Currency demand had been “somewhat subdued” relative to GDP growth in recent years, setting the stage for a sharper rebound, helped by strong rural demand, said Abhishek Upadhyay, co-head of research at ICICI Securities Primary Dealership.
A cut in the goods and services tax on several daily-use items in September also boosted demand.
Lower interest rates have further supported cash usage, particularly in rural areas with a higher propensity to spend, said Soumya Kanti Ghosh, group chief economic adviser at State Bank of India.
He added that higher prices of precious metals may have also lifted currency in circulation through recycling of gold and silver from households.
The surge, if it persists, could pose a challenge for surplus liquidity in the banking system, which the central bank has tried to maintain to support economic activity.HDFC Bank expects the liquidity surplus to average around 1% of deposits in the first half of the current financial year, before easing to 0.5% in second half.
“But if CIC continues to remain elevated due to rise in inflation, further acceleration in rural demand, and any impact from state elections, liquidity balances could move towards the lower band of the forecast range,” economist Sakshi Gupta said.
The RBI said in March that holding the surplus within a range of 0.6%-1.1% of deposits helps in keeping the spread between weighted average call rate and policy rate narrow.
RBI’s infusions have kept banking liquidity in surplus but going forward, while RBI dividend will support it, CIC will drain it further, said Dhiraj Nim, an economist and FX strategist at ANZ.