The Bad and the Good of too much currency in circulation

The currency in circulation has risen exponentially. What are the implications?

The total currency in circulation in India is rising inexorably. By the end of the first week of May 2021, it had crossed Rs 29 lakh crore.  A year ago, it had stood at Rs 25.4 lakh crore. And there are no signs that the rise in currency in circulation is going to slow down anytime soon. It would not have mattered if the economy were booming. It rings alarm bells when the economy is in the doldrums.

Till November 2016, when Prime Minister Narendra Modi decided to demonetise all existing Rs 500 and Rs 1000 notes, and replace them slowly with new Rs 500 and Rs 2000 notes, the “currency in circulation” was something that only economists  bothered to keep track of. The RBI would regularly bring out the data but the average person rarely wondered what it was or how it mattered. Currency in circulation is nothing but the total paper money, coins and demand deposits that are circulating in the economy.

That changed with demonetisation as the government’s favourite economists started using cash in circulation data to say that there was too much untracked cash in the economy giving rise to all sorts of ills – like tax evasion. Among other things, government spokespersons claimed demonetisation would boost digital transactions, while reducing the use of cash.

Digital transactions did shoot up, but as the RBI kept printing notes in accordance to the economy’s needs, and remonetisation took place, cash in circulation started rising once again and soon crossed the pre-demonetisation levels.

Why is that significant? The absolute level of currency in circulation is less important than its percentage to the GDP.  Normally, in a country like India with a large, informal economy, cash in circulation keeps going up largely in step with nominal GDP growth. But when it is going up much faster than the GDP is growing or if it goes up while GDP has shrunk  that policymakers start getting anxious. Currently, the cash in circulation as a percentage of GDP is over 14.5% — compared to the 12% it was even a year ago, and the 10% it hovered around in 2000-01.

Why is this happening? There have been multiple explanations that have been proffered. One reason is that in times of high stress and uncertainty, such as the one we are going through currently, people prefer to withdraw more money and keep cash at home. This is even though they might be doing a fair amount of digital transactions. They may, because of lockdown restrictions, also not be depositing money in their bank accounts. Again, it has been seen in the past that cash in circulation rises when elections take place or there is a festival season. Certainly, a few state elections are just over.

There are other reasons as well – such as if the RBI directly monetises government debt as it used to regularly till the late 1970s or needs to balance its assets and liabilities by printing more cash.

What are the dangers of too much cash in circulation? A big one is inflation. In many western developed countries, when the economy is very slow, central banks like to increase liquidity and cash in circulation in hopes to increasing demand and stoke a little bit of inflation. In India, the worry is too high inflation even when the economy is in a terrible shape – as seems to be happening currently. The WPI has crossed 10% — and is at an 11 year high. Retail inflation too has been somewhat higher than the central bank’s comfort levels, though not as much as WPI.

Beyond that, higher cash in circulation also means people are keeling less long term deposits in banks – which is not a particularly good thing because it affects the banking system’s ability to lend to businesses. And it also indicates a high level of uncertainty in households as they tend to hang on to their cash instead of putting it into savings or assets. It can, as the government keeps saying, also increase tax evasion and result in black money.


Prosenjit Datta

Prosenjit Datta is former editor of Businessworld and Business Today magazines

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