What’s become of money — before and after the ‘demonetisation’?

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Money, as the old cliché goes, is what money does. For our purpose, though, there are two parts to money.
The first is as a ‘store of value’. Money, in its broadest definition (‘M3’ in economics terminology), consists of physical currency (notes and coins) with the public, and total deposits held in banks. That makes it an avenue for people to ‘store’ their savings or wealth. But money is not the only — and perhaps not the best — way to store one’s savings. The value of currency holdings depreciates with inflation over time. Interest rates on fixed deposits, too, rarely offer positive post-tax, inflation-adjusted returns. That’s why people prefer putting their life-savings in other assets — both financial (shares/debentures, mutual fund units, government/corporate bonds, insurance policies, provident/pension fund schemes, etc.) and physical (gold, land and property) — seen to provide reasonable inflation protection.

Money, if anything, can serve as a transient store of value; when savings accumulate to a certain level, a significant part gets converted into non-monetary assets. A criticism of the Narendra Modi government’s demonetisation scheme is that while it purportedly targets ‘black’ money, illicit wealth is seldom held for long as ‘money’ — and even less so in currency notes. Only an estimated 40% of the annual savings of Indian households is in ‘financial’ form. Even within that 40%, just over a tenth is held as currency, and another 45% in bank deposits. Demonetisation, in other words, targets hardly 4% of wealth that is annually generated. The share of currency would be even less as a percentage of the total outstanding stock of wealth — ‘black’ or otherwise.
If money, more so currency, isn’t the best store of value, why do people still need it?
It has to do with money’s other, more important, function: As a means for facilitating purchase and sale of goods and services. ‘Broad money’ (M3), as already noted, includes currency plus deposits in banks. The latter covers both demand as well as time deposits. But for conduct of transactions, what matters is ‘narrow money’ (M1). This is money that includes only currency and demand deposits, and hence is most readily available for commerce. As on October 28 — the last date prior to demonetisation for which figures are available — the total outstanding M3 stock in the Indian economy stood at Rs 124.15 lakh crore. Out of this, currency with the public constituted only Rs 17.01 lakh crore or 13.7%. But a more relevant comparison would be with M1, which amounted to Rs 27.69 lakh crore. Currency’s share in M1 — liquid money accessible on demand for purchase or sale of goods and services — was almost 61.5%.
So, what has demonetisation done?
According to information given to Rajya Sabha by the Union Minister of State for Finance Arjun Ram Meghwal, there were 1,716.5 crore pieces of Rs 500 denomination notes and 685.8 crore pieces of Rs 1,000 notes in circulation as on November 8, the date on which demonetisation was announced. That, in value terms, comes to Rs 15.44 lakh crore. We don’t have figures for total currency or M1 for this date. But even comparing with the October 28 money stock data, the value of notes that ceased to be legal tender worked out to nearly 87% of the total currency in circulation (both with the public and as cash with banks) and 56% of M1. Since M1 is the most liquid part of money supply, it translates into 56% of liquidity in the economy getting withdrawn overnight.
How is that important?
An economy’s health is not a function of the ‘stock’ of wealth or capital assets already created in the past, as much as current production, employment and income generation activity. Key to this ‘flow’ of incomes, output and jobs, is the sale and purchase of goods and services. For every purchase we make, a part of our income is transferred to somebody else’s pocket. That person, then, spends this money, which becomes some other’s income. It is this process of money and incomes changing hands that keeps an economy going, contributing to its gross domestic product or GDP. The medium that facilitates this is money. It is only money that can buy goods and services. Without money, a manufacturer cannot purchase raw materials or pay workers. Even if he produces, there will be no buyers for his product if they don’t have the money.
The November 8 demonetisation decision, we know, resulted in about 56% of money most readily available for transactions suddenly being pulled out. It has caused an unprecedented loss of the vital medium of exchange, or oil lubricating the wheels of commerce. Reserve Bank of India data show that between November 10 and December 7, fresh notes worth Rs 427,684 crore have been issued by banks to the public either over the counter or through ATMs. This barely replaces 28% of the currency in circulation whose legal tender status was withdrawn. Moreover, the bulk of the new notes are of Rs 2,000 denomination. These are useless for most transactions, in the absence of sufficient smaller-denomination notes that receivers can offer as return balance or “change”. It means the economy is still bereft of liquidity, in practical and effective terms.
How can the situation be redeemed?
Well, it depends on how fast the lost liquidity can be restored. Such remonetisation can happen through two ways. The first is, of course, by printing replacement notes, especially of Rs 500 and Rs 100 denominations. The second is by encouraging households and unorganised businesses to go cashless, by replacing ‘physical’ currency with ‘digital’ bank-mediated currency. This would entail reducing the currency component in M1, while correspondingly raising the demand/savings deposits portion that can be drawn upon as effortlessly as cash for carrying out transactions.
Both routes would, nevertheless, take time. Based on current printing capacities, various estimates suggest a minimum of 5-6 months for the pre-demonetised notes to be replaced in effective and practical terms. Creating the infrastructure for going cashless — making sales and purchases through bank account transfers, whether by debit/credit cards, mobile wallets or other prepaid payment instruments — will probably take even longer.