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The growing cash economy

The growing cash economy
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First Published: Wed, Sep 07 2011. 01 15 AM IST

Updated: Wed, Sep 07 2011. 12 35 PM IST
Indian politicians seem to share a belief with finance professionals, though in a radically different context: cash is king.
Most political scandals come with the whiff of currency notes attached. Bellary mining kingpin G. Janardhan Reddy had Rs1.5 crore of cash in his house when sleuths from the Central Bureau of Investigation came knocking early on Monday morning. Many years ago, a former telecom minister was caught with Rs4.5 crore stashed away in his pooja room, of all places. Broker and scamster Harshad Mehta had famously alleged that he had sent suitcases filled with cash to the house of then prime minister P.V. Narasimha Rao. The giant garlands of cash that Uttar Pradesh chief minister Mayawati was given by her supporters are also well known.
Most people do not need more than a few thousand rupees at home in cash, either for regular expenses or sudden emergencies. I once knew of a magazine publisher who never carried any cash at all: he was driven to work in his car and took his meals at his club. He used his credit cards to make any unexpected purchases. Yet, Indian politicians seem to get caught with huge piles of cash at home with unerring regularity.
The arrest of Reddy should once again throw the spotlight on the growing role of money power in Indian politics, and especially during elections. Violence has largely been eradicated from the election scene over the past 10 years, but the use of cash has evidently increased.
In the weeks leading to the 2009 elections in Karnataka, the Election Commission managed to capture Rs46 crore that was being transported in ambulances to various constituencies. Many of these ambulances came from the dusty fields of Bellary. The chief election commissioner had said at the time that this was only an estimated tenth of the cash actually used during those elections to entice voters.
One of the standard stories financial journalists file during an election season is about how the proportion of cash has gone up in the monetary aggregates data that is released by the Reserve Bank of India (RBI) every Friday. Nobody has ever been able to pin down causality, but the correlation over the years has been tight enough for us to assume that the amount of currency in the economy jumps up at election times because it is needed to lubricate various political machines.
However, a slightly longer-term view shows that the use of cash in the Indian economy has been growing rapidly as well.
Take a look at the chart that goes with this column, which shows that the ratio of cash to gross domestic product (GDP) has increased by around 2 percentage points over the past two decades. In its latest annual report, the Indian central bank offers several explanations on why the use of cash has continued to grow in India. High inflation is a prime reason, especially the rise in prices of items of daily use that we usually buy with cash. Vegetables and fruit are two examples. The average citizen has to carry more cash in her bag because more money is needed these days to make daily purchases.
The opportunity cost of carrying cash rather than keeping money in the bank depends on the rate of interest. When interest rates are low relative to inflation, people will have fewer qualms about holding on to cash rather than putting their money in the bank. The spread of ATMs has done little to alter this choice. Also, the rise in government spending on social sector programmes to help the rural poor could be one reason why cash usage has gone up in the economy.
The proportion of cash used in economic activity should gradually decline with a better financial system that promotes the use of cheques and credit cards. The growing use of cash in the Indian economy is thus a puzzle. Undoubtedly, there are strong reasons to believe that factors such as higher inflation or low real interest rates played a part, but that cannot be the entire story.
RBI has also pointed to another important factor: “Also, currency use, being anonymous, facilitates tax evasion. With increasing importance of KYC and CBS and reporting of large value bank transactions for tax purposes in recent years, currency demand can potentially rise, reflected in the uptrend in the currency to GDP ratio.” KYC is the know-your-customer norms that banks insist on and CBS is technology-enabled core banking solutions used by banks.
I have not been able to get any international data to figure out whether the use of cash in the Indian economy is high or low compared with similar countries. But the unrelenting rise in the use of cash over the past two decades may have a lot to do with the growing amounts of money needed to run election campaigns as well as the stubborn use of cash in real estate deals.
Niranjan Rajadhyaksha is executive editor of Mint. Comments are welcome at cafeeconomics@livemint.com
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First Published: Wed, Sep 07 2011. 01 15 AM IST