Increased currency in circulation is a burning issue we are facing now. As on April 29, total value of currency in circulation has reached Rs 16.50 lakh crore, an increase of 15.32% compared to same period last year. This 15% plus yoy growth is happening continuously for the last 2 months now, something not seen after July 2011.

There are several theories explaining this spike. The first theory states that it is because of the just completed assembly elections in five states. But a close look at currency in circulation data will reveal that the increase is more gradual and therefore, these elections are not the main reason behind this spike. More importantly, there were bigger elections earlier and the currency circulation was smaller then. For example, currency in circulation now is 27.55% more than 2 years back, when national election was going on.

Increased banking restriction may be another reason for this. For example, you need to furnish PAN details now for depositing more than Rs 50,000 in cash. Due to this, black money stays outside the banking system. Co-operative banks used to be a safe haven for tax evasion because they were exempt from deducting TDS on deposit by members. Now they have to deduct TDS for everyone, including its members.

Since black money can’t be used for buying financial assets, the same is used for purchasing mostly real estate and gold. The cash component is still very high in real estate transactions. The government’s efforts to tackle gold import by imposing 10% import duty compounded the problems further. Though official gold import figures have come down, a large part of that shifted to smuggled route. Foreign payment for smuggled gold can’t happen through official banking channel and has to be either smuggled cash or through some other stuffs smuggled outside. Similarly, from smuggling point to the end consumer, transactions have to happen in cash.

Situation has come to such level that this has started hurting bank’s deposit growth. So what should the government do? No need to dilute anti-money laundering measures because they are in right directions. Reducing gold import duty is one solution as it will reduce gold smuggling and resultant need for cash transactions.

Since more than 80% of money in circulation are through Rs 500 and Rs 1,000 notes, the best solution to this problem is the withdrawal of these notes from circulation. How will it benefit? First, withdrawal of Rs 500 and Rs 1000 rupee notes will result in immediate unearthing of black money. This is because people who are hoarding black cash currency will be forced to come to banking system for converting.

Second, withdrawal of high denomination notes w ill help to reduce black money generation in future. This is because it will become difficult to deal in cash, especially for large deals that runs into crores. Smuggling of Indian currency outside also become really difficult. This is very important for our national security also because terror outfits usually use smuggling and black money route for financing. Major economies have already started taking steps in this direction. Only recently, the European Central Bank has decided to stop printing Euro 500 bank notes, popularly known as ‘Bin Laden notes’, because of its association with money laundering and terror financing.