The first three months of fiscal 2020-21, which also cover the lockdown period, have seen the currency in circulation increasing by Rs 2.13 lakh crore to Rs 26.60 lakh crore in the system. It is more than two third of the total increase in the fiscal year 2019-20. That was the period when India's gross domestic product (GDP) fell to 4.2 per cent. Despite a consistent fall in the GDP numbers and consequently the nominal growth, the currency in circulation is on the rise.
The currency in circulation stands at Rs 26.60 lakh crore in June 2020, compared to Rs 24.47 lakh crore in March 2020. Such a rise would push the currency in circulation growth to over 17 per cent in the coming part of fiscal 2020-21. Is Indian economy heading towards yet another period of high currency in circulation?
According to the Reserve Bank of India (RBI), there were only four occasions during the last fifty years when currency growth was higher than 17 per cent for three to four consecutive years. On three occasions - 1987-90, 1993-96 and 2005-09 - higher currency demand was caused by relatively high nominal GDP growth.
But the higher currency demand on the fourth occasion, in the period between 2017 and 2020, was largely on account of remonetisation of the economy post the demonetisation exercise in November 2016. As a result, the high growth in currency in circulation was witnessed between 2017 and 2020 despite low nominal GDP growth.
In a post COVID-19 world, the global economies are facing a new monster, which is recession. The central banks of the world have already created a sea of liquidity in the market to save their economies. Back home, the RBI is also infusing liquidity into the system.
As a result, the low nominal growth and the rising digital transactions have no effect whatsoever in reducing the currency in circulation. The numbers are rising at a rapid pace because of the aggressive open market operations by the RBI. The former RBI Governor Raghuram Rajan recently wrote that the monetisation (printing) will neither be a game changer nor a catastrophe, if done in a measured way. "In fact, India is already doing it! However, the caveat - it should be measured - is key."
The need for more economic stimulus and the likely debt monetisation in future may push the currency in circulation to a higher level for a long period of 2-3 years.
A RBI study on 'Modelling and Forecasting Currency Demand in India' has listed out digital payments, high nominal growth rate and low or high interest rates as key factors influencing the currency in circulation in the system. The study covers an extended period of 50 years.
"Digital payments are playing an increasingly important role in changing the payment habits of economic agents. The increased use of digital payments in the recent period has reduced the demand for currency, which has important ramifications for currency demand in the future," says the RBI report.
Currency in circulation is the hard currency in an economy which is used for transaction or business.
The RBI paper says, "the currency demand in the foreseeable future is expected to grow broadly at the same rate as nominal income, which serves as an important guide for policy making."
But given the lower growth trajectory in the economy, the demand for currency will certainly slow down. However, there is also a need for stimulus, which would increase the currency in circulation.
The RBI paper also says, "the currency expands relatively at a faster (slower) pace in a low (high) interest rate environment when the opportunity cost of holding money is low (high), given the inverse relationship between currency demand and the interest rate."
Going forward, the interest rate environment is also looking benign, though the demand for currency will be an issue because of job losses, lower income etc.
The third point raised by the RBI report is on the rise of digital transactions. "Since digital transactions (especially credit and debit cards) have a dampening impact on currency demand, there is a need to sustain the current thrust on digital transactions if currency growth is to be further moderated," says the report.
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