Notes in Circulation is a statistic released by the RBI every week. The Notes in Circulation is nothing but the Indian Rupee (INR) held as cash by the general public (includes individuals and institutions). The cash held by the general public stands at Rs 13,276 billion as of 18th April 2014. In other words, Rs 13,276 billion is out of the banking system and held in the form of cash.
The Notes in Circulation stood at Rs 7040 billion as of 17th April 2009 and this has gone up by Rs 6236 billion over the last five years. The leakage out of the banking system is Rs 6236 billion since April 2009.
The Rs 6236 billion of leakage out of the banking system is a big headache for the RBI. The banking system has been short of liquidity for the last four years and has been borrowing from the RBI on a daily basis to fund its daily liquidity requirements. Banks have been borrowing anywhere between Rs 500 billion to Rs 2000 billion on a daily basis over the last four years.
A liquidity deficit in the banking system hits credit growth as banks have less funds to lend to the economy. Liquidity shortage hits government borrowing as banks have less funds to invest in government bonds. Interest rates tend to rise on liquidity shortage.
RBI has been trying to ease this high liquidity shortage by lowering CRR, buying bonds through OMOs and by encouraging banks to garner FCNR B deposits. RBI has reduced CRR by 2% from 6% to 4%, adding over Rs 1000 billion into the system. RBI has bought bonds through OMOs for Rs 4800 billion over the last five years. RBI opened a swap window for FCNR B deposits that garnered USD 34 billion, adding Rs 2000 billion into the system. Read our analysis on FCNR B swaps.
RBI has injected Rs 7800 billion into the banking system through CRR, OMO and FCNR B swaps apart from the daily injection of funds through repos, term repos and MSF of any where between Rs 500 billion to Rs 2000 billion.
The high amount of liquidity injection by the RBI is inflationary in nature as it is addition of primary liquidity into the system. OMOs are also seen as back door deficit financing by the RBI, which is again inflationary in nature. The CPI (Consumer Price Inflation) has been averaging over 9% levels over the last five years largely due to government borrowing and spending.
The government’s stock of outstanding debt has gone by Rs 24,000 billion over the last six years. The stock of debt has tripled since 2008-09.
RBI needs to curb the money going out of the system as it leads to actions that have long term negative repercussions as mentioned above.
Why is there such high level of currency leakage?
Inflation is one big cause of currency leakage as rising prices of goods and services in an economy that is still largely cash driven despite fast advances in banking leads to higher demand for holding cash.
The next big reason is the property bubble that has seen value of real estate rise multifold despite economic growth slowing down from levels of 8.4% seen in 2010-11 to below 5% levels as of 2013-14. The real estate sector is largely dominated by the politician-builder nexus that predominantly deal in black money. Money goes out of the banking system to the real estate sector and stays there as black money.
RBI needs to control inflation and also keep the real estate market in check to stem the currency leakage from the system. Hopefully both inflation and property prices will cool down going forward as RBI keeps policy on hold and prevent banks from excessive lending to the real estate sector.