In Pakistan, the documented currency in circulation (CiC) has risen to over Rs. 8 trillion, reflecting the country’s growing economy and the use of cash in business transactions. At the same time, total bank deposits have increased to Rs. 23 trillion, which means that Pakistan has a higher CiC-to-bank deposit ratio of 34 percent compared to Bangladesh and India, indicating a larger informal economy in the country.
The informal economy is made up of parts of the economy that are not under the tax net, and they tend to deal in cash. The majority of people in real estate, Kiryana stores, freelancers, plumbers, doctors, dentists, electricians, jewelers, and citizens refuse to pay taxes on income. This leads to a lot of currency in circulation, especially in the service sector, which contributes over 50 percent of Pakistan’s GDP. Compared to Bangladesh and India, Pakistan has a higher percentage of currency in circulation as part of the overall money supply.
However, the financial year 2022-23 has been challenging for Pakistan due to high pressures on rupee liquidity in the interbank market. This liquidity crunch has caused a slowdown in deposit growth rate and an increase in currency in circulation due to high inflation, extortionate interest rates, weak deposit mobilization efforts, and seasonal withdrawal of large sums from deposits. The State Bank of Pakistan’s open market operations have injected Rs. 8.9 trillion into the market, which has contributed to inflation spiking to 50-year highs and money moving out of banks and into the informal sector.
The biggest beneficiary of currency moving out of banks is the real estate sector. Poor taxation policies, distortion in reported and transaction values of real estate assets, and amnesty schemes have all encouraged capital movement into real estate, making it a safe haven for the preservation of grey capital. A largely cash-based market also means that fire sales are rare, as investors prefer to stay underwater because real estate is a safer investment than the formal economy.
Experts suggest that Pakistan’s CiC needs to be reduced to the same level as regional peers, which would mean a reduction in CiC of Rs. 4 trillion. To achieve this, the country needs to restrict the cash economy. Since 2015, the amount of currency in circulation has increased, indicating that cash is not returning back to the system but is instead transforming into its own mini-economy.