Cash over bank deposits-Informal economy or knowledge deficit?

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Pakistan’s hard holding cash accounts for 30% of the M2(currency in circulation+bank deposits) as of Apr’20. That is amongst the highest compared to other developing countries. People in Pakistan prefer to hold cash instead of keeping deposits in banks. One can infer multiple reasons for such high rate. From the top of the head, generally cash in hand is preferred in economies where the informal economy is really high. Secondly, if the cost of keeping deposits in banks is high, people prefer cash over deposits. Thirdly, given the illiteracy rate in Pakistan people either have knowledge deficit or the banking is out of reach for them, specially in rural areas.

Pakistan’s policy rate was amongst the highest(13.25%) in emerging markets uptil last month. Despite the huge opportunity cost of holding cash, people in Pakistan have preference for cash in hand. This not only weakens the monetary policy transmission mechanism by decreasing the bank’s capacity to generate new loans(low deposit rates) but also damage the economy.

Hence, it is important to work on the factors that have contributed to such behavior by individuals. For that to happen, it is imperative that firstly the reasons for such high cash holding be identified appropriately. If the cost of keeping deposit at bank is what dissuade people from holding money in banks then government and central banks should probably consider revisiting their tax policy. If the reason has to do with the informal economy then the government should probably give amnesty to ensure more people register themselves in formal umbrella. And lastly but most importantly, if the reason has to do with lack of awareness and outreach then government and central bank needs to provide awareness and make banking accessible to people.

Cash in hand in developed countries generally hovers around 6-7% and most of their economy works digitally. For Pakistan to improve its financial and economic system, it is imperative the rate is brought down substantially.

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