Rise in small notes win for common man

A lower level of currency in circulation is expected to bring more people into the formal economy.

The impact of currency in circulation on a country’s GDP growth has not been well researched so far. We have both developed and developing countries with high currency-GDP ratios: Japan (nearly 20%), Switzerland (about 12%), Russia (above 10%), and the US (nearly 8%); and those with low currency-GDP ratios: South Africa (2.39%), Brazil and the UK (below 4%).

Consequent to demonetisation, our currency-GDP ratio has drastically come down to 8.8% (2016-17) against around 12% during the past decade and 12.2% during 2015-16. A lower level of currency in circulation is expected to bring more people into the formal economy.

The reduction in cash-GDP ratio is primarily because of the sharp decline (20.2%) in the value of banknotes in circulation as on March 2017 over the previous year. However, the year-on-year decline, as on June 2017, was 11.8% — from Rs 17.08 lakh crore (June 30, 2016) to Rs 15.06 lakh crore (85% of the value as on Nov 4, 2016, just before demonetisation). The public perceives this drastic reduction in banknotes in circulation as causing hardship to them since the main mode of payment continues to be cash in our economy. However, this reduction in value of notes in circulation must be understood in the context of the effect of demonetisation on cash transactions/holdings and steps taken by the government to curtail black money, the change in the composition of notes in circulation and the spread of digitised payments during or post demonetisation.

Generally, some portion of the high-value notes in circulation is “hoarded” by a few people — which may be a part of unaccounted money — and these are not available for circulation. Estimates indicate that around Rs 2-2.5 lakh crore in currency notes was hoarded at the time of announcement of demonetisation on November 8, 2016, in the form of Rs 500 and Rs 1000 notes, which denominations constituted nearly 86% of the value of currency in circulation.

The estimated value of the specified bank notes (SBN) received as on June 30, 2017, is Rs 15.28 lakh crore (around 99% of SBNs), indicating that almost the entire cash has come back into circulation through banking channels. Post-demonetisation, a lot of steps were taken by the government to curb illegal cash holdings — limiting cash transaction to Rs 2 lakh, proposal for capping the cash holding limit to Rs 15 lakh, etc. — resulting in a drastic reduction in illegal cash holdings. Therefore, if one factors in the reduction in the number of “banknotes not available for circulation” during the post-demonetisation period, there may not be much reduction in the actual notes in circulation.

Although there is a decline in the value of notes in circulation, the share of small value currency (upto Rs 100) over high value currency (Rs 500 and above) has increased considerably — both in absolute terms and as a share of the total notes in circulation.

As on March 2017, volume-wise, small value notes were 90.8% (91,037 million) as against 75.6% (68,233 million) in March 2016. The share of high-value currency has correspondingly declined to 9.2%. Although the value of the currency in circulation has declined from Rs 16.4 lakh crore (March 2016) to Rs 13.1 lakh crore (March 2017), the value of small value notes has gone up from Rs 2.2 lakh crore (share 13.6%) to Rs 3.5 lakh crore (share 26.7%).

Greater demand

Correspondingly, the share of high-value currency has come down from 86.4% to 73.3%. This change in composition must be read with the restrictions or prohibitions imposed on high-value cash transactions. For the common man, the increase in small denomination notes is a welcome step since small value notes are always in demand and are mainly used by the poor and middle class.

The third dimension to defend the lowering of the value of currency in circulation is a sudden increase in digitised payments, especially from the date of announcement of demonetisation. The number of point-of-sale (POS) machines post-demonetisation has increased to around 28 lakh (June 2017) from around 15 lakh in (October 2016) — an increase of 87% in eight months, and monthly transactions at POS machines rose from 141 million to 255 million — although that number began to fall in January 2017.

Monthly payments under IMPS (Immediate Payment Services) went up from 42 million to 66 million, mobile banking from 78 million to 116 million, m-wallet from 100 million to 222 million transactions (although these too began falling in January). During the demonetisation period, people shifted to digital payments out of compulsion. Today, they do it out of choice. Once people start experiencing the benefits of digital payments, they stick to them and propagate them to others. Certainly, digital payments will rise and consequently, the demand for banknotes will fall.

With a reduction in illegal cash holdings and increasing digital transactions, the present level of notes in circulation appears to be sufficient. By not increasing the banknotes in circulation, the RBI can save a lot of expenses involved in printing and distribution of banknotes. Post-demonetisation, RBI has met the legitimate demand of the public for banknotes quite well.

(The writer is with ICICI Manipal Academy, Bengaluru)

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