THE INTRIGUING DYNAMICS OF

INDIA’S CURRENCY IN CIRCULATION

After the withdrawal of ₹2,000 notes from circulation in May 2023, many expected India to accelerate its march towards a cashless economy. Or at least, the RBI did! 🤞 Yet, the nation's appetite for cash has only grown stronger. As of May 31, 2024, a staggering 🫰 97.82% of these high-value notes had been returned to the banking system, primarily in the form of deposits. This massive influx of cash, however, didn't diminish the overall currency in circulation.

Contrary to expectations of a rapid shift towards a cashless economy, we're witnessing a perplexing phenomenon - 🤝 a simultaneous surge in both cash circulation and digital transactions.

The Currency in Circulation Conundrum

Rising Tide of Cash

According to the Reserve Bank of India's (RBI) data, currency in circulation has shown a persistent upward trend:

• March 2017: ₹13.35 lakh crore

• March 2024: ₹35.15 lakh crore

This 163% increase over seven years significantly outpaces both economic growth and inflation rates, raising important questions about the driving forces behind this trend.

Shifts in Currency Denominations

A closer look at the composition of currency in circulation reveals intriguing shifts:

• The share of ₹500 notes increased from 60.8% in March 2020 to a dominant 86.5% in March 2024.

• Concurrently, the ₹2000 note's share plummeted to a mere 0.2% by the end of FY23.

This recomposition of currency denominations reflects both policy decisions and changing public preferences. The 'sweet spot' that ₹500 notes hit is both convenience and value storage, or perhaps the lack of a higher denomination alternative to hold cash!

State-wise Cash Usage Trends

Analyzing the May 2024 data, for monthly deposit and withdrawal of notes for different states & union territories, reveals significant regional variations:

• Maharashtra led with cash withdrawals of ₹31,028 crore in May 2024.

• Uttar Pradesh followed closely at ₹29,089 crore.

• Interestingly, Kerala bucked the trend with higher deposits (₹20,756 crore) than withdrawals (₹16,945 crore).

These state-wise disparities highlight the complex interplay of factors influencing cash usage across India's diverse economic landscape. Urban centers are embracing digital faster, while rural areas still rely heavily on cash. It's not one India, but many Indias in terms of financial behavior.

The Digital Surge

UPI: Leading the Charge in Digital Payments

While cash circulation grows, digital transactions, particularly through the Unified Payments Interface (UPI), have seen exponential growth:

• March 2020: ₹2.06 lakh crore in transactions

• February 2024: ₹18.07 lakh crore in transactions

• May 2024: A record-breaking 14.04 billion transactions processed

This exponential growth represents a staggering 777% increase in transaction value over just four years representing a fundamental shift in transaction habits, especially in urban areas and among younger demographics.

Beyond UPI: The Broader Digital Ecosystem

While UPI leads the charge, it's part of a larger digital payment ecosystem that's rapidly evolving:

• Credit card usage increased by 18.5% year-on-year in April 2024

• Point of sale (PoS) terminal deployment rose by 12.8% in the same period

• Bharat QR codes and UPI QR codes saw increases of 11.5% and 22.5% respectively

With these data points, we see a holistic shift towards digital payments across various platforms and user segments.

The Emergence of e₹ (Digital Rupee)

The RBI's pilot of the Central Bank Digital Currency (CBDC) - the digital rupee or e₹ - adds another layer to this evolving monetary landscape. While still in its early stages, the e₹ has the potential to bridge the gap between cash and digital payments. It’s the best of both worlds - offering the security of central bank-issued currency with the convenience of digital transactions.

Verdict: Despite the boom in cash circulation, India has shown a persistent upward trend in cashless transactions & CBDC adoption.

Economic Implications

Impact on Liquidity and Money Supply

The rising currency in circulation has significant implications for India's liquidity profile and money supply components:

• As per the RBI’s data on “Reserve Money- Components and Sources” in the June 2024 report, reserve money stood at ₹4,722,685 crore, with currency in circulation accounting for ₹3,586,577 crore.

• This high proportion of currency in circulation impacts the money multiplier effect, potentially affecting the broader money supply (M3) and the banking sector's ability to create credit.

Monetary Policy Challenges

The RBI faces a complex task in managing monetary policy in this dual environment:

• High currency in circulation can reduce the ⤵️ effectiveness of interest rate changes in influencing economic activity.

• The coexistence of cash and digital systems requires a nuanced approach to liquidity management and inflation control.

Economic Indicators and Forecasts

The currency circulation patterns offer insights into broader economic trends:

• The persistent demand for cash, despite digital alternatives, suggests a robust informal economy and 🤫 potential under-reporting of economic activities.

• It may also indicate precautionary savings behavior, reflecting economic uncertainties or lack of confidence in formal financial systems.

Consumer Preferences and Spending Patterns

The circulation of smaller denominations (₹2, ₹5, ₹10, and ₹20) provides insights into everyday consumer spending habits:

• Their continued relevance indicates the importance of cash for small-value transactions, particularly in the informal sector and among lower-income groups.

• It also reflects the enduring cultural preference for cash in certain types of transactions and regions.

The "Currency Demand Paradox" Explained

The Reserve Bank of India has offered several explanations for this "currency demand paradox":

1. Declining interest rates 📉 reduce the opportunity cost of holding cash, making it more appealing for many.

2. Precautionary savings due to global economic uncertainties and domestic economic fluctuations.

3. The persistence of a large informal economy and the ongoing journey towards majority financial inclusion, translate to a heavy reliance on cash transactions.

4. Direct benefit transfers are often converted to cash by recipients.

On a broader level, this paradox is a reflection of the complexities of a diverse economy in transition. It's not just about technology adoption, but about trust, habit, and the very nature of economic activities across India's varied landscape.

Broader Economic Implications

1. Banking Sector Impact: The high currency in circulation affects bank deposits and, consequently, their lending capacity.

2. Informal Economy: The cash preference might be indicative of a significant informal sector, presenting challenges for tax collection and economic policy formulation.

3. Monetary Policy Transmission: The effectiveness of monetary policy tools may be diminished in an economy with high cash usage.

4. Financial Inclusion: While digital payments are growing, the persistent cash usage highlights the need for continued efforts in financial inclusion.

Looking ahead, several scenarios emerge:

1. Gradual Digital Dominance: As infrastructure improves and younger generations drive adoption, digital payments may slowly but surely overtake cash.

2. Sustained Duality: The current paradox might persist, with both digital and cash economies growing in parallel, serving different needs and segments.

3. Innovative Hybridization: New technologies could emerge, blending the benefits of both cash and digital systems, creating uniquely Indian solutions.

India's journey from a 🤑 predominantly cash-based economy to a 🤳 digital powerhouse is far from over. The financial future of 1.4 billion people will not be about choosing between digital and cash, but about creating systems that seamlessly integrate both, catering to the world's most diverse democracy.