Decoded: Why higher circulation of currency is normal in abnormal times

In India, cash in circulation continues to remain high. While the currency with the public has expanded substantially, there appears to be some moderation in the pace of growth. As on April 9, year-to-date, the currency with the public rose by 16.7 per cent. In mid-February, it was rising by 21 per cent. Anything above 12-13 per cent growth in currency with the public is considered abnormal, but then this situation also dep­ends on the circumstances.

So, is this an abnormal growth?

When one adjusts the present currency with the public (Rs 27.9 trillion) with the gross domestic product (GDP), the growth rate is about 14.6 per cent.

Theoretically, the currency with the public should expand in sync with the nominal income, which again moves in relation to the nominal growth rate of the economy. But the correlation breaks easily when other factors come into play.

One reason for this is the demand for currency. Typically, the currency in circulation swells during the time of elections and definitely during festive seasons. But this can happen in times of stress, too. For instance, during demonetisation announ­ced on November 8, 2016, it spiked 37 per cent. This time, the stress is caused by the pandemic.

There can be a purely technical reason as well. As the Reserve Bank of India (RBI) expands its asset books by bonds and foreign exchange reserves, it balances its liability side typically by printing currency. That’s how the term “deficit monetisation” came into play.

Why did the RBI balance sheet expand? 

The RBI’s balance sheet expanded 30.02 per cent — from Rs 41,029.05 billion as on June 30, 2019, to Rs 53,347.93 billion as on June 30, 2020, as it accumulated nearly $100 billion worth of reserves and bought government bonds.

In the last fiscal, the balance sheet must have expanded substantially as the RBI supported the government borrowing programme by buying Rs 3 trillion worth of bonds, and it continues to do so in this fiscal through the G-Sec acquisition programme (Rs 1 trillion scheduled for April-June quarter). It will be a while before the annual report is out. The central bank continues to accumulate foreign exchange reserves on top of that. The RBI has to balance it out by printing more money.

How did this impact the currency?

A closely related indicator is currency in circulation (CIC), which is calculated as currency with the public plus cash with banks (which is not much). In the last one year, CIC has been expanding for a completely different reason other than festivities or elections. People could be panic hoarding cash fearing the hardships of a lockdown.

The CIC expanded 22.1 per cent in calendar 2020 as lockdowns were imposed due to the coronavirus pandemic. Such was the panic in the first four months (January to April) of calendar 2020 that the increase in CIC of Rs 2.66 trillion was more than the entire 2019 CIC (Rs 2.40 trillion).

What are the pros and cons of such an expansion? 

First, the cons. It stokes inflation in the long term. The good side: That is exactly what some central banks want.

It depends on the situation, really. For example, in developed countries, where central banks want more inflation, expansion of currency is desirable. But in a country like India, where inflation is a curse word, currency in circulation has to be curtailed to control inflation. Besides, in a loose contract economy, surplus cash could mean tax evasion. It also points to inefficiencies in the payments system, something that the RBI and the government are trying to fix through digitisation.

Currency with the public is a form of household savings. At the same time, it is a “leakage” from the system, which means the public is not keeping the money as deposits but preferring to make cash transactions.

Finally, it also means that deposit rates are extremely low. Now, if the deposit rates are increased, lending rates will have to go up, too. That is something the RBI would hope doesn’t happen till the economic recovery is on a firmer footing. So, this high cash float will likely continue for some more time.