Rs 2000 currency note withdrawal: What it implies for the Indian economy and what awaits next?

The Reserve Bank of India (RBI) announced the withdrawal of Rs 2,000 currency notes from circulation on May 19 and said that those holding the existing notes in circulation can deposit them in bank accounts or exchange them from Tuesday (May 23) till September 30. “It is no longer necessary; it has served its needs and now it is time to move on to smaller denominations. It continues as a legal tender so there won’t be any problems,” said T. V. Somanathan, Finance Secretary, while speaking to the media regarding the decision. But the question arises what will be its impact on the Indian economy?

Rs 2000 currency notes withdrawn: Impact on the economy 

1. Currency and GDP

The RBI announced that it would phase out Rs 2,000 denomination currency notes which make up 10.8% of currency in circulation (Rs 3.6 trillion worth). “This means that cash worth 1.2% of GDP will have to interface with the banking system vs. 10% of GDP during the 2016 demonetization episode,” added Prithviraj Srinivas, Chief Economist at Axis Capital Ltd.

2. Rs 2000 currency notes withdrawn: Infused liquidity 

Economists pointed out that large holders of Rs 2000 currency notes will likely attempt to deposit these notes or spend it on durables and there will be a temporary liquidity boon for the banking system as cash in circulation comes back into it. “It is likely to significantly aid liquidity conditions till September by temporarily reducing currency leakage. Effectively pushing back any need for the RBI to infuse durable liquidity,” said Gaura Sengupta, economist at IDFC First Bank. 

Srinivas also seconded the thought and added, “The RBI must announce a deposit facility to absorb this temporary liquidity increase so that fixed-income assets aren't mispriced.”

3. Rs 2000 notes withdrawn: More focus on the digital economy

The Government of India has been promoting the digital economy and moving away from the cash economy for the last few years and this is a step towards the same, asserted economists. “This is a step to push digitization in the economy, alongside ensuring there is no major shock in the economy as well,” said Sarbartho Mukherjee, an economist at Mahindra Group. 

4. RBI withdraws Rs 2000 notes: Impact on monetary policy 

Economists are of the opinion that even if temporarily, there is a chance that RBI may face some complications in terms of monetary policy decisions. “Our key concern is the potential mispricing of financial assets due to the temporary liquidity boon for the banking system. It also complicates monetary policy for the RBI by loosening financial conditions, albeit temporarily,” added Srinivas. 

Also Read: What is RBI's clean note policy? Why was the Rs 2000 note withdrawn?