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LATEST NEWS UPDATES | What the RBI Should Do to Minimise the Impact of Demonetisation -Surajit Das

What the RBI Should Do to Minimise the Impact of Demonetisation -Surajit Das

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published Published on Jan 6, 2017   modified Modified on Jan 6, 2017
-TheWire.in

People have lost their jobs, small businesses are closing down and the agricultural sector has been hit hard as a result of demonetisation. The RBI must increase the supply of cash to curb further fallout.

Money is not cash. In fact, cash in circulation was just 14% of all money in 2015-16 according to the Reserve Bank of India (RBI). Measures of money also count close substitutes of cash including the amount bankers’ deposit with the RBI, as well as demand and time deposits. Notably, the recent demonetisation by the government has affected more than 85% of the cash in circulation and not other forms of stock of money. However, cash is extremely important for carrying out day-to-day transactions between people. While it is true that cashless transactions have increased over time across the world thanks to electronic money, in an developing country like India, the maximum proportion of small transactions take place in cash even today. The RBI is replacing the old notes with new notes and the government says it is expecting the cash crisis to be over very soon. However, over a month after the move was announced, it doesn’t look like this crisis will end anytime soon. About 130 crore people (17.5% of the world’s population) continue to suffer in this unprecedented manner due to this policy measure. The cash crisis is clearly not as temporary as the government seems to think.

The problem today essentially is that people have money in their bank accounts but they are not being able to withdraw it cash (for purchasing goods and services) from either banks or ATM machines. Most banks do not have enough cash to supply their customers. They are trying to satisfy as many customers as they can by ‘rationing’ or by constantly lowering the upper-limit of cash withdrawal. Even if people get some money after spending hours or even days waiting in queues, they remain uncertain about when they will get the opportunity to withdraw cash again. Because of this uncertainty, people are also demanding more cash – naturally, for precautionary purposes– than what they used to hold, on an average, before demonetisation. On the other hand, people are also trying to rationalise their expenditures to the best of their ability. Those who have the option of using credit or debit cards, net-banking or Paytm are executing the majority of their transactions through cashless forms of payment.

Even if people have enough money in the bank (for those who have it), their demand for cash is not being fulfilled by the banking system as a whole. Even if the monetary authority replaces the entire amount of cancelled old notes with new ones, and even if the entire amount reaches banks’ branches and ATMs quickly, the problem is not going to be completely solved. Because at an aggregate level, people are willing to hold relatively more cash now than they were before. Peoples’ confidence in other forms of money-holding has been shaken. If I need cash for paying my domestic helper’s salary or buying vegetables, then the amount of cash I can withdraw is more important than the number that appears in my passbook. Since it is uncertain when I would be able to withdraw next, I would try to withdraw little more, if possible, for precautionary purpose than my immediate need for cash for transaction motive. This extra demand for cash would not come down, irrespective of larger transactions carried out through cash-less means, unless people get back the confidence that they would be able to withdraw cash easily whenever they want either from ATMs or from various bank branches. Moreover, due to larger hoarding of cash, the speed with which cash circulates (how many times on an average cash changes hands within a particular period) would come down. As a result, to match up to the current level of economic activity, much more cash is required compared to what is currently available.

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TheWire.in, 6 January, 2016, https://thewire.in/97721/rbi-demonetisation-impact/


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