Local police inspector K L Murthy said the fake notes had a face value of Rs 10 lakh.
As the word spread about the notes being spotted in the drain near Mithulapuri Colony and Vikalangula Colony, residents of the nearby areas gathered at the spot to collect them, police said.
Many of them thought they had struck a fortune, but were shell-shocked to know that the notes with the face value of Rs 500 were in fact counterfeit.
"Two persons came to the spot on a bike and dumped Rs 500 notes into the drain before fleeing," said K Ravi Kumar, a resident at the area.
According to Inspector Murthy, "Locals had recovered all notes and fled before we reached there. We suspect that some gangs behind circulation of counterfeit currency notes might have dumped them in the drain as they couldn't utilise them anymore in the wake of demonetisation."
He said efforts are on to trace the two persons who are suspected to have dumped the fake notes in drain.