Why 50p coins are headed to the smelter, and small notes towards extinction

It is interesting to note that even as the Reserve Bank of India (RBI) is planning to demonetise currency printed before 2005, the aam aadmi is himself demonetising currency coins at the bottom end - especially the 50 paise coin, the lowest one available right now. The 25 paise coin became history in 2011.

While the RBI's ostensible reason for withdrawing the old notes is to issue new ones with better security features and reduce counterfeiting, The Times of India reports that the general public is beginning to refuse 50 paise coins, given that the currency is practically worthless in everyday use.

However, the most interesting point the newspaper makes is that coins are being collected by weight. It quotes a raddiwala as offering to pay Rs 30 for a kilo of 50 paise coins. What this could mean is that 50 paise coins are now more valuable if they are melted for their metal content than as a means of exchange.

Either way, whether the coins are being melted or being pushed out of circulation by public rejection of their worth in transactions, the larger point is this: inflation is playing havoc with the currency, whether printed notes or coins.

Consider the logic of note and currency printing.

The government is trying to reduce the printing of currency notes - soon Rs 10 notes will be replaced fully by coins - because notes have a short wallet life and cost a lot to print. A Rs 10 note lasts nine to 10 months and cost 95 paise to print; the Rs 10 coin last years and costs Rs 6.60 to mint. (To get an idea of what it costs to print various kinds of notes, read here).

This is why smaller value notes are going out and coins replacing them. Soon Rs 50 could be the minimum value note in circulation, though there is still a Rs 20 note in existence right now.

However, as the case of the 50 paise coin shows, lower-level coins have a way of demonetising themselves due to inflation.

As Vivek Moorthy, a professor of economics at the Indian Institute of Management, Bangalore, wrote in The Financial Express: "Although coins are physically durable, nevertheless they fail to withstand inflation. They tend to disappear with inflation due to one of the two reasons. First, it becomes profitable to melt down the coin because the metallic value has risen above the face value. The higher the price level, the more the meltdown."

Secondly, says Moorthy, "low denomination currency also may disappear due to high inflation when the lowest value transactions considerably exceed the face value of the currency. At present, there are hardly any items that can one can buy for 50 paise... So, one has to accumulate a stash of coins (or a wad of small notes) to pay for items. This is too much of a nuisance for both customers and sellers and so they are induced to throw away the small denominations."

Moorthy explains how. Assuming it is worth melting a coin once its metal value is 30 percent more than its face value, then at a 10 percent annual inflation rate, if the value of the metal in the coin rises in line with inflation, by the end of year three the coin becomes melt-worthy.

The moral of the story is simple: if government wants to make it worthwhile to mint coins and notes where they hold their value for a longer stretch of time, it has to bring down inflation. Otherwise, the mere cost of printing notes and coins will add to inflation. (As an aside, it is worth noting that while note-printing is the liability of the Reserve Bank of India, coin minting is the government's responsibility.)

While all governments have been experts at debauching the value of the rupee by unending note-printing and deficit financing, in the short run one way to rein in the cost of printing and minting money is to simply replace the existing rupee with a new rupee where the old Rs 100 equals a new Re 1.

Replacing all old notes with new ones will cost some economic disruption, but the disruption may be worth it if it is accompanied by a new - and more stringent - Fiscal Responsibility and Budget Management Act (FRBM) that strongly limits the government's power to print currency by monetising fiscal deficits. The current FRBM Act is too easy to change and hence worthless.

The other way to cut currency costs is to mandate the increasing usage of credit and debit cards by offering discounts on their usage. Utility companies already offer bill discounts on electronic or credit card payments, and if all transactions done by cards get a 0.5 percent discount, people will start using money less.

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Updated Date: Mar 10, 2014 11:59:46 IST