Interview | Former RBI Deputy Governor Gandhi sees no need for notes larger than Rs 500

R Gandhi was a deputy governor at the RBI from 2014 to 2017 and handled the central bank's Department of Currency Management during the turbulent demonetisation period.

India does not need currency notes of a denomination higher than Rs 500, said former Reserve Bank of India (RBI) Deputy Governor R Gandhi.

"The way digital transactions are growing, I don't think any currency note of a higher denomination is required," Gandhi told Moneycontrol on May 20.

According to Gandhi, the rise of digital payments systems and lower inflation means that higher denomination currency notes are not required any more.

The former central banker's comments come hours after the RBI said that it will be withdrawing the Rs 2,000 banknote, and gave the public until September 30 to either exchange or deposit the currency with them in bank branches.

While the central bank has said that the Rs 2,000 note will remain legal tender, the decision has drawn comparisons with the government's demonetisation move of November 2016.

The Rs 2,000 banknote was introduced to quickly remonetise the economy following the government's decision to ban the old Rs 500 and Rs 1,000 currency notes in 2016. While Gandhi, who handled the RBI's currency management department while serving as Deputy Governor from 2014 to 2017, admitted that the introduction of the Rs 2,000 note was "against the principles of demonetisation", he said that it was accepted as a "short-term tactical decision".

In a wide-ranging interview with Moneycontrol, Gandhi also discussed the need for 'active' note withdrawal measures over passive ones, the reason for the cap of Rs 20,000 on the exchange of Rs 2,000 banknotes, the problem banks and the public might face, and the impact of the decision on the banking system and management of liquidity by the RBI.

Edited excerpts:

You were at the RBI during demonetisation. Did you think at the time that the Rs 2,000 note would be withdrawn so quickly?

Yes, there was a clear understanding at the time. The introduction of the Rs 2,000 note was against the principles of demonetisation. But it had to be done for quick re-monetisation as it would have taken very long to print a sufficient number of Rs 500 notes. So it was accepted as a short-term tactical decision.

After the first lot of the Rs 2,000 notes were printed, the RBI did not print any more. It was clear that these notes would not be needed going ahead.

Further, the RBI has been withdrawing these notes as and when they came into the banking system. They were not re-issued. Which is why nearly half of these notes have already been withdrawn. Hence, it's not surprising that a decision has been taken to withdraw the remaining notes.

The RBI has said that the value of the Rs 2,000 notes in circulation has been coming down since 2018. Was such an exercise to remove it needed in that case? Could it not happen organically?

In our experience, a process like that has always taken very long. Unless the public is advised to bring it back, it takes several years for notes of an old series to come back (to the banking system).

The RBI has earlier tried to withdraw pre-2005 notes. Prior to that, we tried to withdraw 1996 series notes. It took several years for the whole exercise to be completed because only the banks were part of the process. That was an indirect or passive way of withdrawing the notes. Active withdrawal, where the public is encouraged to bring back the notes, is much quicker.

In case of passive withdrawal, even if a small number of the notes remain in the hands of the public, counterfeit notes can become an issue. Typically, the highest denomination of currency note is always the most attractive to counterfeiters. Passive withdrawal would allow counterfeiting. That is an unnecessary risk.

Over time, counterfeiters can become successful in creating a near-replica of the notes and fool people by their look and feel. The whole purpose of issuing a new series of notes is to remove the ability of counterfeiters to copy. When we introduce a new series, we move one step ahead of them.

Why is there a limit of Rs 20,000 on exchanging the Rs 2,000 notes at a time?

It may have to do with the capacity of bank branches to examine the notes. Because these are high-value notes, they have to be examined before they are accepted. If a large number of these notes are presented by an individual, the time taken to examine them will affect the servicing of other customers. Further, if banks end up accepting notes that are not genuine, it will be their responsibility.

So, the Rs 20,000 limit is not due to the unavailability of notes of different denominations with banks?

Replacement is unlikely to be a problem because notes are available in plenty. Even if all the Rs 2,000 notes, of which there are around 1.5 billion pieces, are to be replaced with Rs 500 notes, we will need 6 billion notes over four months. That is manageable. The limit of Rs 20,000 is primarily to help banks tackle crowds at their branches and ensure that notes are properly examined.

Do you foresee any problems that the public or the banks could face till September 30, or maybe even after that, with this exercise?

The people who have a large number of these Rs 2,000 notes are the ones who might face some problems. They will have to visit bank branches multiple times.

The second set of people who might face some issues are those who are currently abroad and plan to stay there for a period of, say, six months. But it is unlikely that these people will have a very large number of such notes because the Rs 2,000 note is typically not a medium of exchange, but a store of value. Very rarely do you see transactions taking place nowadays involving these notes. These are the two problems, if at all, I can foresee.

During demonetisation, we saw a huge increase in banking system liquidity and a fall in the call rate. Can we expect something similar to happen this time, but on a smaller scale?

That is unlikely. Yes, people who deposit these notes may not be able to withdraw a large amount of currency because there are guidelines on reporting withdrawals of more than Rs 2 lakh, and you have to explain why such a large cash withdrawal is required. Hence, deposits will increase. But because it will happen over a four-month period, a sudden jump in deposits is unlikely. Back in 2016, there were limits on withdrawals, which is why banking system liquidity got a big boost.

There should not be any liquidity management issues for the RBI this time then?

That is very unlikely. It should be manageable.

Do we need high denomination currency notes at all? Can the Rs 500 note be the highest-value banknote?

The way digital transactions are growing, I don't think any currency note of a higher denomination is required. Earlier, cash transactions dominated. Then, there was a thumb-rule that depending on inflation, we may have to introduce higher denominations of currency notes to facilitate transactions.

That compulsion is no longer applicable because of two reasons. One, because of the ubiquity of digital payments. Two, inflation is now under control, unlike the days of double-digit inflation. So that kind of necessity is not there any more.