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Friday, April 15, 2016

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The curious case of rising currency in circulation-Live Mint
Rising currency in circulation along with slowing deposit growth is worsening the liquidity crunch .

The rate at which currency in circulation is increasing in the Indian economy is moving up. The rate at which deposits in the banking sector are growing is moving down.

Together, these two factors are worsening liquidity conditions in the banking sector, putting banks and the Reserve Bank of India (RBI) in a spot.

While the latter is more easily explainable, the former is confounding many in banking circles. Here’s what the data shows.

Currency in circulation, a reflection of the cash in use, has risen by 15.4% in 2015-16 (data for the last week of the year is yet to come).

In FY15, the growth in currency in circulation was lower at 10.7%.

The higher growth this year appears to run counter to most factors that typically drive currency in circulation.

The key among these factors are higher inflation (which necessitates more spending)

or higher transactions in sectors like retail and real estate (where there may be chunky payments in cash).

There are other factors like elections, which also lead to temporary spikes.

The reason FY16’s jump in circulation is puzzling is because inflation has not moved up compared to last year and transactions in sectors like real estate, by all accounts, have been down for most of the year. While state elections, such as in Bihar, may explain a temporary spike, they don’t explain why it has persisted.

The weekly growth rate since the start of FY16 was between 9% and 11% till November. It was only in mid-November that growth in currency in circulation jumped to about 14%, and since then it has remained at 12-15%.

So what’s going on?

There is no clear answer but there are a few theories, some backed by data, some not.


Is rise in currency in circulation because of state polls or higher growth?

This time around, the currency surge is on the higher side, compared with historical data, which is unusual because economic growth is weak and inflation is low

Currency in circulation has increased 15.5% in the month of March, the highest year-on-year increase in a month since May 2011, ahead of state elections in Assam, Kerala, Tamil Nadu, West Bengal and Puducherry.



RBI Governor Mr. Rajan said, “Around election time, cash with the public does increase; you can guess as to reasons why; we also guess. And you see some not just in the state which is going for elections but also the neighbouring states. So, there is something there, we need to understand it better, but it is about Rs.50,000 to Rs.60,000 crore more than we anticipated at this time of the year.”

This time around, the currency surge is on the higher side, compared with historical data, which is unusual because economic growth is weak and inflation is low.

“The sharp spike in currency circulation is unusual, especially as nominal GDP (gross domestic product) growth remains in single digit.

Elections are not new to India and the spike cannot be solely attributed to it. We need to watch out the trend,” said Anubhuti Sahay, head, South Asia economic research (India), Standard Chartered.


Note that currency with the public also moved up last November, when we had the Bihar elections.

There were minor spikes during the state elections in Delhi and Jharkhand and Jammu and Kashmir last year.

But also note that the growth in currency with the public went down at the time of the state elections in Haryana and Maharashtra last year.

The chart shows there have been several instances where state elections did not lead to a spike in currency with the public.

What is the impact of higher currency in circulation?


If currency leakage remains high, it will make the process of liquidity management more challenging and can necessitate more open market operations to infuse liquidity.

More currency with the public could also be one of the reasons for low deposit growth.Ltd.

The divergence between deposit growth and currency in circulation has happened only thrice before in the last two decades—in the second half of fiscal 1999, FY04, and in FY11. These were periods when economic momentum started to revive, begging the question that Credit Suisse poses in its note dated 4 April—is the rise in currency with the public an indication that economic momentum is picking up again?

This is what Raghuram Rajan said in his post-policy conference call with researchers and analysts: “I doubt that there is a structural change in the economy which suddenly requires more currency. So, at least till I see the data, till the data persuades me otherwise, I think this is temporary rather than permanent.”


Why is currency in circulation in India rising?



There were flurry of articles towards end of India’s financial year on this murky term – currency in circulation. All these were looking at possible reasons for sharp rise of currency in circulation.

The question is why should anyone care?

Well, one sees this circulation rising in times of high inflation as people need more money to settle transactions. But with declining inflation, one should not see a rise in the currency numbers.

First what is this Currency in circulation?

This is basically all the paper notes we carry in our pockets. This along with rupee coins and small coins with RBI form currency in circulation. Rupee coins and small coins in the balance sheet of the Reserve Bank of India include ten-rupee coins issued since October 1969, two rupee-coins issued since November 1982 and five rupee coins issued since November 1985.

Next, what is the problem?

See this table:


As we can see currency in circulation has increased by nearly 48% year on year in 2015-16 and 34% in 2014-15. The growth in 2014-15 was also on account of a deceleration in currency growth previous year by 11%.

This is large growth especially when we look at falling inflation numbers. :


The recent increase in currency with the public is confounding economists, as by the numbers it seems the citizenry is hoarding cash in a falling inflation climate. At a time when a majority of Indian households hold a bank account, after the Pradhan Mantri Jan Dhan Yojana, the preference to keep cash handy could be a strong indication of a booming consumer sector but that largely is not the case. Generally, cash in circulation should increase when prices are on the rise at a faster clip and should fall with a slowing of inflation.

“However, with inflation on the decline and under control… the question is whether such a high currency demand basically reflects uncertainty about the prospects of the economy,”

Currency in circulation at the end of 2015-16 on Thursday had risen 15.7 per cent to Rs 2,26,630 crore from Rs 145,080 crore a year before, a rise of Rs 82,000 crore. The growth was 11.2 per cent a year before.
Yet, Consumer Price Index-based inflation was 5.18 per cent in February, down from 5.69 per cent in January. The Reserve Bank of India’s own target is to contain inflation below four per cent in the medium term, which economists say is achievable.

Any increase in currency in circulation points to a leak in the banking system, as otherwise cash gets deposited with the bank, which goes for investment. Currency in circulation does rise during the festive season around October but by the end of the financial year, the situation normalises. This time it hasn’t happened and nobody is sure why.  
First, all this talk of low inflation is plain non-sense.  There are two inflation numbers – one tracked by policymakers & analysts and another faced by people. The latter is always some 4-5% higher than official estimates.

Second, lower inflation does not mean prices have declined. All it means is rate of growth has become lower compared to last year. SO if inflation was 10% last year and 5% this year, it means prices are continuing to rise. They are actually higher than last year prices. But both policymakers and media misguide people most of the time suggesting lower inflation means lower prices. People have to pay even a higher amount for their basket of goods. If one adds unofficial inflation to the official figure, it implies people will continue to need more cash to settle their transactions.

Third, all kinds of reasons have been given like elections, changing behaviour due to ATMs and so on. No one has looked at source of the problem. Currency in circulation does not rise on its own. It is basically an outcome of central bank policy. In this case, it is the continuous boosting of forex reserves which has led to rise in this currency in circulation.

Let me explain.

Currency in circulation are liabilities of the central bank balance sheet. On assets we have government securities and foreign securities as the main assets of a central bank. In a central bank balance sheet there are many non-monetary liabilities (like reserves, profits etc) which form part of liabilities and present a misleading picture. So, we have something called reserve money which subtracts these non-monetary liabilities from the liabilities to present a truer picture. This reserve money is also called as base money or high powered money in textbooks. See this primer for more  details prepared by your truly ages ago.

Simplifying things further, the remodeled balance sheet has liabilities as components and assets as sources. This helps one understand things directly.  There are other components and sources as well, but we just include these three as they constitute most part of the balance sheet nowadays.

Hence, source of rise/decline in currency is mainly these two sources – one’s own govt securities or foreign govt securities. Call it a sin of an emerging market central bank but it prefers to have more of foreign govt securities in their balance sheet which is also called as forex reserve. Whereas the developed world central banks mostly have their own govt securities in their balance sheet as we have also seen in QE etc by these banks.

So whatever source central bank chooses to push, it shows in currency in circulation. It is nothing but simple accountany – assets = liabilities.

In India’s case as forex reserves have risen in last few years sharply, so has currency in circulation. The share of Indian govt securities has been declining as can be seen from this table:
Growth number (year on year)
Currency in circulationG-secForeign Assets
Mar-1615.713.111.5
Feb-1613.72.714.3
Jan-1612.7-9.416.5
Dec-1513.0-22.515.4
Nov-1513.5-19.220.1
Oct-1510.9-22.019.5
Sep-1511.8-20.220.4
Aug-1510.4-12.420.7
Jul-159.6-7.116.8
Jun-1510.2-33.120.2
May-1510.7-36.822.6
Apr-1511.2-32.216.3
Mar-1511.2-44.317.8
Feb-1510.7-35.715.7
Jan-1510.5-29.113.0
Dec-149.6-19.011.5
Nov-148.5-15.48.8
Oct-149.2-20.112.6
Sep-1411.0-21.513.7
Aug-1411.2-19.47.2
Jul-1411.8-21.217.9
Jun-1411.6-2.112.7
May-1411.23.814.3
Apr-149.51.618.1
Mar-149.17.815.6
So, currency in circulation is not the cause but actually an outcome of a central bank policy. This is the first step in any analysis looking at rise in currency in circulation. It is first an accounting entry which we then use to draw economic inferences.

In earlier times, this accounting variable could be used to draw economic inferences as things were relatively controlled by central bank. There was a reason why we had something called money supply targeting where money supply was the tweaking variable. Soon, central banks relaised they had little control over this given financial innovations and flow of money across borders. So they stopped targeting money and moved to interest rates. In famous words of a central banker (from Canada I think) ” We didn’t leave money, it left us”.

Hence, it might not be right to just draw inferences from this number alone. It could be a lot more complicated and we need more data to understand currency usage in India. The currency numbers are not in line with broad reality, tells you the same thing as well..

Why Bank Deposit Growth Slowed To Lowest In 53 Years-NDTV

Total bank deposit grew by 9.9 per cent in the fortnight ended March 18, 2016, marking the weakest growth in 53 years. The fall in bank deposits is surprising because it comes at a time when real interest rate (interest rate minus inflation) continues to be high.

Typically, higher real interest rate gives investors more incentive to park their money in banks to earn inflation-beating return.


According to research by State Bank of India (SBI), deposit growth may be falling because of higher spending by people. Higher real rate in the economy is because of falling inflation and this may be forcing people to spend more, its research says.

Another possible reason for decline in deposits could be increasing outward flow of money from the country, the report said. The Reserve Bank had last year doubled the amount to $2,50,000 that Indian residents can spend overseas per year.

"The outward remittance under Liberalised Remittance Scheme has seen a huge jump as soon as the limits were revised. From $106 million in May 2015, the remittances reached $449 million in Feb 2016, a jump of 324 per cent,"
Another possible reason "could be increased money circulation in the system. That leakage is also leading to a fall in bank deposits," 

RBI chief Raghuram Rajan recently said that cash in people's hands is more by up to Rs 60,000 crore at present.

Mr Ghosh said that the "fall in deposit growth is a matter of concern and needs to be addressed head-on. Otherwise when the credit growth picks up, banks may be in a fix to address the asset liability mismatch."

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