The sudden rise in currency holdings with the public has stumped analysts.
Currency in circulation has increased 15.5% in the month of March, the highest year-on-year increase in a month since May 2011, ahead of state elections in Assam, Kerala, Tamil Nadu, West Bengal and Puducherry.
Reserve Bank of India, or RBI, governor Raghuram Rajan, speaking after the monetary policy announcement last Tuesday, talked of the surge in currency in circulation ahead of the state elections.
In the press conference after the policy, Rajan said, “Around election time, cash with the public does increase; you can guess as to reasons why; we also guess. And you see some not just in the state which is going for elections but also the neighbouring states. So, there is something there, we need to understand it better, but it is about ₹ 50,000 to ₹ 60,000 crore more than we anticipated at this time of the year."
This time around, the currency surge is on the higher side, compared with historical data, which is unusual because economic growth is weak and inflation is low.
“The sharp spike in currency circulation is unusual, especially as nominal GDP (gross domestic product) growth remains in single digit. Elections are not new to India and the spike cannot be solely attributed to it. We need to watch out the trend," said Anubhuti Sahay, head, South Asia economic research (India), Standard Chartered.
The chart has the details.
Note that currency with the public also moved up last November, when we had the Bihar elections.
There were minor spikes during the state elections in Delhi and Jharkhand and Jammu and Kashmir last year.
But also note that the growth in currency with the public went down at the time of the state elections in Haryana and Maharashtra last year.
The chart shows there have been several instances where state elections did not lead to a spike in currency with the public.
What is the impact of higher currency in circulation?
If currency leakage remains high, it will make the process of liquidity management more challenging and can necessitate more open market operations to infuse liquidity, added Sahay. More currency with the public could also be one of the reasons for low deposit growth, pointed out D.K. Joshi, director and principal economist at credit rating agency Crisil Ltd.
The divergence between deposit growth and currency in circulation has happened only thrice before in the last two decades—in the second half of fiscal 1999, FY04, and in FY11. These were periods when economic momentum started to revive, begging the question that Credit Suisse poses in its note dated 4 April—is the rise in currency with the public an indication that economic momentum is picking up again?
This is what Raghuram Rajan said in his post-policy conference call with researchers and analysts: “I doubt that there is a structural change in the economy which suddenly requires more currency. So, at least till I see the data, till the data persuades me otherwise, I think this is temporary rather than permanent."