Mohammad Hussain was arrested yesterday and Rs 40,000 in denomination of Rs 2,000 was recovered from him, they said.
Police said Hussain had received the counterfeit notes from one Nadeem, who allegedly procured them from Muzaffarpur in Bihar.
Nadeem used to smuggle drugs from Bihar and supply them in Delhi, they said.
Hussain was arrested in 2012 from Hauz Quazi area and was convicted for two years in jail. After being released on bail, he again came in contact with Nadeem and the duo started illegal circulating counterfeit notes, the police said.