Pradeep Gaur/Mint
Pradeep Gaur/Mint

The curious case of rising currency in circulation

Rising currency in circulation along with slowing deposit growth is worsening the liquidity crunch

The rate at which currency in circulation is increasing in the Indian economy is moving up. The rate at which deposits in the banking sector are growing is moving down. Together, these two factors are worsening liquidity conditions in the banking sector, putting banks and the Reserve Bank of India (RBI) in a spot.

While the latter is more easily explainable, the former is confounding many in banking circles. Here’s what the data shows.

Currency in circulation, a reflection of the cash in use, has risen by 15.4% in 2015-16 (data for the last week of the year is yet to come). In FY15, the growth in currency in circulation was lower at 10.7%. The higher growth this year appears to run counter to most factors that typically drive currency in circulation. The key among these factors are higher inflation (which necessitates more spending) or higher transactions in sectors like retail and real estate (where there may be chunky payments in cash). There are other factors like elections, which also lead to temporary spikes.

The reason FY16’s jump in circulation is puzzling is because inflation has not moved up compared to last year and transactions in sectors like real estate, by all accounts, have been down for most of the year. While state elections, such as in Bihar, may explain a temporary spike, they don’t explain why it has persisted.

The weekly growth rate since the start of FY16 was between 9% and 11% till November. It was only in mid-November that growth in currency in circulation jumped to about 14%, and since then it has remained at 12-15%. So what’s going on? There is no clear answer but there are a few theories, some backed by data, some not.

At a macro level, one explanation could be a pick-up in urban consumption demand. While urban demand has been stronger than rural demand through the year, there is anecdotal evidence that urban demand may have strengthened further in recent months. Mint’s Sapna Agarwal hears from brick-and-mortar retailers that demand in post-festive months has held strong and purchases are up even after discounts have ended. In a recent conversation, a top executive at a fast-moving consumer goods company pointed to strength in urban demand and added that premium categories in particular are seeing strong growth.

This anecdotal evidence may point to more spending in urban areas in recent months, which, if done in cash, could explain some of the increase in circulation. What gives this theory credence is timing. Retailers speak of a pick-up in demand during festive and post-festive months, which coincides with the increase in growth rate of currency in circulation.

In a 23 March editorial in Business Standard, Soumya Kanti Ghosh pointed out that gems and jewellery output (as shown by the industrial production data) has been particularly strong in FY16. He linked this to the increased use of cash and asked whether this could point to the start of a demonetisation trend.

A second data point that ties in to the increase in currency in circulation is the pick-up in ATM withdrawals. Saugata Bhattacharya, chief economist at Axis Bank Ltd, highlighted that ATM withdrawals between April 2015 and January 2016, were at 21 trillion compared to 18 trillion in the same period the previous year and 20 trillion in FY14. Could this be a behavioural change driven by higher ATM charges making people draw more cash at once, he asks.

There are other possible factors playing out in rural areas, but none seem statistically significant. For instance, direct benefit transfers may be putting out more cash. Also, given the pressure on rural incomes, some have asked whether people are borrowing more from informal channels or liquidating gold holdings. But a dip-stick survey of three people who work in rural areas and in rural lending didn’t reveal anything that would lead us to believe that these areas are contributing to the rise in currency in circulation.

All of this matters because the increase in circulation is being cited as a key reason for the liquidity tightness in the banking sector. The other reason for the liquidity crunch is weak deposit growth. This may be more easily explainable as deposits may be flowing towards other avenues such as equity as suggested by strong inflows into equity mutual funds through most of this year.

The net result is tight liquidity, which bankers believe RBI must address. In an interview to Mint, Hitendra Dave, head of global banking and markets at HSBC India, said this increase in currency in circulation was a key reason for liquidity tightness. “Currency in circulation last March was 14.8 trillion. Now it is more than 16.7 trillion. The difference is about 2 trillion. Assuming that the liquidity conditions have to be maintained at the same level as last year, at least that 2 trillion has to be injected as primary liquidity," said Dave, adding that the liquidity injections have been far below that.

So, will RBI yield to pressure from banks and ease liquidity through a cut in the cash reserve ratio. Bankers and economists are hopeful and say RBI is sympathetic to the issue. But they may choose to wait until a review of the liquidity framework—which the central bank is currently in the midst of—is completed.

Ira Dugal is assistant managing editor, Mint.

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