Cash taken out of system finds its way back in India2 min read . Updated: 13 Apr 2020, 11:29 PM IST
The currency circulation to gross domestic product (GDP) ratio, a measure of the total cash going around in the financial system, touched 12% for the first time since the demonetization of ₹500 and ₹1,000 notes in November 2016. Mint takes a look.
How was the 12% figure arrived at?
The total currency in circulation as of 27 March was ₹24.39 trillion. GDP for 2019-20 is projected to be ₹203.85 trillion. Hence, the cash in the system works out to 12% of GDP. The actual figure might turn out to be higher than 12% of GDP. The GDP forecast for 2019-20 was made before the covid-19 crisis struck. Thanks to the restrictions put in place to prevent the spread of covid-19, economic activity is bound to have taken a beating in the last 15 days of March. As such, the actual GDP for 2019-20 might turn out to be lower than ₹203.85 trillion. With a lower denominator, the cash in the system will be higher than 12% of GDP.
How high could the cash in circulation be?
Let’s say GDP for 2019-20 comes in at ₹200 trillion. The cash in the system then works out to 12.2% of GDP. The currency in circulation figure we have is for 27 March and not 31 March—the end of the fiscal—which is likely to be higher. The currency in circulation as of 3 April was ₹24.57 trillion. So, the currency in circulation has been rising week-on-week and, hence, the average as of 27 March and 3 April can be a good estimate of the currency in circulation as of 31 March. This works out to ₹24.48 trillion. With these adjustments, the cash in the system works out to 12.24%, higher than in March 2016, before demonetization.
Why have currency notes in the system been increasing?
The cash in the system as of March 2016 was 12.1% of GDP. This fell to 8.7% of GDP as of March 2017, as notes of ₹500 and ₹1,000 were demonetized and had to be deposited into banks. It took time to replace these notes. Since then, it has risen year-on-year, crossing 12% as of March 2020. Hence, the cash taken out of the economy has gradually found its way back.
What’s the short-term reason for cash spike?
With the fear of covid-19 spreading being firmly entrenched in the minds of people, cash withdrawals have seen an increase. March saw a 4.3% increase of cash in the system in comparison to February. This was the highest in the last five years, if we ignore the four months post December 2016 following the note ban, when the cash in the system increased rapidly. Also, some of the increase can be attributed to the government putting money into the Jan-Dhan accounts and people withdrawing that money.
What is the learning from this occurrence?
A theory has been built around more cash in the system indicating higher corruption. That’s not true. A country like Japan has more cash in the system than India, but is less corrupt. The corrupt hold just 5% of their wealth in cash. A bulk of the wealth is held in the form of gold, land and flats. The higher cash in the system shows sections of the economy that had been destroyed after the note ban have healed to an extent. Of course Covid-19 changes the story.
Vivek Kaul is a Mumbai-based economist.