MUMBAI, May 20 (Reuters) – India will withdraw its highest denomination note from circulation, the central bank said on Friday. The 2000 rupee note introduced in 2016 will remain legal tender, but citizens have been asked to deposit or exchange these notes by September 30, 2023.
The decision is reminiscent of a shock move in 2016 when the Narenda Modi-led government had withdrawn 86% of the economy’s currency in circulation overnight.
This time, however, the move is expected to be less disruptive as a lower value of notes is withdrawn over a longer period, according to analysts and economists.
WHY DID THE GOVERNMENT WITHDRAW 2000 RUPIE NOTES?
When 2000 rupee notes were introduced in 2016, they aimed to rebuild the Indian economy’s currency in circulation soon after demonetisation.
However, the central bank has often said it wants to reduce high-value notes in circulation and has stopped printing 2,000-rupee notes over the past four years.
“This value is not commonly used for transactions,” the Reserve Bank of India said in its release while explaining the decision to withdraw these notes.
WHY NOW?
While the government and central bank did not specify the reason for the timing of the move, analysts point out that it comes ahead of state and general elections in the country, when cash consumption typically increases.
“Taking such a step ahead of general elections is a wise decision,” said Rupa Rege Nitsure, group chief economist at L&T Finance Holdings. “People who have been using these notes as a store of value may be in trouble,” she said.
WILL THIS HARM ECONOMIC GROWTH?
The value of 2000-rupee notes in circulation is 3.62 trillion Indian rupees ($44.27 billion). That is about 10.8% of the currency in circulation.
“This withdrawal will not create any major disruption as smaller amount notes are available in sufficient quantity,” Nitsure said. “Also in the past 6-7 years, the scope of digital transactions and e-commerce has expanded significantly.”
But small businesses and cash-intensive sectors such as agriculture and construction may face difficulties in the short term, said Yuvika Singhal, economist at QuantEco Research.
To the extent that people holding these notes chose to make purchases with them instead of depositing them in bank accounts, there could be an increase in discretionary purchases such as gold, Singhal said.
HOW WILL IT AFFECT BANKS?
As the government has asked people to deposit or exchange notes for smaller denominations by September 30, bank deposits will increase. This is happening at a time when deposit growth is lagging behind the growth in banks’ lending.
This will ease pressure on deposit rate hikes, said Karthik Srinivasan, group head – financial sector ratings at rating agency ICRA Ltd.
The liquidity of the banking system will also improve.
“As all the 2000 rupee notes will come back into the banking system, we will see a reduction in cash in circulation and that will in turn help improve the liquidity of the banking system,” said Madhavi Arora, economist at Emkay Global Financial Services.
WHAT ARE THE IMPLICATIONS FOR BOND MARKETS?
Improved liquidity in the banking system and an influx of deposits into banks could mean short-term interest rates in the market fall as those funds are invested in shorter-term government securities, Srinivasan said.
($1 = 81.7800 Indian Rupees)
Reporting by Ira Dugal; Editing by Jacqueline Wong
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