Make cash holding difficult

Growing cash economy is becoming one of the biggest economic problems in the country, as it contributes towards looming domestic debt trap. The compliance of FATF is linked to documenting the economy, as cash instruments are used for terror financing and for brewing other extremist elements. Prize bonds and big denomination cash notes are making bribery and other illegal transactions easy.
The cash economy was always high in Pakistan relative to its neighbors and much higher than developed economies. The problem exacerbated in the last 5-6 years, when the cash economy started growing at a much higher rate. Hard currency notes, prize bonds and foreign currency notes are termed as cash economy. In June 2013, the currency in circulation was Rs 1,938 billion and the price bonds were Rs 390 billion - combined, the number was Rs 2,328 billion which was 10.4 percent of the economy size (GDP).
By June 2018, the number more than doubled to reach Rs 5,234 and in terms of GDP, it increased to 15.1 percent. The growth accelerated in the PTI regime and in less than a year, almost another trillion rupees have been added to cash economy. Currently, Rs 5.1 trillion is local currency cash holding and Rs 946 billion worth of unregistered prize bonds - as good as cash, are in circulation.
The toll is 15.8 percent of economy, and if it is taken back to 10.4 percent level of June 2013, Rs 2.1 trillion cash can become part of the banking sector deposits or being documented. Today, the bank deposits stand at Rs 12.1 trillion and this can increase by 15-20 percent. And if the documentation in the country is brought to our neighboring India, another Rs 2 trillion could be added in bank deposits.
Thus, documenting the economy can bring around Rs 4 trillion additional money in the system and that may help in generating tax revenues and providing credit to the private sector, and in turn can become capital for productive sectors, and excess liquidity will bring the interest rates down.
The question is how to do so. How to establish government's writ? The efforts so far to curb the non-tax payers have actually worsened the situation in the past few years. Dar's strategy was to penalize non-filers through higher tax rates (which was used under the name of documentation) and that has resulted in spike in undocumented transactions. This government so far has created the fear of crackdown on cash and prize bonds holders, but that has resulted in further cash accumulation.
The strategy has to change by making cash economy operations illegal and difficult. The cash and price bond holding amounted to around $40 billion and a safe guess could be that foreign currency cash holding is 10-15 percent of it - $4-6 billion. Taking half of $45 billion in cash back to system can revolutionize the formal credit market.
People are keeping these cash instruments in bank lockers, at their residences and other safe places. The government is required to take some administrative steps to discourage this cash holding. Other economies have done exercise to demonetize the economy. India has done it ruthlessly by ending the cash notes while Sudan took a middle route of putting a limit on cash holding.
Pakistan has to do more than Sudan, but our precarious macroeconomic situation does not allow harsh steps like India. A full-fledged demonization exercise can increase demand of foreign currency notes and will put further strain on exchange rate.
A partial demonetization exercise is required. The first step is to document the prize bonds. Out of Rs946 billion, around Rs600 billion are of 40,000 denomination. These are unregistered and are as good as cash. Plus, if you buy a whole series of prize bonds, the return on the holding is around 10 percent. Thus, it is undocumented cash without any opportunity cost of holding cash. It is used for real estate transactions and for bribery to government officials, and in other illegal activities including funding to extremist elements.
The government has rightly decided to register the bonds - a nine months timeframe is given to register. And it has been decided to not stop fresh issuance of these bonds. Similar steps are likely to be taken for 25,000 and 15,000 denomination prize bonds as well. This will help document Rs946 billion in bonds and these may not be able to be used for illegal activities. A requirement for FATF compliance as well.
The next problem is to bring currency notes back in the system, and conversion of foreign currency holding in rupees. Some administrative steps are warranted. Legally, cash cannot be put in bank lockers. Government should ask banks to take undertaking from locker holders to state that they do not have cash in these. Then use technology to find out cash in lockers without opening them.
There should be ban on keeping cash counting machines. All these machines should be registered. The tax filers show the amount of cash in wealth statement, and there should be a law to limit cash holding. The big ticker economic transaction should not be allowed in cash. In real estate transactions, make it mandatory to attach the proof of transaction instrument, and the land owing agency should be bound to cross check with relevant banks/FIs. No real estate transfer should be allowed in cash. A similar procedure should be adopted for vehicle transactions.
Make the dealing in cash difficult and riskier. The carrot is shown in terms of undervalued currency and high interest rates, a much-needed stick is required; and it should be effective.