India's 2000 Rupee Currency Shuffle: A Déjà Vu with a Twist

 

In 2016, anger had surged in India as banks grappled with the task of dispensing cash following the government's sudden decision to withdraw high-denomination banknotes. The government had claimed that this demonetisation measure aimed to uncover significant amounts of undisclosed wealth. However, the announcement sparked frustration among the population, as hundreds of thousands of people endured lengthy queues outside banks, hoping to exchange their 500 and 1,000 rupee notes. The objective behind this action was twofold: to combat the prevalence of unaccounted-for funds, commonly known as "black money," and to tackle the circulation of counterfeit currency.

Now, seven years later, India is poised to undergo another currency transition. The central bank recently announced its intention to phase out the 2,000 rupee note from circulation. This decision draws parallels to the demonetisation event of 2016 when the government swiftly removed 86% of the country's currency supply. However, this time, experts and economists anticipate a smoother process, as the withdrawal of a lower-value note will occur gradually over an extended period. Presently, the value of 2000-rupee notes in circulation amounts to a significant 3.62 trillion Indian rupees, accounting for roughly 10.8% of the total currency in circulation.

Former Union Minister of Finance, P Chidambaram, expressed his lack of surprise as the government and Reserve Bank of India (RBI) announced the withdrawal of the 2,000 rupee note from circulation. In a statement, he speculated that the reintroduction of the 1,000 rupee note might not be far off, suggesting that the cycle of demonetization had completed its course. The introduction of the 2,000 rupee note in 2016 was aimed at swiftly replenishing the currency supply in the Indian economy following the demonetization event. However, the central bank had consistently expressed its intention to decrease the circulation of high-value notes, leading to a cessation of the printing of the 2,000 rupee note over the past four years. The reason behind this decision was that reducing the availability of these high-value notes would significantly impede the hoarding of black money. It is important to note that these notes are not commonly employed for day-to-day transactions but rather serve as a store of value, contributing to the prevalent practice of accumulating substantial sums of undisclosed wealth (see Figure 2).


The withdrawal of banknotes also aligns with the RBI’s Clean Note Policy, which has been in effect for the past 18 years. Under this policy, banks and financial institutions in India have a responsibility to replace worn-out or damaged notes with fresh ones. This initiative aims to uphold the integrity of the country's currency by ensuring that the public has access to clean, secure, and durable banknotes, while simultaneously mitigating the risk of counterfeit currency.

Although the government and central bank did not explicitly state the motive behind the timing of this announcement, analysts highlight its proximity to upcoming general elections, during which cash usage typically surges. Those who have been utilizing the 2,000 rupee notes as a form of wealth preservation might experience some inconvenience. The withdrawal of these high-value notes could stimulate spending, as individuals inclined to keep their cash holdings discreet may choose to indulge in transactions. This shift in behaviour may increase purchases of gold, property, and other avenues to utilize the 2,000 rupee notes.
While the withdrawal is expected to cause minimal disruption, certain sectors heavily reliant on cash transactions, such as small businesses, agriculture, and construction, could face temporary inconveniences. On a positive note, the government's call for people to deposit or exchange the notes for smaller denominations by September 30 will lead to a surge in bank deposits. This development is particularly significant considering the slow-paced growth in deposits compared to bank credit. With the return of all 2,000 rupee notes to the banking system, the overall cash in circulation will decrease, thereby improving liquidity in the banking sector. Improved liquidity and an influx of deposits into banks may result in positive outcomes. It can lead to a decline in short-term interest rates as these newfound funds find their way into shorter-term government securities with lesser risk. The infusion of fresh capital into the market through these investments can also provide a much-needed impetus to the economy, driving growth and creating favourable conditions for funding possibilities across industries.

As the currency shuffle continues, this time it's with a renewed approach. Unlike the demonetisation event, this currency phase-out is expected to unfold gradually over an extended period, minimizing disruptions and allowing for a smoother transition. The decision to withdraw the 2,000 rupee note from circulation represents a meticulously planned announcement by the RBI to address the persistent issues associated with undisclosed wealth and counterfeit currency. The surge in liquidity, coupled with the injection of fresh capital into the market through investments, could lead to positive outcomes. Fuelling economic growth, it can finance opportunities for various sectors, and enhance the economy as a whole.

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