Published on: Nov 24, 2016 @ 12:38
Prime Minister Narendra Modi took a very bold and historic decision of demonetisation of Rs 500 and Rs 1000 currency notes on 8th November 2016 to curb black money and corruption from the system. The move to demonetise these currency notes will also see home loans becoming cheaper as banks are witnessing a sharp rise in cash deposits following the huge inflow of old currency notes into banks.
The Modi government’s decision to demonetize high denomination notes may disrupt economic activity and cause some inconvenience in the beginning but it will certainly benefit the Indian economy in the long term.
The Government has also allowed the people to deposit and exchange their old legal notes in the banks by the end of December 30, 2016. So, post demonetization, cash flow into banks has remarkably increased and banks are flush with high liquidity. It is estimated that a whopping Rs 5.44 lakh crore has been deposited in the bank accounts till date, and a huge amount of money is coming into the savings and current accounts (CASA). We can hope to see further lending rates cut which will help home buyers to buy their dream home.
The surge in deposits in banks resulting from withdrawal of high denomination currency will turn the system liquidity into surplus and should lead to interest rates cut in the economy. Flush with cash, banks have already started reducing deposits rates. SBI, ICICI bank PNB, and Canara Bank are slashing fixed deposit rates. Besides, SBI has cut deposit rates on high-value bulk deposits by as much as 1.75 per cent. Among private banks, Axis Bank has slashed its MCLR by 15-20 basis points. Other banks may follow the suit and reduce deposit rates in the coming months.
The lowering of deposit rates will have an impact on the lending rate. Marginal Cost based Lending Rate (MCLR) is the new system introduced by RBI last year that banks use to fix lending rates. MCLR is linked to cost of funds, deposits rates, and inflation. Banks review MCLR every month and change rates accordingly.
The immediate effect of the government’s move to withdraw high denomination currency will be less currency in circulation among the people. Even though people are moving towards electronic and online payment channels, consumer demand has gone down. Therefore, inflationary worries are likely to get addressed. Retail inflation was at 4.20 per cent and wholesale inflation was at 3.39 per cent in the month of October.
According to an estimate, the notes of denominations of Rs 500 and Rs 1000 together accounted for about 86% of the total currency in circulation in India, worth nearly Rs 14 lakh crore. Banks are expecting cash deposit with banks to reach Rs 10-11 lakh crore as the deadline to deposit old notes with banks is 30th December and thereafter, you can deposit with RBI till 31st March 2017. Therefore, the rest amount of Rs 3-4 lakh crore may not come back into the banking system for exchange and will remain out of circulation. The demonetised currencies that do not get back into the banking system will ultimately no longer be legal tender. This portion will reduce the liability of the RBI as any money in circulation is a liability in the RBI balance sheet books. Thereafter, RBI can print new currencies to replace those old demonetized currencies and benefit the government by 2-3 lakh crores of rupees.
We can expect that the Reserve Bank of India (RBI) to cut repo rate (Rate at which it lends to banks) by 25-50 basis points (bps, 100 basis point is 1 percentage point) in its upcoming monetary policy review meet in December 2016. In its last monetary policy in October, RBI had cut the key repo rate by 0.25 per cent to 6.25 per cent. The longstanding complaint of the RBI that banks do not pass on cuts in key rates to end customers may be addressed soon.
The government’s decision to demonetize these high denomination notes and replace them with new currency might be causing inconvenience to the common people as they are rushing to deposit and exchange old notes in various banks and other financial institutes. In fact, this is a transitional period so there are some inevitable transitory and implementing process hurdles. This move will have some positive impact and lead to some significant economic benefits in the long term including the lowering down of interest rates in coming days.
Ajay Verma, founder and writer of TheHousingWorld, a real estate and mortgage news website. He has over fifteen years of rich experience in the above mentioned industries.