What India’s decision to scrap its 2,000-rupee note means for its economy

The 2,000-rupee note, introduced into circulation in 2016, will remain legal tender but citizens have been asked to deposit or exchange these notes by Sept. 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The decision is reminiscent of a shock move in 2016 when the Narenda Modi-led government had withdrawn 86% of the economy’s currency in circulation overnight.

This time, however, the move is expected to be less disruptive as a lower value of notes is being withdrawn over a longer period of time, according to analysts and economists.

Why did the government withdraw 2,000-rupee notes?

When 2,000-rupee notes were introduced in 2016 they were intended to replenish the Indian economy’s currency in circulation quickly after demonetization.

However, the central bank has frequently said that it wants to reduce high-value notes in circulation and had stopped printing 2,000-rupee notes over the past four years.

“This denomination is not commonly used for transactions,” the Reserve Bank of India said in its communication while explaining the decision to withdraw these notes.

Why now?

While the government and the 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 usage typically spikes.

“Making such a move ahead of the 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 face inconvenience,” she said.

Will this hurt economic growth?

The value of 2,000-rupee notes in circulation is 3.62 trillion Indian rupees ($44.27 billion). This is about 10.8% of the currency in circulation.

“This withdrawal will not create any big disruption, as the notes of smaller quantity are available in sufficient quantity,” said Nitsure. “Also in the past 6-7 years, the scope of digital transactions and e-commerce has expanded significantly.”

But small businesses and cash-oriented sectors such as agriculture and construction could see inconvenience in the near term, said Yuvika Singhal, economist at QuantEco Research.

To the extent that people holding these notes chose to make purchases with them rather than deposit them in bank accounts, there could be some spurt in discretionary purchases such as gold, said Singhal.

How will it affect banks?

As the government has asked people to deposit or exchange the notes for smaller denominations by Sept. 30, bank deposits will rise. This comes at a time when deposit growth is lagging bank credit growth.

This will ease the pressure on deposit rate hikes, said Karthik Srinivasan, group head – financial sector ratings at rating agency ICRA Ltd.

Banking system liquidity will also improve.

“Since all the 2,000-rupee notes will come back in the banking system, we will see a reduction in cash in circulation and that will in turn help improve banking system liquidity,” said Madhavi Arora, economist at Emkay Global Financial Services.

What are the implications for bond markets?

Improved banking system liquidity and an inflow of deposits into banks could mean that short-term interest rates in the market drop as these funds get invested in shorter-term government securities, said Srinivasan.