Withdrawal Of Rs 2,000 Notes Likely To Aid Banking Liquidity, Analysts Say

Sunsetting Rs 2,000 notes out of circulation is likely to aid interbank liquidity as people move to deposit or exchange the denomination by Sept. 30.

In a Friday evening notification, Reserve Bank of India said that the Rs 2,000 note will be pulled from circulation but it continues to be legal tender. People have been asked either deposit the currency note into their bank accounts or exchange them at banks, business correspondent locations, or any of RBI's regional offices.

While the liquidity deluge expected out of this exercise pales in comparison to the one seen at the time of demonetisation, it is still expected to aid addition of a durable deposit base and systemic liquidity.

"As witnessed during demonetisation, we expect the deposit accretion of banks could improve marginally in near term," Karthik Srinivasan, senior vice president of financial sector ratings at ICRA, said. "This will ease the pressure on deposit rate hikes and could also result in moderation in short-term interest rates."

Overall, Rs 2,000 notes in circulation have also reduced significantly over the last few years. From Rs 6.73 lakh crore at its peak in March 2018, it recently stood at Rs 3.62 lakh in March 2023, according to the RBI's notification of the withdrawal.

"The impact after demonetisation on liquidity and short rates was meaningful, but we believe the impact from the current announcement will be smaller because the stock of Rs 2,000 currency notes constitutes ~2% of aggregate deposits – whereas the currency replaced in November 2016 was nearly 14% of deposits," analysts at Morgan Stanley wrote in a Friday report.

An increase in deposits will ease banks' deposit costs and is also likely to impact their net interest margins positively, according to a Monday note from analysts at Kotak Institutional Equities. "Depending on the durability and pace of deposit accretion, the need for RBI intervention to manage tight liquidity reduces significantly," the report said.

Although most Rs 2,000 notes are likely to be deposited at banks and hence boost banking liquidity, some of the impact may eventually wear off, according to a Monday note from economists at Emkay Global. The withdrawal's initial impact on liquidity is expected to be as large as Rs 1.4 lakh crore to Rs 1.6 lakh crore, a chunk of it will wear off due to the following reasons:

• Some part of the notes may be exchanged for lower denominations.

• Some of the new deposits may be temporary in nature and might be withdrawn immediately.

• Rs 2,000 notes held by the public for the purpose of tax evasion may not return to the banking system but instead be spent on consumer durables, gold, or even real estate.

Assuming a new sticky deposit base of 20-30% of Rs 3.62 lakh crore, the durable liquidity impact could range from Rs 70,000-Rs 90,000 crore. This will help ease core liquidity deficit, the report from Emkay Global said.

The move to withdraw Rs 2,000 notes from circulation is also expected to have an impact on the bond market. Short-tenure bonds will see an uptick in—and consequently softer yields—due to increased liquidity inflow and statutory liquidity ratio related demand from banks, according to the Emkay Global report.

Long-dated bonds, on the other hand, are likely to see an uptick in yields as the markets re-adjust their expectations of open market operation buying by the central bank in the second-half of FY24, the Emkay report added.

While people can deposit Rs 2,000 notes into their bank accounts at any time, the exchange facility will be made available starting May 23, 2023. There are no limits on depositing Rs 2,000 notes into bank accounts.

Members of the public can exchange notes up to Rs 20,000 in one go at a bank. Exchange of Rs 2,000 banknotes can also be made through business correspondents up to Rs 4,000 per day for an account holder.