The debate on merits of demonetisation continues with recent data showing an increase in the total cash in circulation (CIC) in the economy, compared to pre-demonetisation levels, raising questions on the resurgence of informal sector.

However, currency circulation at Rs 20.4 lakh crore is still short of trend by at least Rs 1.5 lakh crore, SBI said in its Ecowrap research report. Thus, any argument of cash coming back aggressively into the system and financing informal activities is not entirely correct, SBI Group Chief Economic Adviser Soumya Kanti Ghosh said in the report.

The study rather points out towards a state of paradox, where even though currency circulation has expanded, income velocity of money has shown a sharp plunge. This decline, in the rate of exchange of money from one transaction to another, indicates the inadequate supply of money in the system.

Big states lose more economic activity

In states like Chhattisgarh, Madhya Pradesh, Andhra Pradesh and Jammu & Kashmir, the velocity is above the national average. On the other hand, in states like Maharashtra, Uttar Pradesh and Karnataka, the velocity is lower than the national average. Lower income velocity of money in larger and developed states indicates economic activity is indeed slowing down, the report said.

The report has further highlighted the distress in rural economy, which is also apparent from the latest data on Consumer Price Index (CPI) inflation and Wholesale Price Index (WPI) inflation, and falling bank credit. Thus any meaningful pick up in food and even manufacturing inflation is still at a distance, the report said.

Small notes dominate

A probable reason for this paradox could be the dramatic change in demand for cash more than two years after re-monetisation. “In FY17 when re-monetization was achieved, there was no 200 rupee denomination. However in FY18 the pace of circulating 200 denomination has increased manifold, as has been the case with notes of smaller denomination. This may have altered the demand for smaller denomination notes in a larger way to possibly substitute for the currency of larger denominations (Rs 2000 rupee notes are not getting printed as per RBI),” said the report.

Hence, using currency in circulation as a leading indicator of heightened economic activity, specifically the narrative of large cash usage in informal economy is erroneous, according to the SBI report.

Source : Financial Express