Demonetization 2.0: Withdrawal of Rs 2000 Notes

What has happened?

RBI yesterday announced withdrawal from circulation of Rs 2,000 notes and have given time to deposit the same with banks up to 30^th September 2023. Also a withdrawal of Rs 20,000 per person per day of notes in exchange is allowed

First resemblance of such an announcement would be a comparison with 2016 demonetization announcement by Government of India

Some facts:

1. Currency in circulation base has more than doubled in last 6.5 years from ~ Rs 16 trillion to Rs ~33 lakh Cr.


2. Rs 2,000 denomination notes form ~ 10% of total currency in circulation as against Rs 500 and Rs. 1,000 denomination notes in 2016 which were more than 90% of O/s currency in circulation in 2016


3. RBI is just stopping the circulation of Rs 2,000 notes and would consider it a legal tender. Also the time limit for deposit is significantly higher 4 months as compared to 45 days during demonetization announcement done in 2016.

Impact on macro and markets

Macro variables

Generally, withdrawal of currency from economy can have impact on

1. Liquidity in banking system


2. Durable liquidity infusion


3. Growth and business activity

Liquidity

Near term we believe that banking liquidity due to currency deposits of Rs. 3 lakh Cr by September will increase and we also expect withdrawal of liquidity will be phased out over next 3-4 quarters

Both banking and durable liquidity can see a near term increase by Rs 1.5-2 lakh Cr

Growth and business activity

As Rs 2,000 denomination notes is ~10% of total currency in circulation and with growth in UPI transactions over years, impact on growth on business activities would be negligible

Impact on markets

1. Deposits with banks would increase in near term to tune of ~ Rs 1.5 -2 lakh Cr (net of exchange) which will lead to fall in certificates of deposits (CD) issuances and deposits rates of banks.


2. Rates for short end of curve up to 3 years can fall by 20-30 bps as along with this liquidity surplus we are also near to peak of interest rate cycle and can expect cuts in last quarter of this FY.


3. Secondly as banks need to maintain ~ 20-25% of deposits in government bonds as part of SLR requirements we can expect additional demand from banks especially in 3-5-year government bonds


4. Rates for 3-5-year G-Sec and corporate bonds can also see rally to tune of 20-30 bps over next 3-6 months. Durable liquidity (core liquidity) can see an increase of ~ INR 1 trillion which can lead to delay in OMO purchases by RBI impact could be that the bond curve can steepened post initial rally (short bonds to rally more than long bonds and spread between 3-year X 10 year which is flat currently can widen)

Summary

The hype around the overall demonetization process should largely be discounted by the fact that the RBI has given an extended timeline for the entire process. Further the banks are better equipped to handle operations this time around in a more transparent manner without affecting BAU activities and inconveniencing customers. For the markets we believe, the additional liquidity can be positive for near term banking liquidity and overall in turn favorable for rates (more for short end) with negligible impact on growth.

Disclaimer

Source of Data: Axis MF Research, News Reports.

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