Cash questions

Increased currency circulation is intriguing

One of the most significant developments of recent years is the widespread adoption of digital payments. Facilitated by the Unified Payments Interface, between 2016-17 and 2022-23, digital payments expanded at a compound annual growth rate of 51 per cent in volume terms, and 27 per cent in value. However, intriguingly, despite the adoption and acceptability of digital payments — demand for cash, as reflected by currency in circulation (CiC) — has also been growing. A new research paper by economists at the Reserve Bank of India has analysed this issue. The paper underscores that the use of currency notes as a payment medium is falling, but the demand for cash is being driven by precautionary and store-of-value motives.

The paper has analysed the factors influencing demand for currency. The share of large-denomination banknotes has been increasing. Along with lower withdrawal of cash from automated teller machines, this suggests that digital modes of payments are substituting cash in low-value transactions, but people are depending more on cash as a store of value. The demand for cash increased significantly during the time of Covid-19 pandemic. In 2020-21, CiC increased by 16.6 per cent, against an annual average of 12.7 per cent during the past decade. The demand later moderated, as a result of which CiC was down to 13.2 per cent of gross domestic product (GDP) in 2021-22, compared to 14.4 per cent in 2020-21. Notably, CiC is higher than the 11.5-12 per cent of GDP in the pre-demonetisation period. Disruption caused by the pandemic could be one of the reasons. The GDP would have been higher in the absence of that disruption. It is also possible that the pandemic has led to a behavioural change and people are now keeping more cash to deal with uncertain situations.

There could be other reasons as well. As the paper notes, the informal sector depends on cash for statements, which may be driving the demand. This may be an indication of the growing informalisation of the workforce. The rise can also be attributed to higher inflation in recent years. CiC tends to grow during episodes of high inflation. The rise in both digital and cash usage can be partly explained by the success of direct benefit transfers: The benefits are transferred through digital modes, but their actual usage is in cash because of a variety of factors. While there can be various explanations for higher CiC, the increase is still significant, particularly given the surge in digital transactions. It is possible that cash is still being used in large transactions to avoid taxes. Sectors such as real estate are particularly prone to such practices. Recent reports of cash seizure, especially at the time of elections, suggest that illicit cash is still being generated in the system with all its attendant ills. This means that tax authorities will need to be more vigilant in checking evasion of both direct and indirect tax payments. Nonetheless, irrespective of potential issues associated with the high CiC, the surge in digital transactions is worth celebrating. It has not only increased the ease of payments, but the trail of digital transactions has also brought a large number of small businesses into the formal financial system. This can help in many ways, including improved access to formal credit.