THE ANNOUNCEMENT WAS simple and unambiguous. The Reserve Bank of India (RBI) was withdrawing the ₹2,000 currency note and the public at large had time till September 30 to exchange notes from banks. While there is an upper limit on how many notes can be exchanged—10—there is no restriction on depositing currency.
After a very initial burst of panic—largely manufactured in TV studios about the return of “demonetisation”—the process of exchange turned out to be very smooth. The fact is that except for very dubious cases where large numbers of the high-denomination currency had been hoarded, ordinary Indians—in cities and villages—had little need for stocking large bills of cash.
The attempt to manufacture controversy died quickly as RBI clearly spelt out the rationale for the step. On May 19, the central bank said in a press release: “About 89% of the ₹2000 denomination banknotes were issued prior to March 2017 and are at the end of their estimated life-span of 4-5 years.” The removal of these notes was part of RBI’s “clean notes policy”. RBI Governor Shaktikanta Das said a similar exercise had been undertaken in 2013-14 when notes that were printed prior to 2005 were withdrawn from public circulation and the public was advised that it could come and exchange the notes. He said that while the notes were being withdrawn, they remained legal tender. To be abundantly clear, Das told reporters that his advice was to see the step as “part of currency management operations” of RBI.
In economic terms, the removal of these notes is unlikely to have a negative impact and if private sector economists are to be believed, it may even impart a “temporary punch” to the banking sector that is facing a temporary liquidity issue.
For one, the ₹2,000 notes only account for 10.8 per cent of currency, amounting to ₹3.6 trillion. This is down from ₹6.7 trillion at the peak of circulation for these notes on March 31, 2018. These notes were introduced as part of the remonetisation exercise undertaken after the demonetisation of 2016. That task was substantially complete by 2018. Since then, the proportion of these notes in circulated currency has been falling steadily.
The step announced by RBI on May 19 is very different from the demonetisation exercise of 2016. Unlike the 2016 event, only the ₹2,000 note is being withdrawn and this accounts for only 10.8 per cent of currency. The 2016 demonetisation affected 86 per cent of currency. This will not have any economic impact in the medium or long term. For one, the ₹2,000 note remains legal tender for now. For another, there is a large time window—from May 23 till September 30—to exchange these notes. The danger of a shock to the economy is minimal.
This is the perspective of some private sector economists as well. In a note issued by HSBC India, its economists said: “As such, we are not expecting any disruption in economic activity on the back of the move. And neither are we expecting a significant rise in consumer spending with cash hoarders splurging to get rid of the notes.”
HSBC economists did point to a potential short-term economic effect of the withdrawal of these notes via the banking channel. In their note, these economists said: “If much of the ₹3.6 trillion returns to the banking sector rather than simply being exchanged for lower denomination currency, banking sector liquidity could improve. This is particularly noteworthy because liquidity has been tight, as seen by the rather elevated overnight call money rate (above the 6.5% repo rate recently).” They added that the quantum is interesting. About ₹ 2.5-₹3 trillion of banking sector liquidity leaks out as currency in circulation each year. As such, markets may anticipate some comfort on the liquidity front.
In a way, the sudden injection of currency into the banking system brings temporary relief from a long-standing problem. India, as a supply-constrained economy, has severe trade-offs between liquidity and inflation. A higher level of liquidity can spark off inflationary episodes while not having sufficient liquidity in the system ends up hurting businesses and the economy. RBI’s traditional response in such situations is to tighten liquidity. But this is an imperfect solution to an otherwise difficult problem.
IN THE DAYS after the note exchange process began at banks across India, virtually no stress was reported. Unlike the serpentine queues seen during the 2016 demonetisation—something that everyone affected bore with patience—nothing of that sort was visible. There was no rush and the exchange and deposit-making were easy and given the ongoing heat wave, even languid.
But something has been at work in the system since 2016 that is reducing friction in the financial system as well as empowering individuals in India: the rapid growth of the digital economy. This is not just removing friction but also reducing transaction costs as well as the time taken for transactions.
Back in 2013, before India’s digital transformation had begun, online transactions were largely through debit and credit cards and through internet banking. Data from that year showed that 53 per cent of all online transactions—numbering 800 million—were made using debit and credit cards. Another 44 per cent were done through internet banking. Only 3 per cent digital transactions were carried out using wallets and Immediate Payment Service (IMPS).
In that early period of India’s digital economy, geography mattered. Sixty per cent of the transactions were made in the top four cities: Delhi, Mumbai, Chennai, and Kolkata. Another 25 per cent came from cities like Bengaluru, Ahmedabad, Pune, and Hyderabad. The rest of India accounted for 15 per cent of these transactions. Mobile phones and tablets accounted for just 20 per cent of these ‘digital’ payments. The expectation among experts was that this figure would rise to 30 per cent by 2020.
But then something dramatically different happened. By 2022, UPI (Unified Payments Interface) clocked 74.05 billion transactions with a value of ₹126 trillion. This was unthinkable back in 2013 and critical voices had even raised doubts as to whether India was ready for the transformation that could only be dreamed about back then. In terms of geography, too, there was a drastic change: instead of the four metropolises followed by the four big cities, by 2022 the digital revolution had spread across all states.
Much of this change took place after the demonetisation of 2016 when cash became scarce and digital transactions took off. Critics often point out that cash was back after the central bank remonetised the Indian economy by 2018. But this is only a partial truth: the reality is that after 2016 digital transactions acquired a life of their own. From the huge volume of various kinds of online transactions and the 3.25 billion transactions recorded by the National Electronic Toll Collection (NETC) system—the agency running FASTag-based tolling—amounting to ₹509 billion in 2022, India’s digital space is now independent of constraints that limit physical exchange of products in any market.
The digital revolution, which is still unfolding, was literally built byte-by-byte of digital infrastructure since 2014. On August 28, 2014, Prime Minister Narendra Modi announced the launch of the no-frills Jan Dhan accounts. Two years later, on December 30, 2016, the BHIM (Bharat Interface for Money) platform based on UPI was launched. In those initial days, these devices and applications were not appreciated. But they really took off after the demonetisation of 2016. While it may be a stretch to say that demonetisation spurred their adoption, the reality is that the event did speed up the transition to the digital economy.
The next stage in India’s digital transformation—the creation of India Stack, the ONDC platform, and the spread of BHIM to other shores as well—is progressing apace.
But it is in another, very different, domain that the digital transformation of India is having an impact: checking corruption.
During the run-up to the Assembly election in Karnataka, the Election Commission of India (ECI) seized nearly ₹300 crore worth of cash and other goods like gold, silver and liquor from various parts of the state. This money and the goods were meant to be distributed among voters in a bid to sway them. This was the largest-ever such seizure reported from the state before an election. In Bengaluru alone, ₹100 crore in cash and other items was seized by the end of April.
The story is hardly unusual from an Indian perspective: replace Karnataka with any other state and chances are you will find such reports stretching back many decades. In such operations to influence the electorate, large-denomination currency comes handy. It is untraceable and there is anonymity associated with its distribution, the very features that make it eminently suitable for corruption.
Elections are only one use of these notes. For the past many years, the Directorate of Enforcement (ED) has regularly reported seizures of large volumes of cash from influential politicians across the country where the money represented proceeds of corruption. The garish images of rooms with large piles of high-denomination cash strewn around shows the extent to which high-value notes have become enmeshed with corruption.
In the past decade, vigorous efforts have been made to stop corrupt practices in Indian public life. Apart from establishing paper and electronic trails in most currency transactions, efforts at checking political corruption, too, have gathered pace. Predictably, this has not gone down well with those who earlier enjoyed safety while indulging in such dubious practices.
One example of this resentment is the constant bickering about electoral bonds. At one time, ‘suitcases’ were the easiest mode to make contributions to political parties. Once again, it was the anonymity of cash that permitted corruption. With electoral bonds, a proper KYC trail is established at the bank branch where such bonds are purchased. The banks are exceptionally careful in maintaining the privacy of persons purchasing these bonds. But there is now a proper record of people buying these bonds through the KYC process. The chain of anonymity that permits corruption has been broken while a semblance of privacy has been maintained.
While the device is neat, it is a bugbear for many. Every time an election approaches, the matter is raked up in the Supreme Court. Practically all the arguments against such bonds are dubious to the extreme. In contrast, there is not a whimper against the use of large-denomination notes. It is not surprising that a controversy was sought to be manufactured when RBI withdrew the ₹2,000 note.
RBI’s decision will only hit those who have hoarded cash in the ₹2,000 denomination. One can always go back to the bank and deposit as much as one wants in proper accounts. But large deposits come under Suspicious Transaction Reporting (STR) and Cash Transaction Reporting (CTR) requirements issued by the central bank.
Corruption, as Chanakya observed two millennia ago, is pervasive and difficult to check. What can be done is making periodic dents to check the menace. There is now scholarly literature that notes the abuse of large-denomination currencies for corrupt purposes. In the West, this is linked to the issue of negative interest rates. As long as people hold currency, especially high-value notes, you cannot breach the zero bound—one cannot reduce interest rates below zero as currency continues to pay zero interest—and this is a limitation for central banks in economies with deep problems. In the Indian case, this is not an issue but the abetment of corruption using high-value notes is certainly one. What RBI has done is bound to have a positive impact on checking corruption.