Pakistan’s currency in circulation has reached levels that are increasingly being viewed as a signal of underlying economic stress, despite broader narratives of stabilization and gradual recovery. In an environment where digital payment systems are expanding and financial digitization is being promoted, the rise in physical cash holdings presents a contrasting trend that reflects shifts in public confidence, monetary behavior, and macroeconomic expectations.
Recent data indicates that currency in circulation has climbed to its highest absolute level and remains close to its peak as a share of broad money supply (M2). While seasonal patterns such as Eid-related cash demand can partially explain short-term increases, the broader upward trajectory suggests deeper structural and behavioural factors at play. These include concerns over inflation, uncertainty in the economic outlook, relatively low real returns on deposits, and persistent mistrust toward tax enforcement systems.
Historical patterns show a consistent relationship between falling real interest rates and rising currency circulation. During periods when real rates turn negative and economic confidence weakens, individuals and businesses tend to withdraw liquidity from the formal banking system and hold greater cash balances. This behavior was evident during multiple stress episodes over recent years.
A notable surge was recorded in April 2020 when interest rates were sharply reduced in response to the economic slowdown triggered by the COVID-19 shock. With negative real returns and heightened uncertainty, liquidity shifted away from bank deposits toward physical cash holdings. A similar pattern emerged in mid-2022 following political uncertainty after the vote of no confidence, when fuel pricing adjustments were delayed and inflationary pressures intensified, further weakening confidence in financial stability.
Another significant episode occurred in 2023 when concerns over external debt sustainability and pressure on the exchange rate contributed to expectations of currency instability. During that period, the rupee experienced managed appreciation, but underlying market sentiment remained cautious, prompting increased cash retention outside the banking system.
Against this backdrop, the recent upward trend in currency circulation in 2026 has surprised observers who expected improved macroeconomic stability to support a gradual normalization of financial behavior. The economy has shown signs of stabilization and transition toward growth, while political conditions have remained relatively steady. However, current data suggests that confidence levels remain fragile.
One emerging factor behind this trend is renewed external geopolitical tension, including conflict-related developments in the broader region, which have contributed to inflationary expectations and uncertainty in forward-looking economic assessments. As expectations of currency depreciation increase, the opportunity cost of holding cash declines, encouraging liquidity withdrawal from formal financial channels.
At the same time, structural issues related to taxation and compliance are also influencing behavior. Rising tax rates and increasing friction between businesses and tax authorities have contributed to a shift toward informal economic activity. This shift reduces reliance on formal banking infrastructure and encourages cash-based transactions, further increasing currency in circulation.
The macroeconomic implications of this trend are significant. Since broad money supply consists primarily of bank deposits and physical currency, an increase in cash holdings typically corresponds with a decline in bank deposits. This shift affects the liquidity position of the banking system and reduces its capacity to channel funds into government securities and other financial assets.
As a result, the central bank has been required to inject higher levels of liquidity through open market operations. These injections have crossed Rs15 trillion, effectively functioning as indirect government borrowing through the banking system. The growing reliance on such liquidity support highlights pressure within the financial system and the state’s increasing dependence on domestic banking resources.
From a policy perspective, the rising share of currency in circulation raises concerns about increasing informality in the economy. When liquidity moves out of formal banking channels, it reduces transparency, weakens monetary transmission, and complicates fiscal management. The primary mechanism available to address this trend lies in interest rate policy, where higher rates could increase the incentive to hold deposits rather than physical cash.
Monitoring this development is becoming increasingly important for monetary authorities, particularly as it reflects not only financial conditions but also broader trust in economic governance. The State Bank of Pakistan is expected to evaluate these trends closely in its upcoming monetary policy deliberations, as they carry implications for liquidity management, inflation control, and financial system stability.
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