Demonetisation and capital
More than Rs8.5 trillion worth of money is floating around in the market. This is money or capital that doesn’t go through the official banking system. The growth of money in circulation has been much faster than the growth of the economy.
In June 2019, there was about Rs4.9 trillion in circulation. Since then, it has grown by more than 75%, or Rs3.6 trillion. No matter what time period you look at, the amount of money in circulation has grown a lot, and the prices of assets, especially in the private sector, have gone up as a result.
The amount of money in circulation keeps going up, which keeps pushing up aggregate demand in the market. As demand goes up, supply stays the same, either because people can’t make enough of what they need locally or because they rely too much on imports. This causes inflation to go up.
The current round of inflation, which has caused inflation rates to reach all-time highs, can be partly blamed on a large increase in the monetary base and supply chain bottlenecks. One of the main reasons why inflation keeps going up is that it is hard to move available capital into more useful areas that can increase the total supply.
Policymakers are quick to blame foreign commodity prices for inflation, but they ignore the important role that the dynamics of demand and supply play in keeping long-term inflation in a certain range.
Because people don’t understand how demand and supply work, whether it’s with local currency, foreign currency, or other real goods, policy choices are made on a case-by-case basis instead of to meet a long-term goal.
As a lot of financial capital stays outside of the official financial system, the amount of financial capital in the system goes down, which can help the formal economy grow.
About 70% of all banking assets go directly or indirectly to the government at the moment. As long as the sovereign keeps wanting to borrow money and as long as it keeps running budget deficits, the demand for financial capital will keep going up. As a result, there isn’t enough capital in the system to meet the growing demand. This is because the amount of financial capital in the system is limited, while more and more money is kept outside the system.
When there aren’t enough of something, the price goes up, and the interest rate is basically the price of money. As long as there is a limited amount of financial capital in the system, the interest rate keeps going up. Right now, we have the highest interest rates ever, and if nothing changes, they may go up even more.
Since the government is the biggest borrower in the system, it keeps the private sector from getting credit. This lowers the amount of capital that can be used to grow the private sector, which could lead to industrial or agricultural growth. Since this has been going on for more than 10 years, there hasn’t been much economic growth, and most of the growth that has happened has been through schemes that are very generous and unfair.
The amount of capital that can be given to farmers is actually less than the amount of credit that banks give to their workers. Due to an irresponsible government that keeps running deficits and an increasing amount of capital outside the system, there isn’t much money to invest in building up industrial and agricultural capacity and, eventually, aggregate supply.
At 13% of GDP, Pakistan has generally had one of the lowest savings rates among emerging and frontier markets. A low savings rate doesn’t mean that people don’t save. Instead, it means that people don’t save in the official sector and instead choose to save in the informal sector, whether that means putting money under the mattress or buying real estate in some other way.
Because people don’t save much, they don’t spend much either. This is because there isn’t enough money in the system to invest in infrastructure or the growth of industrial or agricultural capacity.
Demonetization that gets a lot of cash out of circulation and puts it back into the formal banking system is not a one-size-fits-all solution. It does solve the problem of reducing the amount of money in the market while increasing the amount of money in the system.
It helps save some money, but not as much as it could. If the sovereign becomes slightly more fiscally responsible, a rise in the amount of financial capital in the system would finally lead to a drop in interest rates.
The new money that is available can be put to use in export-oriented areas, allowing the country’s export base to grow and become more diverse. This would mean that money that is currently stuck in deadweight assets like real estate and gold would have to be moved to export-oriented businesses that can create jobs and exports. This would also solve the problem of a structural current account deficit.
The same capital can also be used to increase overall supply in places where inflation is more likely to happen. This needs a long-term, well-thought-out industrial policy that is not affected by short-term government changes.
We have a problem with money, which can be fixed by getting rid of paper money. We have a problem with growth, which can be fixed by putting in place an industrial strategy that is backed by an influx of capital from demonetization. We don’t have problems that can’t be solved. We have problems that can be fixed, but we don’t have the motivation to do so.