A possible squeeze in circulation of cash from the market on account of the Centre pulling back high denomination notes could have an impact on inflation, according to Niti Aayog Vice Chairman Arvind Panagariya, if the shortage in supply is not met by the Reserve Bank of India with its open market operations.
“The money supply ‘M1’, in economic terminology, which is the narrow reserve of money, will shrink to some degree. Because the part that is the black money, which was in circulation, goes out of circulation,” Panagariya explained, while addressing journalists at The Economic Editors Conference on Friday here.
“So there, I think, the money supply declines, and in absence of any countervailing action by the Reserve Bank of India, it will have an impact on the prices. So without any action from the RBI, it would reduce the inflation rate. Very likely though, I think the RBI would do some open market operations to at least partially replace this money supply,” he added.
On Tuesday, Prime Minister Narendra Modi announced that existing notes of Rs 500 and Rs 1,000 would cease to be legal tenders.
Panagariya, on Friday, said that apart from having an effect on the unaccounted money in the system, this decision would have a lot of other subtle impacts.
“First thing is that the transactions will now start moving to the white economy. What this also means is that transactions would happen much more through the banking system. So we’ll see some surge in the bank deposits,” Panagariya said.