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Rs 2000 ban by RBI

23/05/2023

As the Rs 2,000 banknote is still a legal tender in India, the likelihood of economic disruptions is comparatively lesser. However, the ease of transactions will be disrupted ex-post to the RBI’s decision to withdraw Rs 2,000 notes. 
 
The Rs 2,000 denomination banknote was introduced in November 2016 to meet the currency requirement of the Indian economy in an expedited manner after the demonetisation of Rs 500 and Rs 1,000 notes.
 
The Reserve Bank of India (RBI), on May 19, 2023, announced that the objective of introducing Rs 2,000 banknotes was met once banknotes in other denominations became available in adequate quantities, and under the pursuance of the Clean Note Policy, it had advised banks to stop issuing Rs 2,000 denomination banknotes with immediate effect. 
 
The Rs 2,000 denomination is not commonly used for transactions, as RBI estimates show that it constituted only 10.8 percent of notes in circulation as on March 31, 2023. In absolute terms, this amounts to only Rs 3.62 lakh crore in 2023, from a peak of Rs 6.73 lakh crore on March 31, 2018, when it constituted 37.3 percent of notes in circulation.
 
Pain for the informal sector
 
This is not demonetisation as the Rs 2,000 notes can be exchanged for notes of other denominations till September 30, 2023, and they will continue to be legal tender even thereafter. However, the move can affect segments of the market where cash transactions are predominant.
 
It is true that cash payments are made to avoid tax. Yet, it is also true that the informal sector is still outside the purview of a full-fledged digital financial system, and this announcement might affect their business. Also, cash-heavy businesses might face transitional issues, temporarily affecting their ease of doing business.
 
People who have saved or accumulated cash outside the formal banking sector in Rs 2,000 notes will get temporarily affected as they can exchange only up to Rs 20,000 at a time. However, such cash savings outside the purview of the financial system happens mostly in times of financial repression or a low-interest rate regime. Given that the interest rate is not negative, the propensity of people to keep their money in banks and earn interest, instead of keeping it at home, will be relatively higher.
 
The election factor
 
The “announcement effect” of this decision is tremendous, coming as it is prior to the polls. The cash in circulation might surge leading up to the elections in five states, and the national polls in 2024. However, the impact on the economy will be limited as Rs 2,000 notes constitute an insignificant share of the currency in circulation, and because it will continue to be legal tender.
 
With Rs 2,000 notes being exchanged at banks, bank deposits could surge, impacting interest rates. As a result, the rise in short-term interest rates will be moderated.
 
With this move, the 2016 demonetisation has reached a full circle. However, whether it has achieved its stated objectives is debatable.
 
A Harvard paper by Gita Gopinath and her co-authors, titled “Cash and the Economy: Evidence from India's Demonetization,” revealed that demonetisation lowered the growth rate of the economy. Another paper by Amartya Lahiri in the American Economic Association journal revealed that demonetisation has not achieved its stated objectives of reducing black money (as black money is a flow problem, not a stock), and pushed the economy into forced formalisation.
 
Digital currency
 
The move towards a full-fledged digital fiat money will take time, as cash is still the predominant medium of exchange in India. Though the RBI has introduced the Central Bank Digital Currency (CBDC) in select cities, the efficacy of CBDC as a medium of exchange is still being analysed, prior to scaling it up to other cities in India.
 
Inconclusive about stated objectives 
 
In India, demonetization happened in 1946 and in 1978 as well. On January 12, 1946, in pre-independence India, citing the Bank of England’s decision to demonetize currency after the World War II, the Government of India demonetized all currency bills of denomination 500 rupees and above. Later, the higher denomination bills were all reintroduced by 1954. However, demonetization was considered as a failed policy then as 94 percent of the demonetized currency was returned to the RBI. It created disruptions and hardship to public, but it was a failure as not much was garnered in the form of unreturned currency1. Both 1946 and 1978 episodes were criticized for their efficacy in not achieving the stated objectives.
 
“On November 2016, the Prime Minister gave two objectives for the demonization move: first, it would help in seizing the unaccounted income (black money) and it is a blow against corruption. Second, it would eliminate the circulation of counterfeit currency. However, estimates from the Indian  Statistical Institute suggested that counterfeit currency accounted for a bare 0.025 percent of the currency in circulation. In subsequent days, two other motives were added to the narrative. Third, demonetization was intended to be a way of pushing India toward a modern digitised economy, which would be less reliant on cash. More digitized payments would bring a larger share of the informal Indian economy into the organized and formal sector. Fourth, by forcing people to convert their old cash into the new currency through the banking system, it was both bringing unaccounted money into the formal tax network and generating greater digital footprints to track individuals and firms who were hitherto hidden from the tax network . After an extended counting process, when the dust cleared, the Reserve Bank of India announced that over 99 percent of the demonetized currency had been returned to it through the commercial banks. Also, within a year of the demonetization, currency in circulation in the economy was also back to its pre-demonetization level”.
- Amartya Lahiri (2020)
 
Chodorow-Reich et al. (2018) use the variation in remonetization at the currency chests around the districts of India after the demonetization notification as a source of exogenous and random variation2. Using different outcome variables that include “night lights” data, labor force statistics, digitization rates, they estimate that demonetization induced at least a 2 percentage point decline in GDP in the quarter of demonetization relative to the counterfactual of no-demonetization. 
 
To conclude, with this announcement on May 19 th 2023 to absorb Rs 2000 notes, the 2016 demonetization has reached a complete circle, however whether it has achieved its stated objectives is still inconclusive, and the RBI’s preparedness to deal with such moves is crucial.
 

1.  https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.34.1.55

2. Chodorow-Reich, Gabriel, Gita Gopinath, Prachi Mishra, and Abhinav Narayanan. 2018. “Cash and the Economy: Evidence from India’s Demonetization.” NBER Working Paper 25370. Cash and the Economy: Evidence from India's Demonetization | NBER
 
 
The edited version of this article was published in Moneycontrol on May 21, 2023. Rs 2,000 ban: Transitional disruptions in ease of doing business likely (moneycontrol.com).
 
Lekha Chakraborty is Professor, NIPFP and Research Associate of Levy Economics Institute of Bard College, New York and Member, Governing Board of International Institute of Public Finance (IIPF) Munich.
 
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.

 

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