Demonetisation: Why it's not a bad idea to bring old Rs 500 note out of retirement

Reintroducing the old Rs 500 notes, especially when they would now be filtered through banks, would not hurt the Indian economy

Sandipan Sharma December 08, 2016 09:40:47 IST
Demonetisation: Why it's not a bad idea to bring old Rs 500 note out of retirement

While announcing its monetary policy on Wednesday, the Reserve Bank of India gave clear indications that the situation is fluid because of withdrawal of certain currency notes from the market.

"In the view of the Committee, this bi-monthly review is set against the backdrop of heightened uncertainty... In India, while supply disruptions in the backwash of currency replacement may drag down growth this year, it is important to analyse more information and experience before judging their full effects and their persistence — short-term developments that influence the outlook disproportionately warrant caution with respect to setting the monetary policy stance," the central bank said.

Demonetisation Why its not a bad idea to bring old Rs 500 note out of retirement

Representational image. Reuters

In its statement, the RBI pointed out that currency in circulation plunged by "Rs 7.4 trillion up to December 2..." and this led to a fall in demand, supply and production.

So, clearly, there is a cash crunch. And there could be just one solution to ensure that the economy does not suffer for too long: supply of more cash in the market.

How about this for a solution: since most of the currency in circulation is already in the banks — and not lying buried under pillows or being thrown into the Ganges — why not introduce the old Rs 500 currency notes back into the market, make them legitimate tender again?

One of the reasons behind the withdrawal of the notes of higher denominations was that it was expected that a large amount of cash would not return to the system. But, as several reports have pointed out, most of the nearly Rs 14.5 lakh crore of the demonetised money that was in circulation will soon be deposited in banks.

Experts would continue to debate the gains from demonetisation for a long time. Some would argue that it has failed because people found a way to bring money back into the system, denying the RBI a windfall through extinguished currency. Others would claim that since the money has come back into the system, it can be taxed and used by banks for cheaper loans. But the gains through enforcement of tax laws, experts contend, could be slow and may not be able to offset the disruptive cost of demonetisation, leading to a net loss to the economy.

But, what is clear by now is that the currency notes, especially the Rs 500 notes, can be easily used after withdrawal from banks once the full currency in circulation gets deposited; there is very little left in the market. It can be safely deployed to cover the shortfall in supply. This will serve two purposes: one, immediately improve liquidity; two, minimise government cost on printing and distribution of new notes.

In fact, given that almost all the notes have now reached the banks, even the Rs 1,000 notes could have been put back into circulation. But, since they have already been supplanted by Rs 2,000 notes, their absence won't hurt the system much.

Also, it is clear that fears of counterfeit currency flooding the Indian market were a bit exaggerated. Different estimates put the value of counterfeit notes to just around Rs 400 million, which is just a fraction of the currency in circulation. So, reintroducing old Rs 500 notes, especially when they would now be filtered through banks, would not hurt the Indian economy.

Several banks, including the State Bank of India (SBI), have been complaining that the increase in deposits would hurt them unless there is adequate compensation. And since the RBI has disallowed them from using the excess cash through a hike in Cash Reserve Ratio (CRR) — a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves either in cash or as deposits with RBI — banks are complaining that they would have to pay interest on these deposits without deploying them in the market for returns.

Obviously, if the curbs on withdrawals are lifted, banks too stand to gain.

Though pragmatic, the reintroduction of the old Rs 500 notes to address the cash crunch would, of course, be seen as a rollback. And, in the context of the heavily politicised debate around demonetisation, which is looking more and more like currency exchange now, the Narendra Modi government would see it as acceptance of failure of the demonetisation policy.

In the end, the notes would be pulped not because they have been rendered useless, but, because of the question all political parties fear: log kya kahenge (what will the people say?)

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