Demonetisation and Money Supply

• 10 Nov 2025

Source: IE 

Why in News?

Currency with the public (total currency in circulation (CIC) minus cash held by banks) has more than doubled since the 2016 demonetisation, rising from Rs 17.97 lakh crore (Nov 2016) to Rs 37.29 lakh crore (October 2025), according to RBI data. 

• However, despite the increase in absolute terms, the currency-to-GDP ratio has fallen below pre-demonetisation levels, indicating stronger economic growth and rising digital payments adoption.

What was the 2016 Demonetisation? 

• About: On 8th November, 2016, PM declared that Rs 500 and Rs 1,000 notes—constituting 86% of total currency—would cease to be legal tender from midnight to address black money, counter fake currency, boost digital payments, and formalise the economy. 
  • The Rs 2000 banknote was introduced in November 2016 after the withdrawal of Rs 500 and Rs 1000 notes. Rs 2000 banknote were withdrawn from circulation in May 2023 but remains legal tender (legally valid money that people are obligated to accept when settling financial transactions). 
  • Demonetisation is the process by which a country withdraws a currency unit’s status as legal tender — meaning the banknotes or coins are no longer officially accepted for transactions. 
• Legal Backing: The notification declaring Rs 500 and Rs 1,000 notes invalid was issued under Section 26(2) of the RBI Act, 1934, which empowers the central government to declare that “any series of bank notes of any denomination shall cease to be legal tender” based on a recommendation from the RBI’s central board. 
• Judicial Stand: In the Vivek Narayan Sharma v Union of India Case, 2023, the Supreme Court, in a 4:1 split verdict, upheld the Union's 2016 demonetisation, ruling that it was proportionate to its stated objectives and implemented in a reasonable manner. 
• Impact:  
  • Economic Disruption: It caused major disruption e.g., demand fell, businesses struggled, GDP dipped by 1.5%, SMEs were hit hard, and the public faced long queues to exchange invalid notes. 
  • Deepening Digital Penetration: UPI has boosted digital transactions, reaching 185.9 billion in FY25. UPI transactions grew at a 49% CAGR between FY23–FY25, showing rapid adoption and deeper penetration in tier 2 and tier 3 cities. 
  • Low CIC to GDP Ratio: The CIC-to-GDP ratio has declined to 11.11% in 2025 from 12.1% in 2016, indicating that the economy—growing over 6% annually—has reduced its reliance on cash. 
    • However, India’s currency-to-GDP ratio (11.11%) is significantly higher than the US (7.96%), China (9.5%), Eurozone (8–10%), and Japan (9–11%) due to its large informal economy and cultural preference for cash.  
      • The currency-to-GDP ratio measures the value of physical cash in circulation compared to a country's total economic output.

Measures of Money Supply in India 

• In India, the money supply is measured using M1, M2, M3, and M4, a classification introduced by the RBI in April 1977. Since then, the RBI has regularly published data on the following four measures: 
  • M1 (narrow money) includes: 
    • Currency with the public (notes and coins, excluding banks’ cash) 
    • Demand deposits with the Banking Systems (excluding inter-bank deposits) 
    • Other deposits with the RBI (from foreign central banks, financial institutions, etc.) 
  • M2: The second measure of money supply is M2, which consists of M1 plus post office savings bank deposits. 
  • M3: M3 (broad money), the third measure of money supply, includes M1 plus time deposits with commercial and cooperative banks, excluding inter-bank time deposits. 
  • M4: M4, the 4^th measure of money supply, includes M3 plus all post office deposits (both time and demand deposits) and is the broadest measure of money supply.

• Among the four measures of money supply released by the RBI, M3 holds special importance and is used while framing annual macroeconomic objectives. The Chakravarty Committee (1982-85), set up to review the working of the monetary system, also recommended using M3 for monetary targeting. 

Frequently Asked Questions (FAQs) 

1. What is “currency with the public”? 
Currency with the public = Currency in Circulation (CIC) minus cash with banks; it represents notes and coins physically used for transactions. 

2. What legal provision backed the 2016 demonetisation? 
The 2016 note invalidation was notified under Section 26(2) of the RBI Act, 1934, which allows the central government to declare any series of banknotes as non-legal tender on RBI recommendation. 

3. Why is India's currency-to-GDP ratio higher than that of the US and China? 
India's elevated ratio (11.11%) is primarily due to its large informal economy and a strong cultural preference for holding physical cash, unlike the more formalized and digitalized economies of the US and China. 

UPSC Civil Services Examination, Previous Year Question (PYQ) 

Q. Which of the following measures would result in an increase in the money supply in the economy? (2012)

1. Purchase of government securities from the public by the Central Bank 
2. Deposit of currency in commercial banks by the public 
3. Borrowing by the government from the Central Bank 
4. Sale of government securities to the public by the Central Bank 

Select the correct answer using the codes given below: 

(a) 1 only  

(b) 2 and 4 only  

(c) 1 and 3 only  

(d) 2, 3 and 4 

Ans: (c)

Q. Supply of money remaining the same when there is an increase in demand for money, there will be (2013)

(a) a fall in the level of prices 

(b) an increase in the rate of interest 

(c) a decrease in the rate of interest 

(d) an increase in the level of income and employment 

Ans: (b)

Q. A rise in general level of prices may be caused by (2013)

1. an increase in the money supply 
2. a decrease in the aggregate level of output 
3. an increase in the effective demand 

Select the correct answer using the codes given below: 

(a) 1 only  

(b) 1 and 2 only 

(c) 2 and 3 only 

(d) 1, 2 and 3 

Ans: (d)