- The RBI announced the withdrawal of INR2000 banknotes
- We believe this exercise is more like 2014 rather than 2016 demonetisation
- There could be short-term macro implications, especially on deposit growth, and liquidity
- We maintain our growth and inflation projections
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What was the announcement?
The RBI announced on Friday that INR2000 banknotes will be removed from circulation over a four-month period, while remaining legal tender in the interim. These high-denomination notes were introduced during the 2016 demonetisation exercise to swiftly remonetise the replaced value of notes. We note that >80% of the INR2k denomination notes were issued before Mar17 and are therefore coming close to the end of their estimated life space of 4-5years. Printing of these notes had already stopped in 2019 and was replaced by INR500 notes.
The RBI also added that the move was also pursuance of the “Clean Note Policy” (press release).
Implications
As of FY23, the total value of these notes in circulation stood at INR 3.6trn i.e., 10.8% of notes in circulation. This marks a decline from its peak in Mar18 to INR 6.7trn in Mar18 (see chart).
We view this exercise as being more like the 2014 note withdrawal rather than the 2016 demonetisation episode. To recall, in January 2014, the RBI had decided to “completely withdraw from circulation all banknotes issued prior to 2005. From April 1, 2014, the public will be required to approach banks for exchanging these notes”. By contrast, the impact of the 2016 exercise was felt for several months and subsequent couple of years (see India: Disruptive demonetisation), via liquidity and growth implications, also eliciting a policy response from the central bank.
We also note -
- 85% of the currency in circulation was withdrawn in 2016 vs less than 11% now
- INR2000 will remain legal tender during the exchange window
- Residents have a four-month window till September 2023 to exchange these notes at the banks, up to a limit of INR 20k at a time at any bank starting from May 23, 2023
Implications to the broader economy from this exercise would likely be short lived, including:
i. Sentiments, as the notes are still legal tender, there might be a spurt in consumer durables/non-durables spending to utilise the saved/stored notes. Cash-oriented sectors, including small traders, micro enterprises might feel the impact in the near-term as they might be reluctant to accept these withdrawn notes. Given the relatively long (4-month) exchange window, we don’t expect this to be prolonged.
ii. Deposit growth is expected to rise depending on how much of the banknotes is deposited vs exchanged, boosting liquidity to the extent to which the deposited monies are not immediately withdrawn and prove to be sticky. If one assumes that 100% of the banknotes are deposited, then the lift will be higher. We suspect it will be closer to 40-50%
iii. Liquidity lift will hinge on the scale and speed of an adjustment in the currency in circulation and is likely to be temporary. Currency in circulation recovered sharply in the years after the 2016 demonetisation exercise (see chart), with the cash to GDP ratio also returning to trend. If we assume that the banking system liquidity rises from the current INR0.8trn to INR2trn over the next 3-6months, there could be impact on the rates market, especially short end of the curve. Banks might have to maintain SLR for the higher net demand and time liabilities, signalling potential demand for bonds.
iv. Higher deposits will be a backstop for higher credit supply.
v. This move will be an additional shot-in-the-arm for move towards digital payments, with higher utilisation of United Payment Interface, private e-wallets, amongst others.
vi. We maintain our growth and inflation projections for FY24, and don’t factor in significant changes to the dynamics because of the recent exercise
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