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There is now a plethora of writings in the public domain analysing the pros and cons of the current demonetisation exercise. While such debates are always helpful to decipher policy nuances, we believe the time has now come to clearly move forward and understand the road to remonetisation. Alternatively, there is nothing wrong if we can evolve a policy consensus on the life after demonetisation, in terms of (a) when we will get back to normalcy and (b) what the future may look like. This article is all about these issues.
To begin with, the importance of currency is primarily to serve as a stable unit of account, a durable store of value and a convenient medium of exchange. We believe the introduction of Rs 500 currency notes in large numbers will fill the vacuum of serving as the medium of exchange between Rs 100 and Rs 2,000 notes. This is currently the largest operational hurdle, but we are convinced that such notes are coming back in plenty to the system December onwards, if we look at the printing trends. Rs 2,000 notes without Rs 500 in circulation are mostly a store of value rather than a medium of exchange.
A closer look into the Reserve Bank of India (RBI) data reveals that by December 10, the value of high-denomination currency notes was Rs 3,451 billion (Rs 4,610 billion net of low-denomination currency at Rs 1,159 billion). If we juxtapose this with the fact that the combined number of high-denomination pieces printed were 1.7 billion, it seems most of the notes printed were Rs 2,000-rupee notes (for example, 1.7 times Rs 2,000 is significantly closer to Rs 3,451 than 1.7 times 500, which is significantly different) by December 10.
Given that Rs 500-rupee notes are now being printed and also given that the regulator and the government are working overtime, we tried to deconstruct the most plausible date when the cash crunch is getting over. For this we constructed the following scenarios.
If only Rs 500 denomination notes are printed in December and January, then a total of 14 billion notes will be printed amounting to Rs 7,000 billion. Given that the RBI has already provided Rs 4,610 billion by December 10 it means that around 50 per cent and 75 per cent of the total value of extinguished notes can then be supplied by December-end and January-end respectively. Now in February, we can have three scenarios.
First, we can assume only Rs 500 denomination notes are printed in February also. This in turn ensures that 98 per cent of the extinguished currency is back in circulation by February 2017. Second, we may assume half of seven billion is printed in Rs 500 denomination and the rest in lower denomination notes (keeping the share of different denominations in the same proportion as it was in the data provided by the RBI for November 10-December 5) in February. This would result in 88 per cent of the extinguished currency coming back by February 2017.
Third, we assume only lower denomination notes are printed in February keeping the share of different denominations in the same proportion as stated above. This in turn ensures 78 per cent of the extinguished currency coming back in circulation by February-end.
However, as the government has already stated that the entirety of the exhausted currency will not be printed and some amount of shifting to digital modes is expected. This rules out the first scenario getting implemented. The second and third scenarios both seem plausible.
Clearly, it seems within the next two months things would be pretty close to normal. Interestingly, this number can go up to 98 per cent if we disregard the currency composition. It is thus incorrect to say the problem will linger on for a significant period as many commentators are indicating.
How do we arrive at this date? The RBI has provided 21.8 billion notes till December 10 and assuming it started printing in September, this leads to an average of 7.3 billion notes per month. However, since the RBI would have printed some of the low-denomination notes out of the 21.8 billion earlier, we can safely assume an average of seven billion monthly printing capacity. Clearly, this is a gargantuan effort by the banks and the RBI to get the system up and running and let us appreciate it wholeheartedly!
In the interregnum we also suggest that the government and the RBI look carefully at the cumulative withdrawal (a proxy for cash requirement) to cumulative deposits ratio across states and wherever it may be low, they could reorient the currency supply. Also states like Uttar Pradesh, Madhya Pradesh, Maharashtra, Andhra Pradesh, West Bengal, Punjab, Haryana, Bihar and Gujarat which are agriculture-oriented cash-dependent may face more issues during this cash crunch period. This may be resolved by putting more cash in the rural areas there.
Now what happens after February? If we assume that growth of total currency in circulation should be equal to growth of the economy (given by GDP growth), then the excess cash floating in the economy comes out to be around Rs 3,000 billion. Also a 10 per cent target of currency in circulation as a percentage of GDP looks reasonable given the global numbers. This also makes excess cash around Rs 3,000 billion. Furthermore, taking the loan portfolio as a proxy for cash requirement, the excess cash comes out to be around Rs 695 billion in the services sector which can be shifted to electronic mode of payment, thus taking down the cash requirement. The best thing, however, is that with at least a seven per cent jump in small-denomination share in the overall currency post-demonetisation, it would enable money more as a medium of exchange and thereby get accounted rather than as a store of value! This could engineer a decisive behavioural shift in people preferences over time and more formalisation of the economy. Already, there are evidences in that direction.
The author is group chief economic advisor, SBI
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
