Return of ₹2,000 notes to bolster bank coffers, money market liquidity, says research report

The Reserve Bank of India’s decision to withdraw ₹2,000 notes could boost banks’ deposit base and liquidity in the money markets by anywhere between ₹40,000 crore to ₹1.1 lakh crore, even if just about a third of these heavily hoarded high currency notes are flushed out by the exercise, according to a research report.

A part of those notes which are being hoarded to avoid taxes on unaccounted incomes could be funnelled into assets like real estate and jewellery, the report reckons. The central bank has said that the notes will remain legal tender, but has asked people holding such notes to deposit or exchange them by September 30 this year.

With no clarity yet on what the status of these notes will be after that deadline, a flurry of exchanges is expected over next four months, which could “rekindle memories of Demonetisation” from 2016, QuantEco Research said in a note. Estimating the stock of ₹2,000 denomination banknotes to be around ₹3.7 lakh crore or 1.3% of GDP — equivalent to 10.8% of the cash in circulation at the end of March — the note said that banks’ deposit base would be bolstered if all of those notes came back by the stipulated deadline.

Hoarded cash

“However, since ₹2,000 denomination notes were not commonly used for transactions, it implies that they were either hoarded for precautionary reasons or for bypassing the formal taxation channel. In either case, the increase in banks’ deposit base on account of its withdrawal from circulation could prove to be temporary as precautionary demand would eventually settle for lower denominations,” QuantEco’s team of economists, led by founder Shubhada Rao, pointed out.

“Unaccounted income might fuel demand for high value consumption items like real estate and precious metals (like the experience post the Demonetization episode in 2016),” they added.

“However, if we assume a scenario where 10%-30% of erstwhile hoarded cash gets back to circulation, then this could have a durable impact on banks’ deposit base and money market liquidity to the extent of ₹400-1,100 billion,” they concluded.

Dividend income

Another decision taken last Friday by the central bank — to transfer a hefty ₹87,416 crore to the government as dividend, compared to around ₹30,300 crore in 2022-23 — would also boost liquidity, the report noted. The government had only provided for about ₹48,000 crore as dividend income from financial institutions, including the RBI, in its 2023-24 Budget.

The move provides a fiscal buffer of about 0.13%-0.15% of GDP to the Centre and will help mitigate some of the expenditure spillovers that could potentially take place through the year, it said. “More importantly, this strong dividend transfer would provide a bonanza for core money market liquidity with the central government eventually using this for its expenditure in the coming months,” the report underlined.