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India to scrap its biggest banknote ahead of harvest season

Fri, 05/26/2023 - 12:36

After positive reports of a national GDP recovery, India is back in the headlines as the Reserve Bank of India (RBI) prepares to withdraw the country's largest denomination note. The 2000-rupee note was only introduced in 2016 but is now being removed from circulation as part of the country's 'clean note policy' to reduce low-velocity banknotes. The note will be phased out gradually over the next four months by September 2023. Many might be wondering why this is significant for world markets. Well, India is not just one of the BRICS group's biggest economies; it's also growing at one of the fastest rates in the world, both in terms of GDP and population. 

And it is precisely this massive population that has the power to move markets, particularly when we take into account some specifically Indian factors like a proclivity towards precious metals and large cash-based transactions. With many analysts tipping potential upticks in gold and consumer durables in response to this news, we will be looking at the factors behind these projections and assessing the expected real impact on global markets.

Metal mania

It's a well-known fact that Indians are crazy about physical gold. Indeed, it is far and away the most popular investment vehicle for investors on the sub-continent, with 53% of Indians stating that they are currently invested in gold. When we're talking about a country with a population of over 1 billion people, it's easy to see how a major move one way or the other could have a palpable impact on the global bullion market. 

Analysts have suggested that the large amounts of high-value 2000-rupee bills floating around the economy could lead Indians to use up the notes by investing in their favourite long-term instrument, gold. Of course, they will be permitted to exchange them in banks for lower-denomination notes. However, there will be a transaction limit of 20,000 rupees per person. The thinking is that many farmers and other seasonal workers, who often receive large payments in cash at harvest time, will prefer to purchase gold as opposed to digitising their wealth. In any case, the effect on worldwide yellow metal prices will clearly be modest, but it could be enough of a bump to push an already buoyant gold above its key resistance of $2,000 and on to a new all-time high should a genuine bull cycle ensue.

Big spenders

As we have already touched upon above, India is still very much a cash-based economy. Digital transactions have been increasing exponentially in recent years, but huge numbers of participants in this largely agrarian economy still deal almost exclusively in cash, which typically means large-denomination banknotes. Apart from gold and silver, another option many Indians are expected to take when it comes to getting rid of their 2000-rupee notes is purchases of big-ticket items. This could mean anything from high-tech items like smartphones, TVs, and laptops to white goods or even major consumer durables like new vehicles. It's not as if the analysts are suggesting all Indians will walk out of the house one day and buy a brand-new truck, but any purchases of such items that were planned for the next one to two years might well be brought forward as a method of using up some of the soon-to-be-withdrawn banknotes.

With India being a major producer of goods for domestic consumption, this is likely to be very positive for the country's GDP, which could move above 9% for the year as a result. Rising retail sales would also likely be a boon for the stock prices of India's largest conglomerates, like Mahindra, Tata and Reliance.

Not India's first rodeo

We often have a tendency to over-dramatise the effect of such a move by a central bank, but the reality is that India experienced a much further-reaching and disruptive event less than a decade ago. In 2016, the RBI scrapped a full 86% of India's national currency in circulation during its so-called "demonetisation" drive that saw all Ghandi-series 500- and 1000-rupee notes withdrawn over a very short period. This time round, only one note will be removed and one that is much less frequently exchanged than the two mentioned above. The Reserve Bank of India is also providing very clear guidelines and FAQs, a move that is expected to greatly reduce panic compared to six years ago.

Aside from the existence of a sufficient supply of 100- and 500-rupee banknotes for those who are heavily reliant on cash transactions, the rapid adoption of digital payments across all demographics will also minimise the impact of the 2000-rupee note's withdrawal. In terms of the rupee itself, the withdrawal is expected to have little to no effect on the exchange rate in the long term. There will, of course, be a temporary increase in demand as notes are exchanged, as well as a slight drop in supply (around 10% of the total money supply), but this impact is projected to be minor and short-lived.

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