What Is Leading The Growth In Currency Demand?

While the simultaneous increase in digital payments and currency in circulation might appear paradoxical, the sustained growth in currency demand is likely influenced by the precautionary and store-of-value motives, according to a research paper by the Reserve Bank of India.

Using descriptive analysis and empirical insights, the central bank's research paper suggests that the transactional use of cash is showing signs of decline, while the ‘precautionary’ and ‘store-of-value’ motives significantly influence the demand for currency in circulation.

This is evident from the growing share of large denomination banknotes contrasted with muted growth in small-value notes and coins, subdued cash withdrawal, diminishing cash velocity and a shift towards digital modes for effecting small-value retail transactions, it said.

Despite the surge in digital payments, the growth in currency in circulation continues with the CiC-to-GDP ratio peaking at 14.4% in FY21. Owing to the perceived substitutability between digital payments and cash, the simultaneous growth in both seems counterintuitive, giving rise to a ‘currency demand’ paradox that necessitates a detailed analysis of the underlying drivers of different payment modes, the research paper said.

According to the paper, the currency in circulation-to-GDP ratio in the recent past may not be an appropriate indicator to gauge efficacy of ongoing digital initiatives due to possible overestimation, driven by a sharp fall in GDP, combined with uncertainty-fuelled uptick in currency in circulation during the pandemic.

Factors like falling interest rates on deposits (or the opportunity cost of holding currency), growing informalisation of workforce, and the larger-than-normal direct benefit transfer-based cash transfers during the pandemic may have contributed to increased preference for cash, it said.

The surplus precautionary financial savings in cash reflected partly the lack of opportunities to spend during the pandemic and partly the need to deal with the uncertain outlook for income and employment, as the economy was normalising from the pandemic shock, according to it.

Although income remains the dominant driver of currency demand in India, the rapid growth momentum in digital payments combined with its inverse association with cash has the potential to moderate the positive income effect, the research paper said.

India’s payments ecosystem has undergone a transformative revolution in the last two decades, it said. The pandemic-induced conditions further bolstered the adoption of digital payments.

Reflecting the success of the policy thrust of the Reserve Bank of India and the government, digital retail payments led by the Unified Payments Interface have grown rapidly between FY17 and FY23, with a compounded annual growth rate of 51% and 27% in volume and value terms, respectively.