Cash holdings in the system (Currency in Circulation, CIC) in FY16 till March 20 have increased by Rs 2.24 lakh crore, compared to Rs 1.44 lakh crore in the same period in FY15 and Rs 1.09 lakh crore in FY14. This has contributed—in addition to the fall in foreign currency flows (Balance of Payments) in FY16 relative to FY15—to very tight market liquidity conditions, and consequent clamour for RBI to increase liquidity infusions in its monetary policy review. While the implications of the rise in cash are more or less clear, the causes are obscure and deserve a deeper inquiry, since, inter alia, this has implications for liquidity projections in FY17.
The increase in cash is also somewhat paradoxical and surprising. The Union government and RBI have expressed a strong desire to move to a less-cash economy, and have implemented many measures to promote the use of digital payments, including electronic money transfers and Direct Benefit Transfer. The National Payments Corporation of India has implemented standardised payment protocols and switches, to shift more payments online. Yet the result is a significant increase in currency holdings.
Outside of RBI, there is simply not enough data available to follow the trail of increased cash, so we have to limit ourselves to some forensic analysis to the extent possible, and beyond that flag certain possible causes. This analysis is as follows.
The accompanying chart shows the cumulative increase in system cash holdings, from April 1 onwards, for 5 years starting 2011-12. To an extent, an increase in cash is understandable, to facilitate transactions associated with an increase in nominal GDP. But the outgo in FY16 has been inordinately high; cash outgo has risen by about Rs 80,000 crore in FY16 compared to about Rs 34,000 crore in FY15 (cash-to-GDP ratio went up from 11.1% to 11.8%). And the pace of cash outflow has been increasing in the past few weeks.
How was this cash sourced? ATM cash drawals in FY16 (April-January) were Rs 21 lakh crore, versus Rs 18 lakh crore during the same period in FY15 and Rs 20 lakh crore in FY14. So the change in FY16 cash drawals of Rs 42,000 crore is lower than the change in cash outgoes of Rs 80,000 crore noted earlier. Also, month-wise increase in ATM drawals in FY16 over FY15 have been steady, with no evidence of the November spike in cash holdings. Ergo, a major part of the increase in cash seems to have largely been non-ATM sourced. There is some evidence of a behavioural change in ATM drawals post the levy of charges since November 2014, with larger amounts drawn per transaction, but this only deepens the gap between the currency leakage and ATM cash.
The first trend which is striking in the chart is that increase in cash in FY16 was normal till (the festive season) October-November, at which point it shot past the FY15 trend. This non-linearity—the November spike—is the puzzle, but the inception coincides with the Diwali festival in early November 2015. So the presumed link is with gold and jewellery (G&J) sales during that period. But the IIP data over the period shows a disconnect. Growth in the ‘furniture’ segment of the IIP (of which G&J is a large part) shows a sharp increase over August-October 2015, before a reversion to more normal levels. Cash outgoes in the 3 weeks centred around Diwali in FY16 was about Rs 66,000 crore (versus Rs 30,000 crore in FY15). Could gold purchases have gone up by Rs 36,000 crore in FY16 Diwali? Unlikely; that’s about $6 billion. India imported $17.4 billion of gold and precious stones during August-November 2015 and exported $13.4 billion. In the same period in 2014, these were $22.5 billion and $15.6 billion, respectively. Without going into the details of the conversion of this trade into domestic sales, this does not suggest a sharp increase in net domestic sales anywhere near the magnitude of the increase in cash during that period. There is a surge in domestic G&J output in FY16, but a bulk of this was prior to the late November spike. Some prior years have also witnessed large gold demand, but the cash surge is not pronounced in those years. One inference, however, is that more festive season gold buying in FY16 was in cash, for whatever reason.
The second observation is that the cash leakage post the spike has persisted. Why? From late November, could rising subventions by the government as part of drought alleviation programmes to rural areas explain part of the increase? The Centre’s food subsidies have gone up between April-January 2016 to Rs 1.32 lakh crore versus Rs 1.12 lakh crore in same period of FY15. That’s a change of Rs 20,000 crore. In addition, some of the Centre’s larger transfers to states—coupled with the funds from the higher borrowings of states—might be disbursed by states as drought relief assistance.
The third feature is a surge in cash outgo in the 4 weeks beginning March 4. One hypothesis is that this is due to the onset of campaigns for the forthcoming state elections. While a similar urge was not evident during the run up to the 2014 general elections, we are led to believe that state election campaigns, with their closer proximity to block levels, are more cash intensive—an intriguing but untestable hypothesis based on public data. Yet there is also the November 2015 spike, which coincided with the last state election.
Speculation that cash transactions have increased due to stricter tax compliance have gained ground, yet there have been no specific triggers for the mid-year spike. Whatever the cause, the surge in cash in FY16 was certainly unusual, but if the hypothesised reasons are indeed correct, it might not be repeated in intensity for much of FY17.
(With contribution from Tanay Dalal)
The author is senior vice president and chief economist, Axis Bank. Views are personal.