Soumya Kanti Ghosh: Unravelling the flush-with-cash puzzle

Currency with the public surged by 34 per cent this fiscal even as some of the markers for such an increase behaved contrarily. But one thing is for sure: people have become more cautious about their transactions

There is something cooking with the public at large. In the current fiscal, currency with the public has jumped 34 per cent. This recent growth in currency with the public is quite puzzling, as none of the economic indicators validate such a level of growth. The only time currency with the public expanded at a more ferocious rate was in fiscal 2011 when it soared 53 per cent, but that, as all of us know, was in the midst of a huge fiscal stimulus in the aftermath of the financial crisis. So what's the black box of this increase?

In simple economic parlance, an increase in currency implies possibly a high precautionary demand for cash. However, with inflation on the decline and under control - in fiscal 2011 inflation was at 11 per cent - the question is whether such a high currency demand basically reflects uncertainty about the prospects of the economy. In fact, as on February 26, even with a reserve money growth of 12.6 per cent - which itself is a statistical aberration - M3 (money supply) growth was stunted at 11.3 per cent, a worrying factor. This suggests that the growth of the money multiplier is actually negative and indeed getting adversely impacted by such a high currency deposit ratio.

Leaving aside the precautionary motive for the time being, an increase in currency with the public should improve real economic activity like industrial production/Index of Industrial Production (IIP), as it creates demand for goods. This is also supported by econometric estimates. However, that is not happening, as IIP growth has been consistently negative for the last three months.

Let us examine the IIP growth in detail, as herein may lie the answer. One of the most surprising aspects of IIP growth in the current fiscal is that during April to December 2015 while IIP grew 3.2 per cent, the weighted contribution of only gems and jewellery (G&J) was at 38.4 per cent, implying that the contribution of all others was at minus 35.6 per cent! Juxtapose this with G&J production growth at a whopping 97.1 per cent (minus 2.1 per cent last year) during the same period. This surge in production was entirely attributed to domestic demand, as exports have declined nearly 12 per cent in the April 2015 to February 2016 period. The poor performance of exports of this sector has not been witnessed before in India, except in FY14 when G&J exports declined around 13 per cent.

There have been reports of loss of jobs in this sector. Also, import duty on gold has increased even as India has signed long-term contracts to buy roughs from Russia and Budget announcements have drawn criticism from the sector. Thus, none of this adds up to such a buoyant growth for this sector.

If we were to draw a link between such a surge in production and the usage of cash, it is possible that demonetisation might have begun even before the government had withdrawn high-value notes from circulation (according to unconfirmed reports, higher currency denomination notes may be discontinued in the near future so as to tackle the menace of unaccounted money). If this is true and with the government, through the Budget, giving people a window to declare unaccounted money over the next six months, this demonetisation trend may actually increase manifold.

This trend behaviour may also be due to the recent introduction of norms that make use of PAN mandatory for purchases over a threshold value. Additionally, over time, the average transaction value per credit card is increasing and in the last four years it has almost doubled. By that logic, currency with the public should have decreased. Average debit card transaction, however, is on the decline. This means that people are possibly paying in cash for unknown reasons and are shunning transaction by cards whenever possible. Even if one were to visit departmental stores now, most people would be seen paying in cash. Is this due to a fear of high-value transactions getting tracked? We don't know yet. But one thing is for sure: people are now more cautious in their transactions.

The possible replacement of high-value notes has also resulted in such notes disappearing from ATMs in the hinterland. This could also lead people to withdraw large amounts for the sake of convenience and to avoid paying withdrawal charges for free ATM transactions.

Such a currency increase defies logic; it has diverse explanations and needs analysis. One way out of the issue is popularising the digital and electronic channels. The total numbers of point-of-sale (POS) machines and ATMs in the country are 1,270,208 and 192,208, respectively. This is inadequate for a population of 1.3 billion. Further, it is not possible for everyone to walk around with POS machines. "Mobile wallet or digital wallet" (hereafter called wallet) will probably be the answer to this problem. The total number of wallets in the country would be in the range of 160 million on the outside. Currently, these are available only in English and on smartphones. At present, many people are using multiple wallets, so the population covered by them is far less than their actual number of 160 million. Also, the efficacy of these wallets improves with good connectivity, which is still not available, especially in several hilly and less populated parts of the country that are classified as black and grey areas.

The author is chief economic advisor, The State Bank of India. The views are personal