Is the public hoarding cash? Look at income velocity for answers, says SBI

Income velocity based on currency with the public went down from 0.93 in October to 0.84 in March says a report from SBI's economic research department

Why are cash shortages being reported in several states, despite data showing a rise in currency with the public?  

A possible explanation for this conundrum is that cash is being hoarded by the public. One way to examine if this is true is to look at income velocity, the rate at which money changes hands. 

The Reserve Bank of India (RBI) routinely publishes three estimates of this, based on M3 (broad money), M1 (narrow money), and currency with the public. But, these are yearly estimates. The most recent ones show income velocity based on currency with the public rose to 10.97 in 2016-17, up from 9.28 in 2015-16. 

Now, a report by Soumya Kanti Ghosh, group chief economic advisor at State Bank of India (SBI), estimates that at the national level, income velocity based on currency with the public went down from 0.93 in October to 0.84 in March. This, the report says suggests that  “currency of higher denomination/Rs 2,000 is not getting adequately circulated in the economy”. 

Based on this data, income velocity declined to 9.55 at the end of 2017-18, from 10.97 in 2016-17. 

Now with currency with the public, as a percentage of total currency in circulation, reaching 96 per cent, it shows an adequate amount in circulation. So, this fall in income velocity suggests hoarding of cash by the public say economists that Business Standard spoke to.  

While state-wise estimates are difficult to get, the SBI report says its “internal estimates suggest that in Bihar, Gujarat, and the southern states, the income velocity is far less than the national average. The other states have also started facing issues, as there has been a ‘domino effect’, whereby any possible tendency to hoard cash might have spread”.

However, there are issues with the report’s estimates. For one, as monthly gross domestic product (GDP) numbers are not available, the SBI report assumes quarterly GDP is spread equally across all months.

Second, the fourth quarter (January-March) GDP estimates are derived from projections in the second Advance Estimates.

Third, rather than using GDP, one should use total output to estimate income velocity, says Pronab Sen, the government´s former chief statistician.
 
However, as the 201718 estimates for output have not been released, it is difficult to estimate velocity by using this method.
 
“It is not advisable to draw an inference on monthly income velocity.
 
First, if high denomination notes are substituted with lower denominations, the circulation velocity should increase.
 
It is also not advisable to compute velocity on a monthly basis, as the measure of aggregate income (nominal GDP) is not available on a monthly frequency,” says Radhika Pandey, consultant at the National Institute of Public Finance and Policy.