A decline in the currency in circulation during the Diwali week is representative of a structural transformation in the economy, according to a research note by the State Bank of India.
Currency in circulation declined on a weekly basis during the Diwali week first time in 20 years, according to a Nov. 3 note by Soumya Kanti Ghosh, chief economic advisor at the State Bank of India group.
"The innovations in technology has changed the Indian payment system," Ghosh said. Over the years, the Indian cash-led economy now has changed to smartphone-led payment economy, he said, attributing the shift to the government's thrust on digitalising the economy.
A lower currency in circulation is also akin to a CRR cut for the banking system, as it results in less leakage of deposits and it will impact monetary transmission positively, Ghosh said.
A look at retail digital transactions data shows that NEFT holds a share of 55% in value terms and most of the transactions are done either at the branch or via internet banking. Payments through smartphones, like UPI, IMPS & e-wallet, have a share of around 16%, 12% and 1% respectively. So, the small retail payments through UPI/e-wallets have around 11-12% in the payment industry, Ghosh estimated.
The trends are revealing as the share of currency in circulation in the payment systems has been declining from 88% in FY16 to 20% in FY22, and is estimated to go down to 11.15% in FY27, Ghosh said. Consequently, the share of digital transactions rose from 11.26% in FY16 to 80.4% in FY22 and is expected to touch 88% in FY27, he added.
Testing the result of UPI transactions on currency in circulation empirically, Ghosh's findings indicate that:
The increase in Prepaid Payment Instruments is negatively impacting the CIC and M0 (monetary base). Further, increase in PPI is positively affecting the M3 (broad money).
Increase in UPI is negatively affecting the M0 and M3 but it has no significant impact on CIC.
The monetary base includes currency in circulation, along with deposits held by the central bank. Broad money is defined as the total stock of money (paper notes, coins and demand deposits of bank) in circulation which is held by the public at any particular point of time.
It has also been found that increase in UPI and PPI are not significantly affecting the money multiplier, though the coefficients are negative.
It has been estimated that every Rs 1 crore increase in UPI leads to decrease in M0, M3 and SCB deposits by Rs 0.81 crore, Rs 0.96 crore and Rs 1.22 crore, respectively.
Further, every Rs 1 crore increase in PPI leads to decrease in CIC, M0, and SCB deposits by Rs 1.52 crore, Rs 3.28 crore, and Rs 0.23 crore, respectively.
Every Rs 1 crore increase in PPI leads to increase in M3 by Rs 11.79 crore.
"If we look the data on CIC, though it is increasing with the rise in economy but the trend is declining because of the rise of digital transactions," Ghosh said. "We however believe that the increase in digital transactions may result in a decline in money multiplier, even though the overall measure of broad money has been expanded," Ghosh said. In particular, there has been a substitution from currency and much of it has gravitated towards digital mode of payments.
The expansion in digital payments facilitated by the stack is an important driver of economic development in India and has helped stabilise incomes in rural areas and boost sales for firms in informal sector, according to Ghosh.
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