Ever since the growth in money supply started slowing down in the last two years, currency in circulation has been increasing. This not only mounts pressure on the government to rely on external debt financing for fiscal support but also dampens the private sector credit. In the first five weeks of this fiscal year, currency in circulation has increased by Rs 54 billion whereas broad money (M2) has declined by Rs 75 billion.
Higher CIC is an old but unaddressed issue in Pakistan; overall CIC is 22 percent of M2 stocks whereas in India it hovers around 15 percent and 3-6 percent in developed countries. That indicates a higher quantum of parallel economy in the form of a black market and an informal banking system. However, the truly alarming sign is the recent upsurge in CIC; in FY09 currency in circulation (CIC) increase was 38 percent of M2 growth, in sharp contrast to the average of 18 percent in FY05-08.
WHERE IS THIS MONEY GOING?Some of this recent money is being lost in illegal transactions, but this phenomenon is not new to our economy. We believe this dichotomy of money loss is primarily attributed to the increase in agriculture income in the last fiscal year.
The higher wheat support price (increased by over 50 percent to Rs 950 per 40 Kg in FY09) coupled with higher production of crop (increased by 12% to 23.4 mn tons) is routing part of this money to the informal banking sector. The poor and uneducated farmers with little or no access to a formal banking system are either keeping this money with them or circulating it in the informal lending segment.
WHAT IS THE REMEDY?Given that the government might announce higher support price for other crops in the near future, it is essential to educate and provide easy access of formal banking channels to farmers. This can be achieved through the governments involvement in promoting microfinance and in supporting commercial banks to take microfinance seriously.
We dont have the data of denominations of currency in circulation to envisage how much is coming from higher farmer income and to what extent the black market is contributing to this issue.
The litmus test would be to demonetize the high currency (Rs 5,000) note by replacing old currency notes with new ones and circulate it through banking deposits. This would reroute a substantial chunk of enhanced black money into the system. However, this could potentially create a market for selling Rs 5000 note at premium.
This issue can not, however, be analysed or solved on hunches and guesstimates alone. Our monetory organisations, SBP in particular, have extensive and capable research wings. We believe they must go to villages and conduct thorough research to assimilate data so that any proposed solution would have its foundation in hard, fact-based evidence.