How much cash will really become scrap?

Long queues at Banks tell the story of changing India. At the same time, the impact from the move seems to be exaggerated too. I formed that opinion after creating the following decision tree. Take a look:

First of all, all the cash in supply is not with the public. A major share is in banks and a good amount of money is with corporate in the form of working capital and Utilities companies too are sitting on cash in the form of customer receipts. It is all unaffected by the move to ban Rs.500 and Rs. 1000 notes.

Let us come to Public holding. Salaried people have already paid tax through TDS, so they do not have issue getting the cash on hand converted. The low wage labors are unlikely to have more than Rs.2.5 lakh cash on hand per person. If they don’t have a bank account, they will get one and the cash will be converted too. Their money is unaffected.

Then we have self-employed people like Doctors, Film actors and people in many other such professions, some of them earn handsome pay while others just earn a comfortable living. These people receive their earning mostly through cash payments and if they had remained on cash, they would be in trouble. And if that money is less than Rs.10 lakhs, they will likely declare it, pay tax and rest of the money goes back to their pockets. Few celebrities may lose good money but they are very few. But yes, some of them will have to part at least with their cash.

Small businesses, like the neighborhood grocery shop keeper, who mostly operated on cash, will face serious troubles. But they can do damage control by depositing their money in the family member’s names, paying advance salaries, settling dues etc. Yet, they are the one to lose considerable money. They looked street smart until now but now their fate has changed for bad.

The real trouble is for the people in the cash-heavy businesses. They are going to lose significant cash wealth. Real Estate looked as a promising business for them but now the rules have changed. But the challenge is to know how much cash is with them.

While the data for distribution of cash is not publicly available, we can do some guess work to get an estimate. Majority of it is likely to be with Banks and utility and service provider companies which is perfect legal and valid. If we assume 1/3 rd of the cash remains with public and half of may be on its way to become scrap. Let us put this into equation:

Scrap Money = % of Rs.500 and 1,000 bills x % with public x % of likely scrap

= 87% x 33% x 50%

= 14.35%

Since this is all guess work, actual numbers might vary. But if my guess work holds good, actual cash to be destroyed will be in the range of 10% to 15% of total cash in the system. It is still huge money but rumors say it would be in the range of 30% and that seems overrated to me.