RBI Withdrawal of Rs.2,000 Notes Won't Be A Déjà Vu Of Demonetisation: Here's Why

The Reserve Bank of India (RBI) announced the withdrawal of R 2,000 notes from circulation on May 19. The notes will continue to be legal tender and can be deposited or exchanged in banks until September 30, 2023.

The RBI said that the decision was taken to "clean up the currency system" and to "curb the use of high-value notes in illegal activities." The withdrawal of Rs 2,000 notes comes nearly seven years after the RBI's 2016 demonetisation exercise that saw the withdrawal of Rs 500 and Rs 1,000 notes from circulation.

Demonetisation saw people queuing up in hundreds in front of banks and ATMs, scrambling to get their notes exchanged. ATMs ran out of cash and people had to go to great lengths, for a couple of months post-demonetisation, to withdraw cash in any form. The reaction to the withdrawal of Rs 2,000 notes was a bit different. Reports said people found different ways to get rid of the notes (read: buy mangoes and choose ‘cash on delivery' for Zomato orders).

The Rs 2,000 notes account for only 10.8% of the total currency in circulation. In addition, the RBI provided a four-month window for people to deposit or exchange notes.

Overall, the impact of the RBI's decision to withdraw Rs.2,000 notes is expected to be limited. However, some disruptions in the economy cannot be ruled out. Two weeks since the announcement, here’s a look at how it could impact the economy.

Impact on Banking Sector

The banking sector is expected to be the biggest beneficiary of the RBI's decision. The withdrawal is expected to lead to increased deposits in banks. This is because people will have to deposit the Rs 2,000 notes in banks in order to exchange them for other denominations.

Ambit Asset Management expects deposits to grow by approximately Rs 3 trillion by September, while Economist at Kotak Mahindra Bank expects deposits to grow by approximately by Rs 2 trillion.

The increase in deposits is expected to help banks improve their liquidity position. This will allow banks to lend more money to businesses and consumers. The increase in lending is expected to boost economic growth. Hence this event is a blessing in disguise for banks as credit growth continued to outpace deposit growth throughout the year.

Impact on Bond Markets

The bond markets could see a drop in interest rates for short-term maturity bonds because of a surge in banking deposits.

Impact on Consumer Discretionary Sector

The consumer discretionary sector is also expected to benefit from the RBI's decision to withdraw Rs 2,000 notes. People may rush to buy goods and services before the deadline for exchanging the notes. This could lead to a surge in demand for goods and services, which would benefit businesses in the consumer discretionary sector such as automobiles, real estate, consumer durables and jewellery.

Reuters reported an uptick in gold prices and increased buying activity in the consumer discretionary sector.

How is This Different From Demonetisation in 2016?

There are a number of key differences between demonetisation and the withdrawal of Rs 2,000 notes. Let's take a look at what they are:

1. Rs 2000 note is not invalid and is still legal tender, which is in contrast with demonetisation.

2. The withdrawal of Rs 2000 notes isn’t expected to have a significant impact on the economy. The Rs 2000 note only constitutes 10% total currency in circulation while Rs 500 and Rs 1000 notes constituted 86% of the total currency in circulation at the time. The time frame for this withdrawal is four months compared to the immediate impact during demonetisation.

3. The Demonetisation exercise of 2016 had a major impact on the economy, as it led to a sharp decline in economic activity. While the current action has been taken as a part of the Clean Note Policy, it will have a limited impact as was evident from the 2013-14 clean note policy action. At the time, RBI withdrew from circulation banknotes that were issued before 2005. Then too the RBI said the withdrawn notes would remain legal tender.

Who Are The Biggest Beneficiaries?

RBI Governor said the impact of ₹2,000 notes withdrawal is ‘very very marginal’ on the economy.

The RBI's decision to withdraw Rs.2,000 notes is expected to have a limited impact on the Indian economy. However, some disruptions in the economy cannot be ruled out. The banking sector and the consumer discretionary sector are expected to be the biggest beneficiaries of the decision.

Sudarshan Bhandari and Nimish Maheshwari are chartered accountants and co-founders of Beat The Street, a financial markets platform which extensively covers Indian economy and business world especially financial markets.