With the RBI announcing a virtual demonetisation of the Rs 2,000 note, the 8’o clock syndrome was repeated once again, or almost. There were signs in the last six months that something like this was on the anvil, but it was never clarified by the central bank. Coming just hours after the government clarified on the issue of tax collected at source on international credit card spends, introduced on grounds of tracking suspicious transactions, this measure does fall in place with the current thinking on black money. So, how will it play out?
To begin with, it must be mentioned that when the Rs 2,000 note was introduced post demonetisation, it was a perplexing decision. If it was believed that Rs 500 and Rs 1,000 notes were a means to store black money, replacing them with Rs 2,000 notes did not help to attain the goal of curbing black money. Quite clearly there is a feeling today that these notes could be used for storing black money.
There were around Rs 4.28 lakh crore worth of Rs 2,000 notes in circulation as of March 2022. This involves around 214 crore physical notes. The RBI stopped printing these notes in 2018-19. Therefore, it was being subtly conveyed that in course of time these notes would not be preferred by the central bank. There are seven possible areas where the use of Rs 2,000 notes would have found favour.
First, households tend to keep a certain amount of currency at home for precautionary purposes. This was heightened during the Covid-19 pandemic as almost every household had to be prepared for the worst. The Rs 2,000 note would have found favour here as it is easier to handle.
Second is the real estate market. Today, it is axiomatic that almost all land deals involve payment of cash. The reason is clear. The developer would have paid cash to buy land, to get the permissions and pay the requisite bribes to various authorities. This is recovered through cash payments from customers. Therefore, it may not be right to blame the developers as the system has not changed much especially for the non-listed companies. This is prevalent even more in the semi urban and rural areas.
Third, there is a large informal market for gold and jewellery which could be bigger than the organised branded stores. Here, payments through cash are common as it works for both parties. One can escape paying tax and more importantly not be tracked. This is an old business, and while GST has corrected this to a certain extent, this model is pervasive in the hinterlands.
Fourth, there is also a big informal forex market where foreign currency can be bought quite easily in cash. Here, too, one can escape identification as well as pay a lower cost. This is rampant in almost all cities which have international airports.
Fifth is in the political domain. During elections, we do get to hear of stories where people are paid cash by various political parties to vote for their candidates. The denominations vary, but Rs 500 and Rs 2,000 are standard. Also, the Rs 2,000 note is useful for storage and can be used for other payments when campaigning is on. This segment will be hit hard as it is likely that large amounts have been stacked given that there are several upcoming state elections.
Sixth, weddings are another occasion where Rs 2,000 notes are used both in terms of paying for arrangements as well as in gifting. There will be disruption here as well. And seventh, donations to various religious institutions are also made in high value currency denominations and these institutions will have to opt for exchanging/depositing them. This was observed even in 2016 when notes were put into the donation boxes.
The interesting part here is that the rules for exchanging or depositing the notes are not very different from what happened during demonetisation. Banks have been told that there will be a limit of Rs 20,000 that can be exchanged at a time. This is bound to create panic and lead to long queues. While time has been given till the end of September, herd mentality will come into play. This will be challenging for banks. Going by the quantum of notes that will be exchanged, hopefully other denominations should be available. These provisions should have been made.
From the banking system’s perspective, there are two issues. The shadow of demonetisation will linger as individuals come to exchange notes. As a limit of Rs 20,000 has been placed, the use of agents cannot be ruled out. The first few days will be stressful for branch officials. Such a large exchange of notes runs the risk of fake notes also being pushed through.
At the system level, typically overall liquidity should increase as people deposit their notes and do not opt for withdrawals. The next three months will be critical to determine whether deposits are going to increase sharply or will currency be merely exchanged. While the latter will be liquidity neutral, the former will enhance it. This will lead to higher costs for banks in terms of interest paid on deposits.
It will be interesting to see if the RBI will consider bringing out a Rs 1,000 note in case the public requires something higher than the Rs 500 denomination note. The RBI will also be keenly following the identities of those depositing the money, and this could give some leads to the government. From here on, banks will be the main protagonists.
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