RBI’s woes spreading from banking regulation to cash management..

It is quite surprising how cash crunches are becoming common since Demonetisation in Nov-2016. We also have issues of some denomination of currencies are not accepted like Rs 10 and small amount coins.

It is for nothing that scholars who studied money and its history advised never to interfere with money. For instance, Milton Friedman quoted John Stuart Mill:

My own studies of monetary history have made me extremely sympathetic to the oft-quoted, much reviled, and as widely misunderstood, comment by John Stuart Mill.

“There cannot . .. ,” he wrote, “be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order” [7, p. 488].

True, money is only a machine, but it is an extraordinarily efficient machine. Without it, we could not have begun to attain the astounding growth in output and level of living we have experienced in the past two centuries-any more than we could have done so without those other marvelous machines that dot our countryside and enable us, for the most part, simply to do more efficiently what could be done without them at much greater cost in labor.

But money has one feature that these other machines do not share. Because it is so pervasive, when it gets out of order, it throws a monkey wrench into the operation of all the other machines. The Great Contraction is the most dramatic example but not the only one. Every other major contraction in this country has been either produced by monetary disorder or greatly exacerbated by monetary disorder. Every major inflation has been produced by monetary expansion-mostly to meet the overriding demands of war which have forced the creation of money to supplement explicit taxation.

The first and most important lesson that history teaches about what monetary policy can do-and it is a lesson of the most profound importance-is that monetary policy can prevent money itself from being a major source of economic disturbance..

Then there is this wonderful quote from Galbraith:

 Men possessed of money, like men earlier favored by noble birth and great title, have infallibly imagined that the awe and admiration that money inspires were really owing to their own wisdom or personality. The contrast between their view of themselves, as so enhanced, and the frequently ridiculous or depraved reality has ever been a source of wonder and rich amusement. Similarly there has always been pleasure of a low sort in the speed with which the awe and admiration evaporate when something happens to the individual’s money.

One can collect and publish similar quotes from many such famous people.

I am sure there have been earlier episodes of cash crunches as demand suddenly spikes and with supplies taking time, the shortage is a natural outcome. However, the difference now is that each time there is a crunch or news over crunch, people are worried over whether policy is behind this shortage. This leads to people hoarding and overreacting and what is just speculated, becomes a reality. It is much like a bank run where just a rumor could lead to even a sound bank shutting very quickly. Banking and money is all about trust and everything else is secondary.

Each time any of these events happen, there is a lot of political backlash and blame games. To avoid these very political fights and ensure continuity, we have institutions like central banks and financial regulators. One major job of these entities is to help people tide through the political cycles. There is a lot of research which agrees and disagrees on whether the regulators managed the cycle well or not.

In all this, it is depressing to see how RBI is completely at odds with what is going on in the economy. Its responses to both banking crisis and now this cash crunch are unfathomable.

For cash crunch it says there is no shortage:

It has been reported in a section of the media that there is shortage of currency in certain parts of the country. It is clarified at the outset that there is sufficient cash in the RBI vaults and currency chests. Nevertheless, printing of the notes has been ramped up in all the 4 note presses.

The shortage may be felt in some pockets largely due to logistical issues of replenishing ATMs frequently and the recalibration of ATMs being still underway. RBI is closely monitoring both these aspects.

Further, as a matter of abundant precaution, RBI is also taking steps to move currency to areas which are witnessing unusually large cash withdrawals.

Really? No shortage!

In a notice released on 12 Apr 2018, it did say ATM recalibration on the way:

As stated in para 15 of the monetary policy statement dated October 04, 2016, the Bank had constituted a Committee on Currency Movement (CCM) [Chair: Shri D.K. Mohanty, Executive Director] to review the entire gamut of security of the treasure in transit. The recommendations of the Committee have been examined and in order to mitigate risks involved in open cash replenishment/ top-up, it is advised that banks may consider using lockable cassettes in their ATMs which shall be swapped at the time of cash replenishment.

2. The above may be implemented in a phased manner covering at least one third ATMs operated by the banks every year, such that all ATMs achieve cassette swap by March 31, 2021.

In another notice on Apr 6 2018, RBI also developed standards for engaging the Service Provider and its sub-contractor for cash management by banks. But again, these are hardly things which will impact the cash demand as we have seen in recent days.

So clearly, the inability to keep its ears to the ground and its earlier decision to demonetise, have led to this crunch. And then there is the Rs 2000 note whise introduction never made any sense and is now beginning to bite. This will lead to even more uncertainty as there is persistent fear that it will be withdrawn as legal tender very soon. Thus, these problems are unlikely to go away soon.

All these events further erode the image and reputation of the central bank. It is also a reminder on how one should never take things for granted. Not very long ago we only worried mainly over whether the central bank can keep inflation low and never really worried over stability of banking and least about cash management. How the tide has turned in quick time….

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