Query from a friend:
I have a doubt. See if u have an answer. Why is the Government introducing a Rs. 2000 note? Generally, a govt prints higher denomination note in higher inflation environment. So I was wondering why Rs. 2000 note? Also, wouldn’t this create further black money in Future with Rs. 2000 note, black money will start circulating after a while right? Rather, the circulation of 100s, 50s and 20s should increase to force people to use card and mobile wallets. Thereby, bringing them to the legal channel for small purchases and then the percentage of high denomination notes will also reduce?
MY ANSWER:
Introduction of 2000 Rs note:
Of the total value of currency 86% is(was) in the form of Rs. 500 and Rs. 1000 notes. The increase in such denominations in circulation has started from 2002 onward. Earlier the share of Rs. 500 and Rs. 1000 was ~35%. Currently, India has a “currency circulation to GDP” ratio of 16%. In a developed country like the USA the ratio of “currency in circulation to GDP” is 7% to 10%, so this move help us move to Cashless society. In fact, there is still room for demonetization.
Now, coming to the introduction of Rs. 2000 note. As stated above 86% of the money is in the form of Rs. 500 & Rs. 1000. As people deposit their old monies in bank and assuming, that everyone withdraws as much as they deposited, there will be a huge Demand for currency. With a time limit of ~50 days, there is need to have higher denomination currency along with Rs. 500 note to bridge the gap.
The time for printing in limited and given the inherent secrecy in operation; the Government needs to have a via-media to replace this amount. So, the Rs. 2000 note is been introduced. That’s the first thought that comes to my mind.
In about six months, we will get an idea of exactly how much money will be printed in Rs. 2000 notes. Further this knee-jerk reaction will make middle class or tax payers wary of using Rs. 2000 notes. They would be moving more towards the Cashless economy.
I believe, even the Rs. 2000 notes will soon be moved out systematically in a year, as soon as they get back to the bank. These are my thoughts; all in all it is positive for economy.
About inflation point: This move will be more deflationary because, the Government is not like “Issuing only Rs 200 notes”. They are replacing currency. Thus assuming 100% replacement, overall currency will be same. However, that won’t be the case, as I explain further lower that ~40% of money will be either a) destroyed, b) taxed or c) be part of the banking system. So, this Rs. 2000 notes or this current move will only lead to creating systemic liquidity; which will lead to reduction of Inflation.
Let us look at what really hits the economy.
Further there are some simple assumptions that are play for people of country depositing money segregated in three parts:
- 33% does not get into the system i.e. of the money in circulation
- 33% of money is of poor honest tax payers which was lying in home that gets re-deposited
- 33% becomes subject to tax
First set: 33% does not get deposited, so this creates a Fiscal headroom for the Government and reduces both the Asset & Liabilities of RBI. At 33% of this amount aggregates to Rs. 4.5 L cr. This amount gives Government additional Fiscal deficit headroom for either printing money or strengthening the country’s balance sheet.
Second set: Say another 33% is honest money. That come backs to system, this will strengthen bank balance, provide liquidity in system and can lead to lower interest rate coupled with inflation reduction. People will be wary of withdrawing this money immediately and will keep it in bank, which will better for the Country.
Third set: ~33% becomes taxable. So say ~4.5 L cr., becomes the taxable income for the people. Assuming a lower 20% tax revenue, this move will generate ~Rs. 80,000 cr. as tax revenue for the current financial year.
So, lets pray that ~33% does not get deposited and ~6% of say 7%; taking the tally to 40%.
