The documented currency in circulation (CiC) has increased to over Rs. 8 trillion in Pakistan, representing the growth in the size of the economy and the use of cash to do business.
Meanwhile, total deposits with local banks have risen to Rs. 23 trillion, representing a CiC-to-bank deposit ratio of 34 percent which is higher than Bangladesh and India, and shows that Pakistan has a bigger informal economy than its South Asian counterparts.
As of 2022, Bangladesh has BDT (Bangladeshi Taka) 2.5 trillion CiC against total bank deposits of BDT 15 trillion, representing a CiC-to-bank deposit ratio of 16.7 percent. Meanwhile, India has INR 32 trillion in circulation and roughly Rs. 180 trillion in total bank deposits (17.8 percent).
Liquidity, PKR Drop, and the Real Estate Joke
Parts of our economy that are not under the tax net usually accept cash and the volumes are growing. The majority of the people, especially from real estate, Kiryana stores, freelancers, plumbers, doctors, dentists, electricians, jewelers, and citizens refuse to pay taxes on income.
Pakistan’s service sector which contributes more than 50 percent of the country’s GDP is mostly cash-based and least documented. Compared to Bangladesh and India, there is a lot more currency in circulation as a percentage of the overall money supply in Pakistan.
The financial year 2022-23 has been particularly hard on Pakistan due to exceptionally high pressures on rupee liquidity in the interbank market. A combination of macro indicators led to this liquidity crunch which caused a slowdown in deposit growth rate and a rise in currency in circulation. They include high inflation, extortionate interest rates, weak deposit mobilization efforts, and seasonal withdrawal of large sums from deposits due to increased public demand for cash to meet expenses.
The State Bank of Pakistan’s (SBP) open market operations (OMOs) aren’t helping either due to PKR depreciation against US Dollar. The central bank has injected Rs. 8.9 trillion through OMOs in 2023 alone, which is one of the major reasons for inflation spiking to 50-year highs and money moving out of banks and into the informal sector.
Lastly, the biggest benefactor of the currency moving out of banks is real estate. A poor taxation regime, massive distortion in reported and transaction value of real estate assets, and amnesty schemes to further accelerate capital movement to real estate rather than actual productive avenues have ensured that plots remain a safe haven for the preservation of grey capital.
A largely cash-based market also ensures that fire sales are few and far, as investors prefer to stay underwater because real estate is a safer structure than investing in the formal economy.
Over the last ten years, a decline in the savings rate has been accompanied by an increase in CiC as a percentage of GDP in Pakistan, indicating that an increasing amount of economic activity is conducted in cash rather than through formal financial institutions such as banks.
If Pakistan’s CiC was to be brought down to the same level as regional peers (average of 17.25 percent), that would mean a reduction in CiC of Rs. 4 trillion ($15 billion). While speculative, many experts have opined that SBP should discipline banks and avoid extending an ‘OMO olive branch’ if one of them runs out of petty cash.
All things considered, Pakistan’s undocumented cash economy is rapidly expanding even without banks. The catch is that the cash economy must be restricted. Since 2015, the amount of currency in circulation has increased and indicating that cash is not returning back to the system. It is transforming into its own mini-economy.