Withdrawal of Rs. 2000 notes by the RBI: Reasons, concepts

Withdrawal of Rs. 2000 notes by the RBI: Reasons, concepts

Subject: Economy

Section: Monetary Policy

• RBI issues and withdraws notes of various denominations under powers granted as per Section 24(1) of the RBI Act, 1934.
• Withdrawal is different from demonetization in that the currency in case of withdrawal still remains a legal tender, but becomes void in case of the latter.

The objective of the Reserve Bank’s Clean Note Policy is to give the citizens good quality currency notes and coins while the soiled notes are withdrawn out of circulation.

• This has been done as part of ‘Clean Note Policy’ as part of which RBI aims to ensure that currency notes and coins that are of:
  • Good quality, not soiled
  • Not counterfeit
  • Good security features
• The Reserve Bank has also instructed the banks to issue only good quality clean notes to the public and refrain from recycling the soiled notes received by them over their counters. The Reserve Bank has installed high speed Currency Verification and Processing Systems (CVPS) machines at all its offices which deal with currency. These machines are capable of processing 50,000-60,000 pieces per hour and soiled notes are shredded and briquetted on-line.
• All notes prior to 2005 have also been withdrawn by RBI earlier in 2014. This was done as per standard international practice of not having multiple ‘series’ of denomination in circulation, as newer notes had better security features. But any note prior to 2005 continues to be legal tender.
• For Rs. 2,000 notes although RBI has given a time limit to deposit/exchange, they will continue to be legal tender.
• Currency with the public is seen as a leakage out of the financial system as soon as it no longer serves as the base for creation of money as per Fraction reserve banking, wherein a certain multiple of credit can be created by the bank for every rupee held.
  • Around 2-3 million rupees banking liquidity leaks out as currency in circulation.

Process:

The RBI has established rules in place for the disposal of notes unfit for circulation.

The currency notes, after collection from the concerned banks, are deposited at the Issue offices of the Reserve Bank. After their grouping and sorting under the Currency Verification and Processing System (CVPS), the RBI examines the currency notes to determine their genuineness.

• Each CVPS installation is capable of processing up to 60,000 currency notes each hour. CVPS counts the notes and separates genuine ones from the fake currency notes. The fake notes are destroyed by shredding.
• The genuine currency notes which still had quality and life left for circulation before being deemed scrapped, are shredded in a way that they could be recycled into the new currency papers.
• This means that paper used to make you ₹2,000 currency note would eventually come back to your pocket in some other denomination.

What happens to fake or less-qualitative currency notes?

• They are shredded and converted into briquettes. Such briquettes are sold for industrial use through a tender invited by the Reserve Bank of India.
• In 2016, when India’s Prime Minister Narendra Modi announced the demonetisation of about 89 per cent of the country’s currency in circulation, RBI’s state branch in Kerala state’s Thiruvananthapuram sold it to India’s only hardboard making factory, The Western India Plywoods Limited.
• The factory in the state’s Kannur district reportedly uses a combination of around 5 per cent of the paper pulp created from these notes with 95 per cent of conventional wood pulp to make hardboards.
• The Kannur factory reportedly received around 80 metric tonnes of shredded demonetised notes in the first three weeks after November 8, 2016 when the demonetisation was implemented.

Background:

Ever since 1999, when the Governor announced the Clean Note Policy, several steps were taken for augmenting the supply of currency notes and coins. The members of public were urged not to write on the currency notes and banks were instructed to provide unrestricted facility for exchange of soiled and mutilated notes.

 As per the Reserve Bank instructions, currency chest branches of the banks must offer, even to non-customers, good quality notes and coins in exchange for soiled and mutilated notes. Complaints, however, continue to be received in this regard from the public and trade bodies that these instructions have not been given full effect.

Withdrawal of Rs. 2,000 notes to have following effects:

1. Improve short term banking system liquidity: As the withdrawn notes are deposited with banks, they will have excess liquidity, which will go towards:
   1. Government securities: Banks resort to parking excess funds in government securities.
   2. Overnight money (Call money) market: Generally the overnight interbank (call rate) is more than the repo-rate. But this may change with sudden increase in short term fund availability.
2. Reduce short term interest rates: The rates for government bonds will see a reduction, firstly for the t-bills and then later possibly for 3 and 5 year bonds also.
3. Increased demand for Treasury bills: The increased demand in auctions will result in higher prices for government bonds.
4. Decrease bond yield ie. increase bond prices: Bond yield is nothing but the implicit rate at which the face value of the bond is discounted to get today’s price. Thus say a Rs. 1000 bond discounted by 10 % implicit rate is priced at Rs. 909. So bond price and yield follow an inverse relationship.
5. Dip in cash: Since all the 2000-rupee notes will come back in the banking system, we will see a reduction in cash in circulation and that will in turn help improve banking system liquidity