BackCurrency holdings growth explained by rural wages, says JPMorgan
67% of the recent increase in higher cash holdings in the economy can be explained by rural wages alone, says report
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A study by JPMorgan Chase Bank’s India economists says the sharp rise in currency holdings with the public in India is explained by a rise in rural wages.
“The real growth of currency-in-circulation has a stable, long-run relationship with the rural economy, as proxied by real rural wages," wrote economists Sajjid Z. Chinoy and Toshi Jain in a 14 September report.
Their model shows 67% of the recent increase in higher cash holdings in the economy can be explained by rural wages alone.
At the end of August, annual growth of currency in circulation was 17.6%, a clear 7 percentage points higher than a year ago.
The growth in cash holding started around September 2015, led to tighter liquidity conditions and has been one of the reasons for the central bank to shift its liquidity stance.
Conventional wisdom said currency holdings with the public shoots up during elections. But public currency holdings growth continued to accelerate after the assembly elections in May.
New reasons came into vogue. Some economists said it was owing to a rise in service taxes, while others said it was driven by the government’s stricter rules for purchase of gold jewellery, leading to people holding on to cash.
The JPMorgan economists said the currency holdings growth seems to mimic the rural economy. As rural growth accelerated sharply in the mid-2000s because of government programmes such as Bharat Nirman and the Mahatma Gandhi National Rural Employment Guarantee Scheme, currency holdings also grew.
Conversely, the rural economy slowdown since led to a moderation in currency holding growth till the end of 2015.
That the currency growth can be explained by the rural economy is also “consistent with the fact that other indicators (motorcycle sales) suggest the rural economy may be inflecting," wrote Chinoy and Jain.
Why is this important?
As rural incomes grow even more—on the back of a better monsoon and good harvests —there is a possibility that currency holdings growth will accelerate even more. Thus, if the Reserve Bank of India (RBI) stays committed to its stance of keeping the liquidity deficit neutral, it will make the process of liquidity management more challenging.
That will either necessitate more dollar purchases (releasing rupees into the system), which appears difficult because of the coming repatriation of FCNR(B) deposits or buying more bonds though open market operations. RBI has already purchased Rs1 trillion worth of bonds this fiscal.
To be sure, a balance of payments surplus and robust capital inflows will reduce the pressure on open market bond purchases. But a large amount of bond buying from RBI will help transmission, Chinoy and Jain added.
However, that also adds to RBI’s problems. If rural growth accelerates, it pushes up inflation and currency in circulation. “But that’s a potential conundrum for a later date," they wrote.
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