Has note ban made money more efficient?
It is now nearly eight months since November 2016. As on July 7, 2017, the newly printed currency in circulation (CIC) reached 84 per cent of the extinguished one (CIC at 86 per cent of pre-demonetised levels). In addition, cash on hand with banks, a CIC component has now declined to 5.4 per cent of the former (from the peak level of 23.2 per cent in November 2016).
Even as the economy is now close to complete remonetisation, two issues continue to hog the limelight: (1) Whether ATMs are now churning out currency according to the customer needs and (2) the tangible benefits from this humongous exercise. We take up these issues one by one. Before we address such issues, let us make some reasonable estimates of currency printed by the Reserve Bank of India (RBI) of different denominations till date. Given that RBI has refrained from publishing the currency notes printed after December 19, 2016, any estimate of currency notes will be based on certain assumptions.
RBI publishes the number of currency notes printed of different denominations in its annual report. In March 2016, there were 16 billion and 6 billion pieces of ~500 and ~1,000 notes, respectively, aggregating 48 per cent and 38 per cent of the total currency value. There were also 16 billion pieces of ~100 notes, contributing 10 per cent of the total value. The remaining 4 per cent of the currency value were contributed by notes up to ~50, which aggregated to 53 billion.
Now fast forward to current printing status. According to RBI’s annual report, it placed indent for 24.6 billion pieces for FY17. Assuming that printing presses supplied the requisitioned as well as extra amount which was printed to meet the demand arising out of demonetisation, possibly an incremental 37 billion pieces of currency notes of small denomination, constituting 28 per cent of the total value (14 per cent earlier), are now in circulation. Even if we assume that the remaining amount is divided equally between ~500 and ~2,000 denominations or 72 per cent in value terms (12-13 billion pieces of ~500 and 2 billion pieces of ~2,000), this means an incremental ~2.5 lakh crore of notes in value terms are still to be printed (3-4 billion pieces of ~500 notes may not have been printed) if we replenish the entire demonetised stock. Herein lies the importance of new ~200 notes.
Going by the above data, it thus seems that there has been a significant move towards relocating distribution of currency towards smaller denominations post demonetisation. However, while such a move is laudable and consistent with the long-term vision of a less cash economy, we also need to consider the following. Though the number of small-denomination notes has increased, the mismatch caused by the presence of ~2,000 denomination straight after ~500 denomination is causing difficulties in exchanging the high-denomination notes. Interestingly, this may also be resulting in people holding back smaller denomination notes like ~100.
Whatever be the reason, an ATM machine typically holds 10,000 bills and if these were to comprise say only notes of ~100, the number and cost of replenishment goes up significantly. Herein lies the paradox. Notes of ~2,000 denomination in ATMs may find few takers because of missing middle —~200.
How is this reflected in currency data? Historical trends suggest that cash on hand with banks is roughly 3.8 per cent of CIC and is currently at 5.4 per cent. This means at least an additional amount of 1.6 per cent or ~25,000 crore of excess currency may be currently lying in ATMs because of reasons as pointed out above.
How does all these add up for our answer to question number 1 as posited earlier? Yes, the ATMs are now churning out currency notes of smaller denomination like ~100. However, these notes have to be replenished quickly given ATMs’ holding capacities. In this context, ~200 notes can be a missing middle between ~500 and ~2,000.
Let us now come to the second question. One of the most perceived benefits of demonetisation is declining velocity of money (defined as GDP/currency with public) as we progressively move towards digitisation. It is an irony that income velocity of money that was at 8.8 in FY1960, was mostly in double digits till FY2000, after which it has been consistently in high single digits.
If we try to juxtapose it with the monthly income velocity, velocity on an average during H1FY17, it more than doubled after demonetisation (Q3FY17). However, velocity since Q3 has been declining. This in turn implies that situation is improving with sufficient amount of cash available for transaction in the system, though the velocity is still higher than pr ede mon et is at ion levels.
Interestingly, the significant increase in income velocity during demonetisation defies a conventional explanation in economic terms. In economic parlance, velocity of money is stable and is primarily determined by the level of economic activity among others. The only way velocity of money could have jumped in Q3FY17 was possibly that economic activity in the informal sector was supported largely by credit, given that cash was not forthcoming. If this is true, this may also explain why Central Statistics Office’s (CSO) gross domestic product numbers for Q3 defied all odds to fetch up a growth in excess of 7 per cent! The surge in consumption in the CSO estimates during this quarter also becomes easier to substantiate with these unorthodox explanations.
To sum up, if velocity of money continues to decline, it would mean money is indeed becoming more efficient post demonetisation amidst increased digitisation! It can, however, also be argued that close to ~3 lakh crore of CIC in the banking system is still idle and this may be driving the velocity down. But the good thing is that there has also been a cultural transformation in the psyche of customers who are now doing more than 40 per cent more transactions at PoS (point of sale) machines compared to pre-demonetisation levels! This means that a large part of such idle cash could be a permanent money creation in the banking system, driving down the cost of credit in natural progression!