Cash is king, once again. Should you be worried? | Business Standard News

Clipped from: https://www.business-standard.com/article/economy-policy/bs-number-wise-cash-is-king-once-again-should-you-be-worried-121060800847_1.html

A BS analysis shows that a crisis leads to a higher demand for money, which is complemented by an increase in currency in circulation

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Have you ever wondered how much all the cash held by the entire country would add up to? While we were exploring this question, we did not arrive at a clear answer. Instead, we faced a deeper question. The nature of cash in India is not the same anymore. It is changing.

But to understand this we need to explore how we perceive money.

In 1936, a few years after The Great Depression. John Maynard Keynes, the timeless economist, presented a new theory of money. The 1929 stock market crash necessitated a relook at the parochial, consumption-based, meaning of money.

Keynes further deduced two “reasons” for money demand: speculation and precautionary demand.

Recall how your spending patterns have changed since last year. While our consumption has reduced, investments have barely changed. But all of us are holding more cash than usual for emergencies.

Indeed, the cash circulating in India has been galloping every week. Indians own nearly Rs 30 trillion, or Rs 30 lakh crore, cash as of May 2021. In fact, currency in circulation, or CIC, has increased 17 per cent over last year, faster than the usual rate of 12 per cent growth. As a ratio of the gross domestic product, cash has now reached 14.6 per cent—the highest ever.

All this happened while the economy shrunk 3 per cent in FY21, its worst contraction in four decades.

To unravel this phenomenon, let’s revert to Keynes’ formulation.

Consumption has certainly taken a hit. Refer to BS analysis by Shally Seth MohileViveat Susan Pinto & Arindam Majumder to. find out more.

Booming stock market indicates a spurt in speculative demand. BSE Sensex, a benchmark of India’s 30 biggest stocks, has risen 81 per cent in almost a year. The Sensex and the economy moving in opposite directions further fuels speculation.

Besides, uncertainty has given rise to precautionary demand. Worse, it has perpetuated “hoarding”. However, this might not be related to the pandemic alone. A Reserve Bank of India report illustrates that the growth in high-denomination currency was greater than the growth in low-denomination currency even in FY19, validating the hypothesis of cash being hoarded and used as a store of value, even before the pandemic.

A BS analysis shows that a crisis leads to a higher demand for money, which is complemented by an increase in currency in circulation.

The average growth of notes in circulation was 8.3 per cent for a decade until 1971-72. But as India faced the oil crisis of 1973, the currency rose by 15 per cent. Similarly, in the emergency period, a political crisis, it increased by 17 per cent in a year.

As a result, a lesser proportion of cash is changing hands. In economic jargon, the “velocity of money” is decreasing. Investopedia defines it “the rate at which consumers and businesses in an economy collectively spend money”.

But there’s a silver lining.

Even though the velocity of cash has diminished in the last year, digital transactions have risen. Analysing consumer-centric-fast-paced digital transactions (UPI, IMPS, NEFT, digital wallets), we found that digital money has increased at its highest pace since FY20.

In FY21, digital transactions accounted for 44 per cent of the GDP, a phenomenal increase from 31 per cent in FY20 and 21 per cent in FY19. In an increasingly digital world, e-money is zooming while hard cash sleeps in pockets and bank accounts!

Hence, the nature of cash has changed. It is no longer solely a means of transaction, but a store of value.

Although people hoard more during uncertainty to help themselves, to prepare for emergencies, it also prolongs the crisis as low spending crumbles the economy.

But if the economy opens up fast, a sudden spurt in money exchanging hands may lead to inflation, while it boosts consumption. Consumer confidence may also improve, with the bogey of inflation.

In this context, though people are not borrowing much, a recovery may accelerate credit disbursal due to strong deposits growth. But this would depend strongly on the pace of vaccination.

We are thus currently sitting at crossroads, and the money bus can take us in either direction. It remains to be seen if our cash habits would change even after the pandemic.

Would you be holding more cash once the pandemic ends? Ponder over this question, and let us know what you think.

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