₹2,000 note withdrawal to enhance liquidity, support deposit growth

The Reserve Bank of India (RBI)’s decision to withdraw ₹2,000 denomination notes is likely to result in a transient rise in banking system liquidity till September and support bank deposit growth, Gaura Sen Gupta India economist, IDFC FIRST Bank has noted.

Comparing the impact of the demonetisation of ₹500 and ₹1,000 notes in November 2016, it was estimated the impact of the current move is likely to be much lower as the value of ₹2,000 notes in circulation, i.e., ₹3.6 lakh crore as against ₹15.4 lakh crore that was withdrawn during the demonetisation exercise seven years ago.

“The ₹2,000 notes constitute around 10.8% of total currency in circulation. The notes can be exchanged or deposited till September 2023. Compared to demonetisation, this time the quantum of currency being withdrawn is significantly smaller and the period to complete the process is more spread-out. In H1FY24, the liquidity infusion (via lower currency leakage) is likely to lower the overnight rates to repo rate and steepen the g-sec yield curve”, the analyst points out.

According to Sen Gupta, if 50% of ₹3.6 lakh crore is converted into other denominations, the currency leakage till September 2023 will be reduced by ₹1.8 lakh crore. “The experience from Demonetisation shows that it took 14 months for currency in circulation to rise to pre- November 2016 levels. This time around the process is likely to be much quicker given the lesser quantum involved. If we assume that it takes around 8 months for currency in circulation to rise by INR1.8tn, starting from H2FY24. This implies that full year currency leakage is likely to be lower by ₹50,000 crore,” Sen Gupta said.

The analyst also said the withdrawal of ₹2,000 notes is likely to slow currency leakage (temporarily) and this combined with FY24 Balance of Payments closer to balance, due to expected reduction in current account deficit, pushes back the need for a durable infusion of liquidity by RBI.

“Core liquidity is expected to rise substantially by September 2023, due to lower currency leakage. In H2FY24, core liquidity is expected to reduce as currency leakage picks-up pace, opening-up space for durable infusion of liquidity by RBI by end of FY24 (if needed). The expected improvement in liquidity conditions by September also implies that RBI is likely to retain its stance of withdrawal of accommodation in its June policy”, Sen Gupta notes.