Economic Survey - Where have all the high-value notes gone?

Indians may be buying more cell phones, cars and colour television sets with the economy chugging along at nine per cent as the Economic Survey proudly points out.

But that is nothing compared to the market for high-denomination currency notes, which is growing at an even faster clip.

Consider the evidence. The Reserve Bank of India says that individuals and businesses stored Rs 75,691 crore in high-denomination currencies (Rs 500 and Rs 1,000 notes) as of March 2002.

Yet, by close of March 2006 their appetite for such currencies has grown by more than 325 per cent, to touch Rs 2,46,650 crore (RBI Annual Report 2006).

The economy hasn't grown anywhere near this rate - growing only by 45 per cent - during this period.

Far from growing, the currency in circulation, as a proportion of the total money supply, which includes bank deposits, has actually declined from a high of nearly 40 per cent in 1971-72 to a respectable 15 per cent by 2005-06.

In other words, the rise in circulation of high-denomination currency notes is despite a relative decline in the circulation of small denomination notes up to Rs 100.

So, what explains the phenomenal growth of Rs 500 and Rs 1,000 notes? The RBI thinks that the large number of ATMs and the banks' penchant for stuffing them with crisp, brand new notes is the culprit.

Banks may find dispensing cash with smaller denomination to be a logistical challenge, as that would mean frequent replenishment, reasons the RBI.

But senior bank officials have a different take on this.

They told Business Line that their ATMs are stuffed typically with Rs 500 and Rs 100 notes; in any case they do have sorters to identify ATM-quality notes, which come back to them to be sent back.

Also, with average withdrawals in the region of Rs 2,000-2,500 for a medium-sized bank, the need for stuffing the ATMs with Rs 1,000 notes is not all that high, they suggest.

One thing is certain. If these notes were not fed back into the ATMs, the banks would be saddled with a huge hoard of high-denomination notes.

The currency on hand in the banking system is nowhere near the volume of such notes in circulation.

Interestingly, the US, with far greater penetration of ATMs and with a much larger economy in purchasing power parity terms, seems to make do with a much smaller denomination of currency notes.

The $100 note is the highest denomination of the US; when derated suitably for the higher prices and the relatively larger size of its economy, it would translate into a currency denomination roughly the equivalent of Rs 250.

The volume of high-denomination notes in circulation cannot be justified by either the size of the economy or the technology used for banking transactions.

Does it suggest that notes in such denominations are used more for hoarding illegal gains? A former senior official from the banking industry thinks that the growth in the volume of high-denomination currency notes in circulation is a useful proxy for the growth of black money in the economy.

Now, that is something for the Finance Minister to reflect on, as he gets ready to present his Budget for the next fiscal.