Rs 2000 note withdrawal may have unintended consequences

Rs 2000 note
RBI draws flak for Rs 2000 note withdrawal; questions abound over soundness of the decision.

Last week, the Reserve Bank of India announced the withdrawal of Rs 2000 notes from circulation. These notes will continue to remain legal tender even after September 30, however, it is not sure how many takers will these notes find. The sudden move has drawn criticism from economists and monetary policy experts who have warned of unsound policy effects. This comes at a time when India is going through a phase of jobless growth and low investment.

The effects have started to show with citizens already finding it difficult to get their notes changed as shopkeepers or suppliers are refusing to accept them. The government has said that measures have been taken to ensure that the public does not go through any hassle while getting the notes changed, but the ground reality is never as portrayed.

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Why has RBI withdrawn Rs 2000 notes?

When RBI had rendered Rs 500 and Rs 1000 notes useless, the bigger denomination notes of Rs 2000 were introduced to quickly infuse cash into the system. That means people were able to hastily swap out large amounts of cash when enough legal banknotes were not in circulation. The RBI claims that the situation is not the same now and there are sufficient notes of other denominations in circulation.

The apex bank has also claimed that the infusion of Rs 2000 notes in the economy was always a temporary measure and to that effect, the bank had stopped printing new notes in FY2019. While these notes have been demonetised, they were anyway getting old and would have soon become unusable. The government has also claimed that these bigger notes were no longer being used in most transactions. They constitute only 10.8% of all notes in circulation, at a value of Rs 3.62 trillion. This is a sharp drop from 2018, when they accounted for 37.3% of all notes valued at Rs 6.73 trillion.

The bank has also used its old argument against higher denomination notes that they are easier to hoard hence contributing to growth of black money.

Is withdrawal of Rs 2000 notes unsound policy

The latest strike on notes is not comparable to the demonetisation move of 2016 when the notes were overnight declared worthless and other currency denominations were also available. In fact, after demonetisation, there has been a surge in digital transactions and e-commerce which means the problems seen after demonetisation are not expected this time.

This is not to say that the common man will have an easy time in the coming months. Most businesses in India still largely operate on cash and hence have high cash-based reserves. This rings especially true in the unorganized economy where cash reserves are kept in lakhs to pay up for labour charges and working capital needs. Now, these firms and businesses have less than 130 days to get these notes changed.

Political analysts are also of the opinion that the decision is well-calculated and is made after the Karnataka election results where BJP failed to gain results. The move is hence aimed at cleaning up the image of the ruling government ahead of upcoming state elections. Just like demonetisation was used to create a perception that the government is proactive against black money, the latest move is also being seen in that vein, especially because in 2016, the poor had accepted that the ruling dispensation was acting against the black money holders.

The timings of the withdrawal are also being questioned considering the public-sector bank system and its bureaucracy is already stressed, which means how can any transition be smooth. Management and effective execution is always a painful work for those who are entrenched in the system. Further, after the introduction of Rs 2000 notes, ATM machines across the nation had to be recalibrated. All the resources that went into printing these notes to recalibration of the system have also been rendered useless. The RBI had spent Rs 79.65 billion in 2016-17 on printing new notes, the total soared to Rs 49.12 billion in 2017-18.

The critics of the Modi government have claimed that the ruling party has an environment of intellectual bankruptcy which also shapes much of the current government’s policymaking-advising space. Any decision it takes is hardly coherent or clear in its macroeconomic or fiscal vision. Also, no efforts are made to consult domain-knowledge experts or have white papers in place to learn from its own experiences of past-implementation failures.

For instance, while announcing the demonetisation move in 2016, the government had claimed that it would render a great part of black money completely useless. But in 2018, the RBI reported that 99.3% of the money withdrawn from circulation had been returned to banks. Simply put, all the pains that people went through after demonetisation were for nothing.

However, the move will at least help boost the cash reserves of banks as people with large amounts of these notes will deposit them in their accounts. According to a new report, it is expected that the banks’ deposit base will jump between Rs 400 billion to 1.1 trillion even if just about a third of these heavily hoarded high currency notes are flushed out by the exercise.

In a country like India where administrative challenges abound, the government ought to be aware of the complex procedural and implementation challenges associated with a given policy/law. Whether this move has taken into account the future issues or not is yet to be seen.

Another aspect the RBI may have ignored is the credibility of a currency issuer at a time India is keen to make the rupee an international currency. The demonetisation move of 2016 is criticised as a monumental failure. There are no parallel in the modern history where a major economy withdrew its currency notes.

The $10,000 dollar notes issued by the United States from 1928 are no longer in circulation. In 1969, the Federal Reserve and the US Treasury discontinued these bills. But they are still legal tender which means they can be redeemed at the face value if presented at a bank or the US treasury. With India emerging as one of the five largest economies, there is a need for RBI to work on the credibility of the country’s currency. It cannot afford knee-jerk reactions that could damage the reputation of the rupee.