Transitioning away from a cash economy

What's wrong with extremely high levels of cash in our economy, and what needs to be done to fix this.

As the global economy graduates towards digital payments and digital currency platforms, Pakistan is moving in the opposite direction with rising demand for cash.

State Bank of Pakistan (SBP) data indicates that the Cash in Circulation (CinC) has increased to Rs9.2 trillion ($32 billion) at the end of June 2023, which is equivalent to 30 per cent of the total money supply (M2), or around 11pc of the national GDP. These are alarming numbers when compared to other emerging economies, where on average CinC accounts for only 5pc of national GDP.

CinC is the difference between the total stock of money supply and the deposits available with financial institutions (banks, microfinance, and NBFIs). High CinC is inflationary in nature because it directly fuels consumption of goods and services. Higher consumption also stimulates import demand, expanding trade deficits and driving currency depreciation.

By reducing the flow of funds that should enter the banking system, thereby expanding the country’s loan base through the banking multiplier, high CinC undermines investment and savings, leading to lower job creation in the economy.

In addition, higher CinC diverts capital resources towards unproductive, speculative activity (mostly real estate, but also hoarding of commodities, foreign currency, etc). As it sits outside the net of the central banks’ policy rate, it dilutes the effectiveness of monetary policy in containing inflation; and by reducing the pool of savings available with the banking sector it increases the cost of funds for the formal sector.

Since the government is by far the single largest borrower in the banking sector (Rs29tn vs Rs11tn for the private sector), the impact is disproportionately higher on their borrowing costs. Currently, the government pays approximately 23pc interest for every rupee it borrows, leading to serious concerns over its debt sustainability.

Despite the adverse impact of high CinC, policymakers have paid little attention to this growing problem. The National Financial Inclusion Strategy, spearheaded by the SBP, is an ambitious plan that aims to tackle the low penetration of financial services.

However, data suggests that there has been no discernible impact on reducing CinC. There is limited analytical work conducted locally to understand the growing demand for CinC; no comprehensive research paper has been published on the causes and no policy recommendations have been presented to tackle this problem, as such.


There is ample evidence that government tax measures are a significant cause of the exponential increase in CinC. The imposition of withholding tax on banking transactions (non-cash) and cash withdrawal led to a significant shift toward CinC, and on top of that, the distinction between filer and non-filer added fuel to the fire.

While these tax measures had limited success in increasing tax collection and the number of registered taxpayers, they discouraged deposits with banks. This has led to a sharp increase in the holding of cash. Since FY15, the average annual growth in bank deposits is 12pc, whereas during the same period, the average growth of CinC has been 17pc.

It is likely that the rapid increase in CinC is linked to the growth of the informal economy outside the tax net. In order to avoid declaration of wealth and evade taxes on income, CinC is often parked in real estate, agriculture, retail and/or other asset classes which are not part of banking deposits, including foreign currency stored in lockers, gold, etc. Since the real estate sector has tax and valuation glitters, there is an incentive to park funds in plots and properties. But no analytical research exists to quantify these numbers for effective policymaking.

Tax avoidance

A breakup of deposit data by economic sectors published by SBP gives interesting insights. It shows that the rural economy has the lowest deposit penetration. Total deposits of crop-producing farmers were only 2pc of their respective GDP at current market prices. Livestock farmers, the third largest sector of the economy, held only 0.3pc of their incomes in bank deposits. This potentially indicates that lower literacy rates, lack of access to bank branches, and higher transaction costs discourage rural households and businesses from keeping money in banks.

The wholesale & retail sector is the largest sector of our economy, estimated at Rs13tn in FY22 with a share of 20.7pc in the national GDP. According to SBP data, the deposit penetration of this sector is only 5.8pc. This industry is dominated primarily by SMEs and they operate mostly in urban and semi-urban areas. They have access to bank networks — but banks only service their financial needs on a very limited scale, and the sector stays in the informal economy for most part, operating through cash rather than via bank accounts.

The result is a high degree of tax avoidance, even though the sector already enjoys significant tax concessions. Their powerful lobbies are able to exert political influence, as witnessed last year when the government reversed incremental taxes imposed on retailers and traders.

A comprehensive policy response is needed to tackle the growing challenge of CinC. Comprehensive assessment is needed to identify the flows and workings behind the growing use of cash by large segments of the economy.

Tackling the problem will also need the benefit of evidence from other countries — Indonesia, Mexico, Turkiye, for example, that have been able to keep their CinC below 5pc consistently over the years — and can also serve as valuable inputs for policymaking. It is quite probable that a simpler tax framework and lower effective tax rates all around will assist the effort to encourage tax compliance.

Digital payments

A major development in other emerging economies, where digital payments and mobile wallets are gaining strong traction, shows the effectiveness of digitisation in reducing the need to hold cash. In China, WeChat and Alipay digital wallets have come to dominate the payments system. In Africa, mobile providers have launched successful money transfer services, such as Safaricom M-Pesa in Kenya.

In India, the Unified Payments Interface (UPI) platform has revolutionized digital payments ecosystem, allowing for free and fast account-to-account transfers using the mobile phone. Digital payments today account for 40pc of all transactions in India, with an estimated annual value of $2.4tn.Nearly half of these payments were classified as smaller micropayments, with an estimated average transaction value of up to INR200.

In Pakistan, a similar initiative was launched in 2021, the ‘Raast’ gateway. The SBP Annual Payment Systems Review for 2022 highlights a significant expansion in the digital payments ecosystem, as a result of the Raast payment gateway. Mobile banking surged by 100.4pc to 387.5m transactions and internet banking witnessed a 51.7pc growth to reach 141.7m transactions. Despite encouraging indicators, a huge gap still exists between digital services and consumers, with there being 79m mobile money accounts in 2021 of which only 45m are active.

The government is the single biggest entity for payroll payments and also for the purchase of goods and services in our country. A major opportunity exists in accelerating the digitization of government payment systems, which in turn could absorb CinC into bank accounts.

Cash transfers under the BISP social support programme demonstrate this via a rapid increase in limited mandate beneficiary bank accounts. Such digitised inter­­vention needs to be widened and deepened to encourage all beneficiaries of government payments to maintain full-service bank accounts, assisting in expanding formal savings and overall financial inclusion.

It may be noted that Pakistan had launched Nadra much ahead of other emerging economies (in fact, helped other countries to set up similar infrastructure), and has run it very successfully over the years. We have not used this virtual treasure-trove of a database as a “utility” to leverage it for the quantum leap we need in our payment digitisation efforts.

Nadra should move away from the mindset of a “profit centre” to the role of a “shared utility” for accessibility of data in the most cost-effective manner, for the larger good of the economy. Just to put things into perspective, Nadra charges Rs10 to Rs45 per transaction for accessing their database depending upon authentication and extraction of demographic profile, whilst charges in India for similar services are a fraction of that — perhaps to recover their cost of infrastructure/information security only.

Similar data repository and sharing, maybe through the already established electronic Credit Information Bureau (eCIB) in public and private sectors, is necessary in other consumer interfacing utilities and regulators like Nepra, Ogra, PTA, SECP and SBP.

All this data may be connected with Nadra and FBR for better access for all concerned, with the objective of enhancing the documentation of the economy and recovery of dues in time by triggering cross-default.

According to the IMF’s 2020 report, digital payments relieve governments of many burdens associated with cash, which in turn can create considerable savings.

This includes the manual processes involved in collecting, counting, recording, and transporting cash — all of which can happen almost instantaneously and at zero marginal cost through digital payment infrastructure. IMF staff calculations show that digitalising government payments could create a value of roughly 1pc of GDP for most countries by reducing leakages and increasing the efficiency of payments for governments.

Real estate, forex and gold

The government must also address the large undocumented real estate market. Land records and registration of titles are not fully digitised, with prescribed property valuation rates well below market rates. Given the low tax incidence on property, this provides the opportunity for holding large amounts of cash in the form of land titles.

Mushroom growth of illegal housing societies across all major urban centres thrives on the cash economy. The government needs to create a digital real estate registry where all transactions will be recorded and made available to the public, which will also help in prescribing the minimum property rates in line with the market. This should be made mandatory and will discourage the trading of ‘files’, a method used to evade taxes.

Also, over time, through challenge and invalidation of the under-valued original price declaration, digitized records will assure reduction in the historic trend for under-declaration. Plugging the real estate sector leak will be crucial in reducing tax asylum available for holding large volumes of CinC.

The other safe-haven that can be used for storing large volumes of CinC includes foreign currency and gold. These assets have provided higher returns on savings than most rupee-based assets — stocks, bonds, real estate, and others — particularly in the last two years, and also provided a window to whiten the black money.

Policymakers and financial institutions need to create avenues for these assets to be documented and to aid formal savings growth once people save and trade dollars and gold through their bank accounts and eschew lockers. The import of gold should be conducted through bank LCs or Consignment Contracts, with a maximum limit on the amount of cash transactions allowed for the jewellery trade.

The recent measures taken by SBP to allow banks to buy and sell foreign currency to individual clients, and the crackdown of law enforcement agencies on smuggling, hoarding and illegal trading of currency is a welcome step, and has started bearing fruit already.

Fear of higher competition has led the exchange companies to reduce the margins charged to the clients and has improved the availability of dollars in the market. The rupee has strengthened as a result, discouraging investors from holding foreign currency or routing them through other channels but banking.


Recent growth in CinC has been spurred by fast growth in overall money supply. In the last two years, the single largest contributor to the money supply has been the SBP’s open market operations (OMOs). The size of OMOs increased to a staggering Rs9.4tn by the end of September 2023, roughly the same size as the CinC — and close to the size of outstanding private sector credit.

Injection of this very large quantum of fresh money has diluted the impact of monetary tightening measures taken to counter runaway inflation. Further­more, the local ‘purchi trade’ — mainly executed through bearer cheques and loose handwritten undertakings on a plain piece of paper, in the main wholesale and retail markets across the country — assumed to be at 10-15pc of the current CinC levels, doesn’t show anywhere in the formal data, but does have a multiplier impact on credit within the informal economy.

Some legal method must be established to control the size of this informal credit, to restrict such ‘bearer’ instruments to not more than Rs100,000 per promissory note.

The case for demonetisation

Demonetisation offers itself as an obvious initiative. But careful assessments need to be undertaken, before being embarked upon both in terms of timing and process.

In 2016, India took the decision — for the third time in their history — to withdraw the INR1000 and 500 notes from the money supply to cut down on CinC as a step aimed at documenting the informal economy. But since it had not understood the extent of the role cash played here, it had not envisaged the deep impact the step had on disrupting markets and businesses. According to The Guardian, the measure is estimated to have cost the economy 1.5pc of GDP and an estimated 1.5m jobs were lost.

It is also important to note that the gains made in India from demonetisation were diluted over time despite the country having taken great strides in digitisation of the economy. Initially, the currency in circulation fell sharply in 2017 to around 5pc of GDP from around 10pc of GDP.

However, these gains proved to be temporary, and in the subsequent years, CinC has again grown sharply to over 10pc of GDP in 2022. Interestingly, the Reserve Bank of India (RBI) annual report stated that 99.3pc of the money withdrawn from circulation had been returned to banks, indicating either there was less “black money” than government expectations and/or that avenues to launder money had been successful.

While demonetisation for Pakistan, particularly Rs5,000 notes estimated to be 1/3rd of the total CinC, makes sense but this can’t be achieved without pain, especially given the fact that large rural population remains unbanked and has weak digital connectivity. Demonetisation will need to be attempted in Pakistan with laser-sharp precision and perhaps in a phased manner, minimizing disruptions to livelihoods.

Sales Tax

Tax policy is another area that can play an effective role in reducing the money in circulation.

The government has discouraged the use of cash for payments in restaurants by reducing the GST rate to 5pc on payments made on bank credit/debit cards. This measure has had a significant positive impact on consumer behaviour, especially in urban areas. These incentives can be expanded towards all goods and services, while simultaneously imposing penalties on retailers that don’t allow for digital payments.

Let us conclude by saying that bringing down CinC to within acceptable limits will need an integrated suite of measures, to be applied as a continuous process. It cannot be achieved through isolated, rifle-shot measures.

The process will gain momentum over time as the government’s resolve and commitment to achieve the goal of a better-documented economy in a more open society seeps into general awareness and achieves acceptance.

The social contract between the public and the government needs to be strengthened. The government needs to show better delivery against higher tax revenue; on its part, the public must appreciate that paying taxes is necessary for better public services.

And above all, our elites must learn to accept their obligation to pay all due taxes and fulfil their side of the bargain, to ensure the viability of an economy within which they have prospered. Their neglect to do so will only vitiate the capacity of the Pakistani economy to offer the continued GDP expansion businesses need for their own future.

Syed Salim Raza
Syed Salim Raza
The author is the former governor of the State Bank of Pakistan (SBP).


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