and the influx of deposits into banks could potentially lead to a drop in short-term interest rates in the market, as these funds get invested in shorter-term government securities, suggests Srinivasan.
FAQs (Frequently Asked Questions)
Q1: What is the reason behind the withdrawal of 2000 rupee notes in India? The government and central bank aim to reduce high-value notes in circulation and have stopped printing 2000 rupee notes over the past four years. These notes are not commonly used for transactions.
Q2: Why did the government choose this particular timing for the withdrawal? The timing of the withdrawal coincides with upcoming state and general elections in India, during which cash usage typically increases. It is seen as a prudent decision to make the move ahead of the elections.
Q3: Will the withdrawal of 2000 rupee notes negatively impact economic growth? The withdrawal is not expected to cause significant disruption since notes of smaller denominations are available in sufficient quantities. However, small businesses and cash-oriented sectors might face some inconvenience in the near term.
Q4: How will the withdrawal affect banks and banking system liquidity? The withdrawal will lead to increased bank deposits, easing the pressure on deposit rate hikes. Banking system liquidity will improve as all the 2000 rupee notes come back into the system, reducing cash in circulation.
Q5: What are the implications for bond markets? Improved banking system liquidity and the inflow of deposits into banks may result in a drop in short-term interest rates as these funds get invested in shorter-term government securities.
Source: REUTERS
