Growth in currency in circulation during this fiscal year was high despite the government’s stepped up efforts to document the economy.

According to the State Bank of Pakistan’s statistics, CIC swelled by Rs642bn between July 1, 2015 and June 3, 2016, up 67pc from Rs384bn in the year-ago period.

Chances are that by the close of the fiscal year on June 30, CIC may expand further, according to well-placed SBP sources familiar with this trend.

Historically, CIC as a percentage of Broad Money or M2 has remained high in the country as the economy is not well documented and the existence of a large informal sector necessitates, facilitates, promotes and incentivises cash holding (See graph).

“But the pace at which CIC has surged during the current fiscal year is troubling because this has happened despite several efforts to document of the economy,” notes a former deputy governor of the central bank.

That then raises the question about documentation quality which, many analysts point out, has focused on boosting tax collection through indirect taxes instead of bringing a significant number of untaxed people and companies into the tax net.

Sources in the SBP say volumetric rise in CIC in FY2016 has been so strong that they fear that CIC as percentage of M2 would rise past 26pc, against the last five-year average of about 22.5pc.

Sources in the SBP say volumetric rise in CIC in FY2016 has been so strong that they fear that CIC as percentage of M2 would rise past 26pc, against the last five-year average of about 22.5pc

Central bankers regularly brainstorm on the issue of an unusual growth in CIC and, at times, also seek feedback from top bankers and active players of financial markets, says the head of a local commercial bank. “But no central bank alone can keep a decisive check on excessive CIC growth if the government policies aimed at documenting the economy begin to produce just the opposite results.”

The soaring of CIC in FY2016 is being seen as a backlash of the government move to tax banking transactions of all non tax-filers and growing political uncertainty in the country, senior bankers say. They believe that the imposition of withholding tax on banking transactions and the initial insistence of the government to deal with small businesses with an iron-hand led countless businesses to switch over to cash dealings. And, even those who had to use banking channels for business dealings started withdrawing from bank deposits more heavily than before.

“Fast growing and intense activity in the real estate market is also partly responsible for fuelling CIC as the bulk of black money is parked in the real estate and a boom in this market is bound to coincide with higher growth in CIC,” according to an official of Exchange Companies Association of Pakistan.

The perceived threat to small businesses in mishandling of the issue of withholding tax on banking transactions has also led to a big rise in investment in prize bonds. These bonds being a part of National Saving Schemes are counted outside Broad Money or M2 but make part of M3, a wider scale of measuring total money supply.

The, prize bonds tend to serve the undocumented economy as it is next to impossible to trace their real sources of investment. In ten months of FY2016, about Rs100bn investment went into prize bonds which was one half of the total investment of about Rs200bn in the entire NSS portfolio. In preceding five years, from FY211 to FY2015, inflows in prize bonds never exceeded 30pc of the fresh investment in overall NSS.

A marked decline in growth of total bank deposits in FY2016 compared to FY2015 also indicates that withdrawals from bank accounts accelerated during this year. And, this happened amid a decline in interest rates coupled with the fiscal authorities’ obsession with taxing banking transactions. In 11MFY16, total bank deposits grew by 9.35pc against 14.2pc in 11MFY15, SBP statistics reveal.

Officials of the ministry of finance insist that changes in the tax regime for FY2017 are such that they would help in further documentation of the economy, particularly in such key sectors as the real estate and luxury lifestyle goods. They believe that with a more independent monitory policy committee being in place now, attaining increased efficiency in regulating money supply has become easier for the SBP. “Besides, one single year is too short a time to read a trend of unusual growth in CIC,” one senior official said in response to this writer’s queries.

“Not all the money outside the banking system in a given year is bound to remain as such forever. A large part of it has to come back into the system after circulating in many hands and passing through several stages of economic activity, We hope that in FY2017 CIC growth will return to a long-held average of 22-23pc (of M2).”

One important thing that some central bankers and finance ministry officials point out is that CIC growth has not been accompanied by any rise in inflation. Average CPI inflation rather fell to 2.8pc in July-May FY2016 from 4.7pc in July-May FY2015.

But independent analysts argue that the decline in inflation this time around is more due to the effects of depressed global commodity prices plus weaker local demand as a result of lower-than-targeted economic growth. “Besides, effects of monetary variables on inflation come after a lag of time,” says a former central banker. And, “inflationary impact of an unusual rise in CIC can also remain mitigated if the CPI basket of goods and services does not include certain items like the ones that are used widely by a certain beneficiary class of the parallel economy.”

Published in Dawn, Business & Finance weekly, June 20th, 2016