Rs 2000 notes withdrawal

Subject: Economy

Section: Monetary policy and Banking

Context:

Withdrawal of Rs 2,000 notes could see an infusion of Rs 1-1.8 lakh crore of liquidity over the June-September period, according to a Care Ratings report.

Withdrawal of Rs 2,000 notes:

While almost the entire Rs 3.6 crore worth of Rs 2,000 notes is expected to come into the banking system as another four months remain for the deadline to exchange or deposit of these notes, the surplus cash accruing to the banks is expected to bring down deposit rates as witnessed during the 2016 demonetisation.

What’s the impact on currency in circulation so far?

Currency in circulation refers to cash or currency available with the public that is physically used to conduct transactions between consumers and businesses.
According to RBI data, currency in circulation (CIC) has fallen by Rs 36,492 crore to Rs 34.41 lakh crore during the week ended May 26.
The RBI asked banks to exchange or deposit Rs 2,000 notes from May 23. CIC is expected to decline further in the coming weeks.

How do banks view this?

With another four months to go for the deadline of September 30 for exchanging notes, banks expect almost the entire amount to come back into the banking system.
Banks believe that almost the entire amount of Rs 3.6 lakh crore will come back (Rs 3 lakh crore excluding the amount in currency chests) to the banking system.

What’s the impact on liquidity, deposits?

Withdrawal of Rs 2,000 notes could see an infusion of Rs 1-1.8 lakh crore of liquidity over the June-September period, according to a Care Ratings report. Comfortable liquidity conditions could ease short-term rates going ahead, it said.
According to SBI, there will be a favorable impact on liquidity, bank deposits and interest rates. Banks will already be holding some of these notes in their currency chests, thus the impact on deposits will be limited.
Assuming that 10-15 percent of the total Rs 2000 notes are in currency chests, then of the remaining Rs 3 lakh crore, Rs 2-2.1 lakh crore would be spent by the consumers (either direct purchase or by exchanging it with smaller denominations notes), approximately Rs one lakh crore is destined deposits in banks, SBI says. However, going by the trend so far, deposits are likely to be higher than Rs one lakh crore estimated by the banks earlier.
The withdrawal of Rs. 2,000 banknotes is likely to boost short-term liquidity in the banking sector thereby reducing the pressure on deposit rates. The banks may use incremental deposits to increase credit growth. This is likely to reduce the pressure on net interest margins,” said a Care Ratings report.

What’s the impact on bond yield?

The transitory change in the liquidity would lead to decline in yields, more at the shorter end of the curve. “
The yield on 10-year benchmark government bonds has fallen below 7 per cent level to 6.98 per cent on Wednesday. Various factors like comfortable liquidity, rise in deposits and fall in yields and inflation are likely to prompt the RBI to keep the policy interest rates unchanged in the June policy review.

Will cash with the public surge?

According to the latest RBI data, cash with the public jumped by 87.6 percent, or Rs 15.74 lakh crore, from Rs 17.97 lakh crore on November 4, 2016, days before the demonetisation was announced.
After Rs 500 and Rs 1,000 notes were withdrawn from the system in November 2016, currency with the public, which stood at Rs 17.97 lakh crore on November 4, 2016, declined to Rs 7.8 lakh crore in January 2017 soon after demonetisation. However, analysts don’t expect a big surge in cash with the public following the withdrawal of Rs 2,000 notes.