Explainer- What does India’s decision to cancel its 2,000 rupee note mean for its economy?

by Ira Dougal

MUMBAI (Reuters) – India’s central bank said on Friday that India will withdraw its highest-denomination notes in circulation. The 2,000 rupee note, which was introduced to circulation 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 government led by Narendra Modi withdrew 86% of the economy’s circulating currency overnight.

But this time, the move is expected to be less disruptive as less value of banknotes is withdrawn over a longer period of time, according to analysts and economists.

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

When the 2,000 rupee notes were introduced in 2016, they were intended to quickly replenish the currency of the Indian economy in circulation after it was de-circulated.

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

“This denomination is not commonly used in transactions,” the Reserve Bank of India said in its letter, 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 before the country’s state and general elections when cash use usually picks up.

“Taking such a step before the general elections is a wise decision,” said Rupa Reggie Netsur, chief group economist at L&T Finance Holdings. “People who have used these notes as a store of value may experience inconvenience,” she said.

Will this hurt economic growth?

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

“This cloud will not cause any major disruption, as the small ones are available in sufficient quantities,” Netzor said. “Also in the past six to seven years, the scope of digital transactions and e-commerce has expanded exponentially.”

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

To the extent that people who carry these notes choose to buy with them instead of depositing them into bank accounts, Singhal said, there may be some surge in discretionary purchases such as gold.

How will it affect banks?

Since the government has asked people to deposit banknotes or exchange them for smaller denominations by September 30, bank deposits will rise. This comes at a time when deposit growth is slowing bank credit growth.

Karthik Srinivasan, Group Head – Financial Sector Ratings at Rating Agency ICRA Ltd.

The liquidity of the banking system will also improve.

“Since all 2,000 rupee notes will return to the banking system, we will see a decrease in the liquidity in circulation and this in turn will help in improving the liquidity of the banking system,” said Madhavi Arora, Economist at Emkay Global Financial Services.

What are the implications for bond markets?

Srinivasan said that improved liquidity in the banking system and the flow of deposits into banks could mean that short-term interest rates in the market fall as these funds are invested in short-term government securities.

($1 = 81.7800 Indian Rupees)

(Reporting by Ira Dougal; Editing by Jacqueline Wong)