Mumbai 9 November, 2016 (GPN / NOMURA First Insights ) : In a master stroke to combat black money and reduce the counterfeit currency currentlyin circulation, the government announced that INR500 and INR1000 notes will cease to be legal tender immediately (midnight of 8 November). Banks will be closed on 9 November.
Instead, new INR500 and INR2000 notes will be introduced on 10 November. Citizens have been given until 30 December 2016 to deposit the old currency notes with bank/post office/RBI, while showing their IDs. Banks will share this information with the income tax department, as they deem fit.
While this decision is a surprise, it is a continuation of various measures taken by the government to fight black money and corruption. These include a recent scheme for disclosure of black money, agreement with many countries to add provisions for sharing banking information, etc.
According to government officials, circulation of large currency had expanded significantly in recent years and de-monetisation of large currency notes had become necessary to combat tax evasion. Between 2011 and 2016, circulation of INR500 and INR1000 notes rose by 76% and 109%, respectively, far outpacing the economic expansion (30%). As per the RBI data, INR500 and INR1000 denomination notes accounted for 86% of total value of bank notes in circulation as of March 2016 (Figure 1).
From a macro perspective, we see the following implications. First, while citizens will be inconvenienced in the short term, this is a big medium-term positive in the government’s effort to crack down on black money and corruption.
Second, as the old currency notes are deposited with banks, bank deposit growth will witness a pickup and currency in circulation will moderate – a positive for banking sector liquidity. Third, as rural households open new bank accounts to deposit old notes, this may also end up giving a boost to the government’s financial inclusion thrust. Fourth, since black money played a role in real estate transactions, this crackdown is very likely to hurt the real estate market, which is already reeling under high inventory in top tier cities such as Mumbai and Delhi. Fifth, as some of the black money is brought under legitimate channels, the government’s tax revenue collections will get a boost.
Finally, we believe the move generally bodes well for the inflation outlook since black money was associated with higher inflation. However, it is likely to hurt near-term consumption demand.
Overall, we see the de-monetisation of INR500 and INR1000 notes as a medium-term positive for the economy.
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