Withdrawal of currencies: need and challenges – Explained, pointwise

Introduction 

The Reserve Bank of India (RBI) recently announced the withdrawal of 2000 currency notes from circulation, while emphasizing that they will remain legal tender. This move aims to address various concerns and align with the RBI’s Clean Note Policy. 

About the recent withdrawal of currencies

Background and objectives: The 2,000 rupee note was introduced in November 2016, following the demonetization of 500 and 1,000 rupee notes, to meet the urgent currency requirements of the economy. The objective was to expedite the process of replacing the invalidated notes and ensure smooth transactions. However, as the availability of smaller denomination notes improved over time, the need for the 2,000 rupee notes diminished. 

Legal framework: The RBI, as the central bank of India, has the authority to issue and withdraw currency under the provisions of the RBI Act, 1934. The withdrawal of ₹2000 currencies falls within the purview of the RBI’s mandate and its objective to ensure a robust monetary system. 

Continued legal tender: Despite the withdrawal, ₹2000 currencies will remain legal tender. This means that individuals can still use these notes for transactions and receive them as payment until further notice. 

Exchange and deposit Options: Individuals have the option to exchange or deposit their ₹2000 notes at any bank branch. They can exchange them for smaller denominations or deposit them into their bank accounts. 

Compliance and deadlines: The RBI has set a deadline of September 30, 2023, for individuals to exchange or deposit their ₹2000 currencies. It is important for individuals to comply with the guidelines and complete the necessary transactions within the given timeframe. 

Legal consequences of non-compliance: The specific legal consequences for non-compliance with the withdrawal directive have not been explicitly stated by the RBI. However, it is advisable for individuals to adhere to the withdrawal process and complete the necessary transactions to avoid any potential issues. 

What are the reasons for the withdrawal of currencies?

What are the previous instances of withdrawal of currencies in India? 

There have been several instances in the past where currencies were withdrawn or demonetized in India. Here are some notable examples: 

1946: In January 1946, the British government, in consultation with the Reserve Bank of India, demonetized high-denomination banknotes. Notes of Rs 500, Rs 1,000, and Rs 10,000 denominations were no longer considered legal tender. This move was prompted by the aftermath of World War II and the need to combat black market activities. 

1978: In January 1978, the Indian government, demonetized banknotes of Rs 1,000, Rs 5,000, and Rs 10,000 denominations. This decision was aimed at curbing the circulation of black money and illegal transactions. 

2014: In 2014, the Reserve Bank of India announced the withdrawal of all banknotes issued before 2005 from circulation. The public was required to exchange these notes at banks, as the older currency lacked advanced security features present in the newer notes.  

2016: In 2016, the Indian government, announced the demonetization of Rs 500 and Rs 1,000 banknotes. These notes were rendered invalid and ceased to be legal tender. The move aimed to curb black money, counterfeit currency, and corruption. 

What are the various advantages of the withdrawal of currencies?  

Here are some common benefits associated with the withdrawal of currencies:

Curbing black money: By invalidating certain currency notes, the government can make it difficult for individuals holding black money to convert their illicit wealth into legal tender. 

Countering counterfeit currency: By replacing older notes with new ones that incorporate advanced security features, the government can make it harder for counterfeiters to produce fake currency. This helps in preserving the integrity of the monetary system and protecting the public from financial fraud. 

Encouraging digital transactions: With the limited availability of cash, individuals are incentivized to use electronic payment systems, mobile wallets, and online banking, leading to a more transparent and efficient financial ecosystem. Increased digital transactions can also reduce the circulation of unaccounted cash and facilitate better monitoring of financial activities. 

Enhancing financial inclusion: Currency withdrawal can be an opportunity to promote financial inclusion by encouraging individuals to open bank accounts and participate in the formal banking system. The exchange of old currency notes for new ones often requires individuals to provide identification and complete KYC (Know Your Customer) processes, which can help bring unbanked populations into the formal financial sector. 

Boosting government revenue: When individuals exchange or deposit their old notes, it provides an opportunity for authorities to track and tax previously undisclosed income or assets. This can contribute to increased tax compliance and generate additional government revenue. 

Improving monetary policy transmission: Withdrawal of specific currency denominations can enable better control and management of monetary policy. It allows central banks to adjust the money supply, interest rates, and liquidity in a more effective manner, thereby facilitating macroeconomic stability and addressing inflationary pressures. 

What are the challenges faced while withdrawing currencies? 

Disruption to daily transactions: Currency withdrawal can cause inconvenience and disruption to daily transactions, especially for individuals who heavily rely on cash-based transactions. For example, if a large denomination note is suddenly withdrawn, people may face difficulties in making purchases or conducting routine business transactions until they can obtain smaller denominations or alternative payment methods. 

Cash shortages and long queues: During the initial phase of currency withdrawal, there is a risk of cash shortages in banks and ATMs. This can lead to long queues and wait times as people rush to exchange their old notes for new ones or withdraw cash for essential needs. The situation can be particularly challenging in areas with limited banking infrastructure or remote regions. 

Impact on informal economy: Currency withdrawal can have a significant impact on the informal or cash-based economy. Many small businesses and individuals operating in the informal sector rely heavily on cash transactions. If their preferred currency notes are withdrawn, it can disrupt their business operations and financial stability. 

Counterfeit currency adaptation: In some cases, counterfeiters may adapt to currency withdrawal measures by producing fake versions of the newly introduced notes or by shifting their operations to target alternative currencies. This challenges the objective of curbing counterfeit currency and requires continued vigilance from authorities. 

Conversion of black money: Despite efforts to curb black money, individuals holding illicit wealth may find ways to convert their unaccounted cash into alternative assets or currencies. This poses a challenge to the effectiveness of currency withdrawal in tackling the issue of unreported income and illegal financial activities.

Economic slowdown: Sudden currency withdrawal can temporarily disrupt economic activity, especially if it leads to a significant decrease in liquidity or a decline in consumer spending. Businesses may face challenges in managing their cash flow, and consumer sentiment can be affected, potentially leading to a slowdown in economic growth.

Diminish the RBI’s image: RBI’s ‘clean note’ policy is ambiguous. For instance, even today, lower-value bills issued at least as far back as 2013 are being used far more frequently in everyday transactions and they continue to remain in circulation. This raises doubt about the withdrawal of Rs. 2000 notes. RBI’s administrative flip flops and lack of transparency diminish the trust in RBI’s “promise to pay the bearer” at the note’s face value.

What should be done? 

Sufficient availability of alternative currency: To prevent cash shortages and long queues, it is essential to ensure sufficient availability of alternative currency denominations, especially smaller notes and coins, before initiating the withdrawal. This requires effective coordination between the central bank, commercial banks, and other financial institutions. 

Efficient banking infrastructure: Strengthening the banking infrastructure, particularly in remote areas, is vital to handle the increased demand for currency exchange and withdrawals. A sufficient cash supply should be maintained in ATMs and bank branches to meet the needs of the public during the transition period. 

Extended exchange period: Providing an extended period for exchanging or depositing the withdrawn currency can alleviate the challenges faced by individuals. This allows people more time to complete the necessary transactions without feeling rushed or overwhelmed. 

Facilitating digital payment alternatives: Promoting and facilitating digital payment alternatives can help mitigate the impact of currency withdrawal. Encouraging the use of mobile payment apps, online banking, and other electronic payment methods can provide individuals and businesses with viable alternatives to cash transactions. 

Monitoring and evaluation: Continuous monitoring and evaluation of the currency withdrawal process can help identify any challenges or issues that arise and allow for timely corrective measures. 

Feedback from the public and stakeholders should be considered to address concerns and improve the effectiveness of the withdrawal strategy. 

Adequate public awareness: To mitigate the challenges of currency withdrawal, it is crucial to ensure widespread public awareness well in advance. Clear and timely communication should be provided to educate people about the withdrawal, its purpose, and the steps they need to take to exchange or deposit their old currency notes. 

Sources: Live Mint (Article 1 and Article 2), Hindustan Times, India Today, The Hindu (Article 1 and Article 2) and Forbes

Syllabus: Economic development: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.