The unusual cash crunch situation in several States has thrown up a conundrum. Is this due to an unmet demand in cash supply or an unusual drop in the circulation of currency due to high withdrawals that have dried up ATMs? A look at data related to cash in circulation and GDP growth shows that there are both supply and demand issues that have resulted in the cash crunch in some States.
Partly, these issues are a consequence of the demand related issues that have lingered since demonetisation, exacerbated by specific local considerations related to elections. Partly, these are related to the government’s desire to keep the cash-GDP ratio low, one of the justifications for demonetisation.
Peak and trough
A look at cash in circulation in February 2018 shows that it has peaked, increasing steadily after hitting a trough in December 2016 (after demonetisation) [Graph 1]. The rise in cash use has resulted in an increase in the cash-GDP ratio to 10.7% in the present year from a low of 8.8% for FY 2016-17. But it is still lesser than the 11.6% before demonetisation.
A look at the growth rates in GDP and cash in circulation every two years since 2012 [Table 1] shows that the latter has grown slower than the GDP rates hinting at a possible unmet demand in cash. If the cash-to-GDP ratio did not precipitously decline due to the artificial withdrawal of cash during demonetisation and had remained more or less intact, the cash requirements should have been much higher for the economy.
One argument that the government has used since demonetisation is that there has been a significant increase in digital transactions of money which has mitigated the need for cash in the economy. A look at PoS transactions shows that there has not been an appreciable growth. Combined with mobile wallet payments (which went up but remained low - ₹131 billion), this is not enough to mitigate the unmet cash demand.
The RBI in its statement responding to the cash crunch issues, said that there was no shortage of currency and that there was sufficient cash to meet the demand. The economic affairs secretary, on the other hand, pointed to a slew of possible reasons, including the lack of adequate deposits of ₹2,000 due to hoarding. Hoarding could not only be a cause for the unmet demand but could also be a consequence of it, as people tend to hoard if they perceive that it is difficult to access or withdraw money. Despite the RBI’s denial of a cash crunch, the Secretary’s statement about printing new ₹500 notes suggests that there is indeed a case of an unmet demand in cash, which is acute in some States such as Karnataka, Andhra Pradesh, Telangana, Madhya Pradesh and Bihar.
Karnataka has elections scheduled next month and cash use has been known to be high during polls. A.P., Telangana, Rajasthan and Madhya Pradesh also have elections scheduled later this year or within a year from now. Bihar figuring in this list must have to do with the fact that it has the lowest ATM density among major States; this means a relative lack of supply to a large population.
Supply issues
Beyond reasons of demand, there is also the fact that the RBI has either halted or slowed down its supply of ₹2,000 notes and has instead supplied lower denomination notes to meet cash requirements.
The break-up of currency notes in circulation as of now is unavailable, but ₹2,000 notes constituted close to 50% of the total value of cash in March 2017. Since April 2017, more than 48% of the new notes supplied have been of lower denominations, according to a reply by the Ministry of Finance in the Lok Sabha.
The ₹2,000 notes were themselves printed to quickly replace the loss of the old ₹500 and ₹1,000 notes (which together constituted 86% of the value of currency before demonetisation). If ₹2,000 notes are being hoarded, this explains why the supply of lower denomination notes are not enough to meet cash requirements.
An investigation by the data portal Factly into the cash crunch in Telangana by looking into the supply of notes to currency chests of the State Bank of India in the State bears this out.
Between October and December 2017, there was a drastic fall in the supply of ₹500 and ₹2,000 notes to SBI, the largest public sector bank in India and which has the highest number of currency chests in the country. It is not a surprise that the government has been left with no option but to increase the cash flow by printing more ₹500 notes immediately.
The cash crunch seems a consequence of both demand and supply issues.
( With inputs from Vignesh Radhakrishnan )
