This time, plan better

RBI should lay out its strategy for remonetisation

There has been a great deal of discussion around the rationale and implications of the decision to withdraw Rs 500 and Rs 1,000 currency notes from circulation. Whatever the merits, it is obvious that the move destabilised money supply considerably; and so it is past time to give serious consideration to the question of what the new equilibrium for the money supply should be and how it will be accomplished. The government has stated in the Rajya Sabha that on November 2 there were 17,165 million Rs 500 notes and 6,858 million Rs 1,000 notes in circulation, which in value terms add up to Rs 15.44 lakh crore. That was about 86 per cent of the total value of currency in circulation. Reserve Bank of India (RBI) Governor Urjit Patel told a Parliamentary panel on Wednesday that Rs 9.2 lakh crore was in circulation. Printing presses are now operating at capacity and withdrawal limits are slowly being eased. The question is: What is the RBI’s estimation of the final, post-demonetisation value of currency in circulation; how has it arrived at that value; and how will it achieve this?

When demonetisation was first announced, it was suggested that only a limited number of Rs 2,000 notes would be introduced. This was in keeping with the intent of the demonetisation exercise, which was to reduce high-value currency notes in circulation, given the belief that a cash-based economy led to substantial stores of black money. However, it is worth noting that if an overwhelming proportion of demonetised cash is returned to banks, it is possible to argue that cash stocks were almost entirely driven by normal demand. If so, then the original figure of almost Rs 18 lakh crore of currency in circulation was driven by demand. In which case, there are two issues that need to be analysed. First, the structural changes ushered in by demonetisation, if any, may reduce or increase this demand-driven level. Second, the proportion of this Rs 18 lakh crore that is in high-value notes must be calibrated. Questions of efficiency and the velocity of money will need to be examined in this regard. A currency stock that features a large number of Rs 2,000 notes, which are difficult to change to lower denominations, will not be helpful in terms of velocity.

When making this determination, the RBI must be careful to err on the side of caution, and not print less than what will be necessary. In other words, it may need to put enough cash in the system in order to lubricate the various transactions that were delayed or put aside due to demonetisation. It will also be necessary to alleviate the behavioural changes that the trauma of the demonetisation exercise may have introduced — people may need to be shown that there is no reason to hoard currency notes. How this currency is introduced into circulation will be key. Demand for money must be allowed full play — such demand is currently constricted by cash withdrawal limits. In any case, the RBI’s thinking must be made transparent and public. Remonetisation must be planned better than demonetisation.