The sudden shortage of cash in some parts of the country is puzzling given the fact that currency in circulation is now back to normal levels in absolute terms, though still down as a percent of nominal gross domestic product. The finance ministry has said in a statement that there has been an unusual spurt in the demand for cash in recent months.
Why? A lot of wild conspiracy theories are doing the rounds, but what should worry Indian policymakers is the possibility that citizens have begun to hoard cash because of overblown fears about the stability of the banking system. Such worries can go viral in a country where smartphones are almost ubiquitous. A higher demand to hold cash can also reduce the money multiplier that is a pivotal process in a modern economy.
The Reserve Bank of India will have to use its printing presses to spew out more currency into the economy. It should also begin to move currency from surplus to deficit areas. However, the most important thing right now will be credible communication to cap any potential panic.