The Reserve Bank of India's decision to withdraw its highest-value currency drew an obvious comparison to the 2016 demonetisation drive of Prime Minister Narendra Modi's government that withdrew 500- and 1,000-rupee notes overnight.

While the comparisons are understandable, there are significant differences between these episodes.

Firstly, the withdrawal of the 2000-rupee note, which was born out of the necessity to replenish currency in circulation post demonetisation, was only a matter of time. It was understandably, a temporary move.

The idea behind the 2016 demonetisation was to lower the circulation of high-denomination notes to prevent counterfeiting. It was also to curb corruption. Continuation of the 2,000 rupee note could have negated the very purpose of the demonetisation drive.

In the US, the Federal Reserve issues only issues $1, $2, $5, $10, $20, $50, and $100 notes.

Clean Notes

After its board meeting on Friday, the RBI issued a circular announcing the withdrawal of 2,000 rupee notes under its "clean note policy". Unlike in 2016, when 500- and 1000 rupee notes were outlawed overnight, citizens can deposit or exchange 2,000 rupee notes still Sep 30, 2023. At a time, only ₹20,000 worth of 2,000 rupee notes can be exchanged or deposited.

According to the RBI, the 2,000 rupee note was introduced to meet currency requirements "expeditiously" after the withdrawal of the legal tender status of 500- and 1000-rupee notes.

After the target was met, the printing of 2,000 rupee notes was stopped in 2018-19. About 89% of the 2,000 rupee note was printed between November 2016 and March 2017 or about four months.

The estimated life span of currency notes was 4-5 years and since these are not being printed since 2018-19, these notes are being withdrawn as part of the central bank's clean note policy.

The total value of 2,000-rupee notes in circulation has fallen from ₹6.73 trillion rupees at its peak of March 31, 2018, accounting for 37% of notes in circulation to ₹3.62 trillion constituting only 11% of notes in circulation as on March 31, 2023.

The RBI also said 2,000-rupee notes are not being used commonly for transactions.

(Un)Intended Benefits

Unlike the previous episode in 2016, this withdrawal is unlikely to be disruptive to economic activity. It was estimated that about 1.5-2% of GDP was lost due to the demonetisation drive of 2016.

Over the years the share of 2,000-rupee notes in circulation has been steadily declining and the share of 500-rupee notes has been steadily increasing. The 500-rupee notes accounted for around 73% of all notes in circulation as of March 2022.

The size of digital payments is significantly larger now at more than 50% of GDP as against 12% of GDP for currency in circulation, estimates show. Digital payments were less than 1% of GDP in 2017-18.The impact on the economy is unlikely to be severe. There are benefits seen from the central bank's move, especially if the entire stock of 2,000-rupee notes in circulation comes back into the banking system.

It is possible that many had hoarded 2,000-rupee notes for precautionary notes. Some may have hoarded for sidestepping the taxation channel. If all this money comes back, banks' deposits will grow significantly alleviating tightness in the money markets.

It is also likely that some of the accumulated notes could go into gold and real estate. Estimates are that bank deposits will be boosted by around ₹1 trillion even if 2,000-rupee notes could be exchanged for 500 rupee notes over the next few months.

Another decision taken by the RBI's board Friday will help with interbank liquidity. The RBI's board approved a surplus transfer of ₹874 billion to the government for the year as against the budgeted estimate of ₹480 billion (from RBI and banks).

Core liquidity in the banking system will increase in the coming days but will remain within the central bank's threshold of 1.5% of NDTL, which could be perceived to be inflationary. Until the Monetary Policy Committee changes its stance, the RBI's board's decisions on Friday will alleviate some of the liquidity concerns of banks and bond markets.