On November 8, 2016, the government “demonetised” old Rs 500 and Rs 1,000 notes, setting in motion perhaps the world’s biggest such exercise in the modern era to retire and replace old currency notes.
On May 19, 2023 the Reserve Bank of India (RBI’s) decided to withdraw Rs 2,000 denomination banknotes from circulation.
There is a major difference between the demonetisation of 2016 and the currency withdrawal of 2023. Demonetisation was a policy shock, because it wiped out the legal status of 85 percent of the banknotes in circulation, resulting in cash shortage.
During demonetisation, the full and free convertibility of bank current and savings account deposits into cash stood suspended. A firm or an individual may have had money in the bank, but could not withdraw as much of it as desired in cash. This affected the economy. Consumption spending, the very edifice of the India growth story, dramatically collapsed for about a quarter.
India’s rate of growth dropped to 6.1 percent in January-March 2016-17, from 9.1 percent in the year-ago period (added) , mirroring the impact that the sudden flush out of high-value notes and restricted cash access had had on household spending and corporate investment.
Private Final Consumption Expenditure (PFCE), a metric to measure household spending, fell to 58.7 percent of GDP (in current prices) during January-March 2016-17, from 61.6 percent in the previous quarter and 59.1 percent in the fourth quarter of 2015-16.
The difference this time is that around Rs 3.62 lakh crore worth of currency, or about 10.8 percent of banknotes in circulation as of March 31, 2023, will be “withdrawn” from circulation, not banned or scrapped as was the case with demonetisation. To that end, the impact on people’s consumption spending will be limited.
But, how much of the Rs 3.62 lakh crore of Rs 2,000 notes in circulation is held by the public?
Also, many legitimate transactions take place in large amounts of cash every day. For example, at petrol stations and farm mandis. Will such entities be allowed to exchange more than the Rs 20,000 cap in Rs 2,000 notes at banks?
The answer to the first question will offer a critical insight. Rs 3.62 lakh crore is six times the annual budget of the Mahatma Gandhi National Rural Employment Guarantee Scheme for 2023-24. The RBI says that “it has been observed that this denomination (Rs 2,000) is not commonly used for transactions”. Since the notes will continue to be legal tender even after September 30, 2023, it will be interesting to see how many of these are returned to banks, for that will indicate if a substantial amount was being hoarded in cash to carry out transactions outside of regulatory boundaries to evade taxes.
The answer to the second question could throw interesting insights. Such organisations may be more inclined to dispose of their cash in Rs 2,000 notes through transactions, rather than exchanging these at banks, demonstrating a “passing the buck” syndrome.
Also, it will be interesting to see how much of the cash is exchanged for smaller denominations, and how much is deposited into bank accounts, as that could help gauge people’s inclination to hold cash.