Bring Back Demonetized Notes

demonetising Rs 500 and Rs 1,000 notes

Since government has achieved its objective through scrapping of `500 and `1000 notes, it now think of bringing them back rather printing new notes of same denomination


While announcing its monetary policy amid speculation of the key rate cut by 25 basis points on December 11th, 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 analyze 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.

In its statement, the RBI pointed out that currency in circulation plunged by “`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 `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 `14.5 lakh crore of the demonetized money that was in circulation will soon be deposited in banks.

Experts would continue to debate the gains from demonetization 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 demonetization, leading to a net loss to the economy.

But, what is clear by now is that the currency notes, especially the `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, minimize government cost on printing and distribution of new notes.

In fact, given that almost all the notes have now reached the banks, even the `1,000 notes could have been put back into circulation. But, since they have already been supplanted by `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 `400 million, which is just a fraction of the currency in circulation. So, reintroducing old `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 `500 notes to address the cash crunch would, of course, be seen as a rollback. And, in the context of the heavily politicized debate around demonetization, which is looking more and more like currency exchange now, the Narendra Modi government would see it as acceptance of failure of the demonetization 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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