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Mumbai: Buoyed by festival demand and a bumper kharif harvest, a renewed pick-up in Currency in Circulation (CiC) was beginning to form in Q3-2016-17 when demonetisation abruptly stifled it.

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Underscoring this point with regard to the trickling down of CIC in the aftermath of demonetisation, the Reserve Bank of India Annual Report 2016-17 states that over the first seven months of 2016-17, the behaviour of reserve money (RM) was largely conditioned by the stance of liquidity management–the Reserve Bank’s resolve in its April 2016 bimonthly policy statement of progressively moving ex ante liquidity in the system towards neutrality. In terms of components, currency in circulation (CIC) rose sharply in Q1 but fell back in Q2, reflecting the usual seasonality.

Demonetisation, according ot RBI imposed a compression on the level and path of RM. Following the withdrawal of legal tender status of specified bank notes (SBNs) on November 9, 2016, CIC fell precipitously to a low of Rs 9 trillion on January 6, 2017 (around 50 per cent of the peak), a level seen more than six years ago. While banks’ vault cash shot up in the immediate aftermath, it quickly dropped as the Reserve Bank mounted unprecedented liquidity absorption operations to mop up the massive influx of liquidity as SBNs were returned by the public. As a result of these large changes, a downward spiral in RM took it down to Rs 13.8 trillion (61 per cent of the peak) by January 6, 2017.

On November 4, 2016, CIC had scaled an all-time high of Rs 18 trillion taking RM to a peak of Rs 22.5 trillion. During this seven-month period, bankers’ balances with the Reserve Bank – the other component of RM – unwound from the usual balance sheet related build up at the end of March 2016 and banks generally economised on their holdings of excess reserves in view of the Reserve Bank’s liquidity provision operations in consonance with its stance including the reduction in daily maintenance requirements with respect to
the cash reserve ratio (CRR) from 95 per cent to 90 per cent.

The volume of notes in circulation continued to increase till November 8, 2016 when the Government of India notified that banknotes of Rs 500 and Rs 1000 denominations of the existing series issued by the Reserve Bank of India till then (henceforth, specified bank notes), shall cease to be legal tender with effect from November 9, 2016 (also termed as demonetisation).

After demonetisation, currency in circulation declined by about Rs 8,997 billion (up to January 6, 2017), which resulted in a large increase in surplus liquidity with the banking system, equivalent to a cut in the CRR by about 9 per cent. This, in turn, posed a formidable challenge to the Reserve Bank’s liquidity management operations.

Initially, conventional instruments, especially reverse repo auctions under the liquidity adjustment facility (LAF) window, were deployed to absorb surplus liquidity. Recognising, however, that these operations could potentially be constrained by the finite stock of domestic securities available with the Reserve Bank, a pre-emptive strategy was put in place.

With the withdrawal of the legal tender status of Rs 500 and Rs 1,000 denomination bank notes was a surge in deposits relative to the expansion in bank credit, leading to large excess liquidity in the system. The magnitude of surplus liquidity available with the banking system increased further in the fortnights ahead. In view of this, it was decided to absorb a part of this surplus liquidity by applying an incremental cash reserve ratio (CRR) as a purely temporary measure, as under:

The CRR remained unchanged at 4 per cent of outstanding net demand and time liabilities (NDTL)

On the increase in NDTL between September 16, 2016 and November 11, 2016, scheduled banks were required to maintain an incremental CRR of 100 per cent, effective the fortnight beginning November 26, 2016. This was intended to absorb a part of the surplus liquidity arising from the return of SBNs to the banking system, while leaving adequate liquidity with banks to meet the credit needs of the productive sectors of the economy.

The Reserve Bank separately revived the Guarantee Scheme to enable deposit of SBN balances at the Reserve Bank or at currency chests and get immediate value.

Currency management during 2016-17 was geared towards managing the process of demonetisation of specified bank notes effected in early November 2016 and the subsequent remonetisation by making available adequate quantity of banknotes to meet the legitimate demand of the public in the shortest possible time.

Hence sustained efforts continued to be made towards indigenisation of banknotes production with sophisticated security features.

Simultaneously, a new series (Mahatma Gandhi New Series) of banknotes of a different size and design, highlighting the cultural heritage and scientific achievements of the country, was introduced.

In view of the withdrawal of legal tender character of nearly 86 per cent of value of notes in circulation on November 8, 2016, the focus of the Reserve Bank subsequently shifted to making available banknotes generated from printing presses to currency chests and from there to bank branches and ATMs in the shortest possible time.

This process was facilitated by air lifting of notes as also direct remittances from the presses to currency chests wherever feasible and adopting a hub and spoke model of distribution. As a result, during a short span from November 9 to December 31, 2016, the Reserve Bank pumped in 23.8 billion pieces of bank notes into circulation aggregating Rs. 5,540 billion in value.

The pace of remonetisation continued ceaselessly thereafter also and the notes in circulation (NiC) as on March 31, 2017 increased close to 74 per cent of the NiC prevailing on November 4, 2016.

Sustained efforts were made towards indigenisation of banknotes production along with enhanced security features during the year. The Bank Note Paper Mill at Mysuru started commercial production. Efforts towards a greenfield project for production of security inks were also undertaken.

Banknotes in Circulation

The value of banknotes in circulation declined by 20.2 per cent over the year to Rs 13,102 billion as at end-March 2017. The volume of banknotes, however, increased by 11.1 per cent, mainly due to higher infusion of banknotes of lower denomination in circulation following the demonetisation. In value terms, the share of Rs 500 and above banknotes, which had together accounted for 86.4 per cent of the total value of banknotes in circulation at end-March 2016, stood at 73.4 per cent at end-March 2017. The share of newly introduced Rs 2000 banknotes in the total value of banknotes in circulation was 50.2 per cent at end-March 2017. In volume terms, Rs 10 and Rs 100 banknotes constituted 62.0 per cent of total banknotes in circulation at end-March 2017 as compared with 53.0 per cent at end-March 2016.

Predominantly driven down by the compression in currency in circulation, reserve money contracted during 2016-17 while the growth of money supply moderated, despite the surge in deposits.

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Besides demonetisation, intra-year spikes in deposits growth were caused by mobilisation under the Income Declaration Scheme (IDS) and arrears of the 7th CPC to central government employees. The surge in deposits led to excess liquidity in the banking system which was absorbed through an array of liquidity management measures, viz., reverse repo under the Liquidity Adjustment Facility (LAF), incremental Cash Reserve Ratio (CRR), and issuance of Cash Management Bills (CMBs) under the Market Stabilisation Scheme (MSS). Credit growth touched a low in more than two decades on account of factors such as subdued state of economic activity, risk aversion of the banking sector, capital adequacy requirements, loan write-offs, substitution of bank credit by UDAY bonds, loan repayment by use of specified bank notes (SBNs) and banks’ pre-occupation with exchange of notes and deposits following demonetisation. As the pace of remonetisation gathered momentum, monetary aggregates started recovering with currency in circulation as of end-June 2017 reaching around 85 per cent of its pre-demonetisation peak.