Still driven by cash, black money bl-premium-article-image

K. KANAGASABAPATHY Updated - August 30, 2012 at 09:14 PM.

The use of cash in financial transactions continues unabated, pointing to the prevalence of the black economy at the higher end of the income spectrum and the absence of financial inclusion at the lower end.

BL31KAN

The recent movements engineered by social activists run along two parallel lines. One group steered by Anna Hazare demands a Lok Pal Bill to wipe out corruption in the realm of government, and the other steered by Baba Ramdev, calls for unearthing of black money.

There are two dimensions of the black economy which are talked about -- the money stacked abroad in foreign bank accounts, especially Swiss banks, and the money accumulated or floating around in the internal economy.

Assuming that internally, the black money is accumulated through transactions which are not captured by the organised banking system, such transactions must be cash-based. The other alternative may perhaps be gold.

On the above ground, one of the demands of Baba Ramdev is to ban use of higher denomination currencies of Rs 500 and Rs 1,000. Is there any ground to believe that a large volume of cash transactions in the economy is shifting in favour of high denomination notes? We attempt to examine this point.

High Denomination Notes

On the composition of bank notes, the recently released Annual Report of the Reserve Bank says the following about the trend during the year ending March 2012, which fared badly in terms of economic growth: “At 12.5 per cent, the growth in value of banknotes outpaced the growth in volume terms (7.4 per cent) in 2011-12. Notes of denomination 500 and 1,000 together accounted for 82 per cent of the total value of banknotes in circulation.”

During the last three years, the growth in high denomination notes of Rs 500 and Rs.1,000 was 20.5 per cent, 24.1 per cent and 14.9 per cent, respectively. This was much higher than the growth in total bank notes over the same period, viz., 15.7 per cent, 18.7 per cent and 12.5 per cent. Accordingly, the share of high denomination notes to total bank notes increased from 76.4 per cent to 81.6 per cent over the last three years.

Decadal Trend

The trend in the composition and growth of high denomination notes since 2002 shows that the situation in 2011-12 is no exception.

The compositional shift has been a continuous process, indicating that almost the entire value of bank notes at one stage may be held in high denominations ( see table ).

The growth in high denomination notes was significantly higher every year than the growth of bank notes as a whole.

And the growth in total bank notes also was perhaps larger than the GDP growth, indicating a high elasticity of bank notes to real GDP.

This is perhaps a sign of financial inclusion not succeeding and a larger volume of transactions still being handled in cash.

Between the years ending March 2002 and 2012, the total bank notes in circulation jumped from Rs.2.45 lakh crore to Rs.10.52 lakh crore, growing annually in the range of 12.4 per cent and 18.7 per cent.

On the other hand, the value of high denomination notes galloped from Rs. 0.75 lakh crore to Rs.8.60 lakh crore between the same years, growing annually in the range of 14.9 per cent and as high as 45.0 per cent.

In the very recent past, there has been some softening of growth rates in both total bank notes and that of high denomination notes. The former may be attributed to success of financial inclusion combined with slower economic activity.

Should the latter be attributed to the Anna Hazare or Baba Ramdev effect, or is it a reflection of substitution of currency with gold by hoarders of unaccounted money? It is anyone’s guess.

Money Velocity

With increasing financialisation, one would normally expect that currency will be substituted by higher-end assets like bank deposits and other forms of financial assets.

Taking only the transactions demand for money, say, the currency and demand deposits, the ratio of currency to demand deposits should reflect a secular declining trend.

But, the currency to demand deposits ratio, after declining from 2.69 in 1961-62 to 1.00 around 1977-78, increased to 1.58 in 1978-79 and since 2001-02, it is hovering mostly in the range of 1.2 to 1.4.

From another angle, the velocity of currency, measured as a ratio of nominal GDP to currency, should reflect economising of currency in terms of a secular increase.

However, the velocity after increasing from 7.7 in 1955-56 to 12.92 in 1975-76, gradually decreased over the years and in the recent period, ruling in the range of 9.0 and 9.7 ( See graph ). This is despite the fact that a large volume of transactions has shifted to debit/credit cards in the last decade.

Yet another dimension of the same problem is how far the financial savings are still in the form of currency.

This is reflected in the variation of currency every year as percentage to change in total financial assets, including currency. Instead of decreasing over time, the saving in the form of currency to total financial saving of the household sector remained rather stubborn at around 10 per cent or above over the last decade.

Financial Inclusion

The above trends overall would show that financial inclusion should address both lower and the higher end of the economic spectrum.

At the lower end, it is true that about half the households are excluded from banking, and much more from other financial services like insurance and pensions.

At the higher end, it is not that they are not covered by the banking system, but there seems to be a huge volume of financial activity carried on cash basis which should be brought within the purview of the banking or the organised sector.

The other dimension of the problem is, of course, that of the external wealth hidden by domestic households abroad, which is a hidden reserve of the country not available due to capital flight.

(The author is Director, EPW Research Foundation. The views are personal.)

Published on August 30, 2012 15:44