Demonetization , Digitization, and Cashless Economy

Demonetization, since it was announced in November 2016 has been subject of intense media debate. Fairly so, since it has been quite many years since such a disruptive policy experiment has been conducted by the Govt. of India. Besides, demonetization has no parallels anywhere else in the world.

At the core of this intense debate is whether demonetization is a success or a failure. Before we delve into that aspect, let’s look at what could have led to this decision. One of the primary reasons demonetization was announced is the huge rise in the black money aided by the number of high value notes (Rs 500 and Rs 1000) in circulation in the Indian economy.

According to RBI, at the time of demonetization, 15 trillion rupees comprised of these high value notes was circulating in the Indian economy and an estimated one third of this 15 trillion rupees was circulating outside the formal bank economy making it black money.

Such huge amount of black money is a direct result of tax evasion, directly impacting Govt’s revenue. Secondly, it is responsible for rapid rise in asset prices be it real estate, gold, or other commodities as witnessed in India over the last decade or so.

Demonetization — Success or Failure

The way to measure the success of an action or an event is by measuring the predefined objectives that you must have set before executing that action or event.

In this case of demonetization, the largely publicized objectives by the Govt. were

• Elimination of black money
• Curbing the menace of fake notes
• Denting terror financing

On the later two points of fake notes and terror financing, we do not have sufficient data yet to reach a conclusion. However, on the black money front, recent data cited by RBI that a whopping 99 percent of the total demonetized money in circulation has returned to the RBI/banks could be seen as argument to pronounce that demonetization has failed.

The other argument that has been cited by pundits to state that demonetization is a failure is that it has caused a slump in GDP growth rates and has wrecked the economy, especially the informal economy which makes up a large percentage of Indian economy.

I am no economist.

But, in my opinion, given the unprecedented event of demonetization and its ripple still being felt across the economy, it is too early to judge its impact both on the black money and the growth rate.

The amount of demonetized currency that has returned or rather the complete return of demonetized currency as a parameter is not the right way to judge this experiment’s success or failure.

Just because one has deposited his demonetized money back into the bank doesn’t automatically convert that money into white neither does it mean that you have escaped tax scrutiny.

Given that deposits above Rs 2 lakh (including suspicious small scale deposits across zero balance accounts) amounting to Rs 2.89 lakh crores are being scrutinized by the income tax department, it is better to keep an open mind and await the final outcome before passing a judgement.

Of course, in the days to come if it becomes clear that the govt has failed in identifying the black money from the deposits made and failed in taxing those deposits and people behind appropriately, then it could be safe to say that demonetization is a failure in achieving its main objective.

Digitization — The biggest beneficiary

Demonetization, whatever the original intent of it, has resulted in one positive consequence — Digitization of Indian economy. Given that cash, the primary and central source of monetary transactions was banned overnight, people started looking at alternate ways to make payments and complete transactions.

That has led to adoption of digital payment methods and surge in digital transactions across the country.

One could see the volume of transactions through usage of debit cards, credit cards, payment wallets at POS terminals rise sharply. Besides, the volume of transactions through mobile banking and NEFT also witnessed rapid growth.

To be fair this is not to say that digitization itself has kick started post demonetization. The path towards digitization started much earlier with internet penetration, telecom revolution leading to widespread availability of smartphones, 3G availability, and rise of e-commerce startups & e-wallet companies.

All these led to people getting familiarized with digital platforms and online transactions. It’s just that post demonetization the trend towards digitization and cashless transactions has significantly accelerated.

For example — the launch of BHIM ( Bharat Interface For Money) app by Govt. of India. Unlike a wallet, this app allows one to make direct bank to bank transactions without loading any money from a third party source and unlike credit/debit cards, this app doesn’t require any POS terminal/swiping machine to transfer money.

Currently, this is nearing 20 million downloads and penetration level is about 36% in rural areas and much higher in urban areas.

Another example of a mobile payment solution launched by Govt. of India is Bharat QR, which is a QR code based alternate payment solution for merchant locations instead of traditionally used credit or debit cards. The advantage being the elimination of POS (point of sale) machines leading to lesser capital costs, no theft of card data, and interoperability with all the banks in the country.

The Govt. aims to see the expansion of these payment methods at all retail locations to achieve a target of 25 billion transactions by 2018.

Formalization of Indian Economy — The other beneficiary

One another positive outcome of demonetization has been the formalization of economy which essentially is shifting firms, especially small & medium, and jobs from informal to formal.

One needs to understand that India’s economy, essentially the labor market is largely informal i.e about 80%. For India to clock high GDP growth rate it needs to create safe and well paying jobs for a large number of people who are currently under the umbrella of informal economy.

Although the measurable progress seems to be pretty small now, in the long term, one could witness the positive effects of demonetization in transforming India into more a formal economy.

Consider this for example. A small firm which was paying wages to its employees in cash was forced to make salary payments to their respective bank accounts, post demonetization, at least for a few months till cash made a comeback.

That would have brought millions of people into the formal banking system temporarily and would have created a digital financial footprint making them eligible to access credit from banks, paving the way for financial inclusion.

Aadhar and the opening of bank accounts under Prime Minister Jan Dhan Yojana (PMJDY) program provided the necessary infrastructure to create such a financial footprint.

Despite numerous problems, the implementation of the GST is a key complementary reform that will support formalization, as firms have a strong incentive to register with GST to obtain input tax credits and to gain from compliance rating of their vendors.

But a lot more needs to be done if Govt. is really serious about making people stick to the formal economy.

Digitization and Formalization — What can be done to boost it

Although there has been significant rise in digitization and formalization of economy, we can surely do a few things to accelerate the process of formalization further and to become a completely cashless economy in the future.

1. Incentives

Since cash doesn’t come with any costs, it would be the de facto attractive payment channel for everyone. Therefore, to make digital payment instruments attractive they must be incentivized for the participating consumers.

Currently, there are transaction costs involved on most of the digital channels whether it is electronic banking transfers, payments through credit cards at POS terminals, or transfers involving e-wallets which is a big bummer.

Simultaneously, cash transactions above a certain limit should be discouraged, hence making the physical cash premium and digital payments attractive. The earlier decision by the Govt. of India to cap the cash transactions above ₹3 lakh is a step in the right direction.

2. BHIM App and Bharat QR

As discussed earlier, recently launched BHIM app and Bharat QR have great potential to forward the agenda of a cashless economy. This is achievable given that 99% of India’s rural households now have at least one member with a bank account and with 90% having a feature phone and 40% having a smartphone.

These being products of NPCI (National Payment Corporation of India) make use of UPI (Unified Payment Interface) to directly link the user’s bank account and make the necessary digital payments faster, easier, and safer.

3. Network effect

Network effect, a phenomena which underscores that “higher the usage of a product the more valuable it becomes” plays a huge role in the adoption and success of tech products.

Currently, the market has too many service providers for wallets and for enabling payments through mobile phones. But still, users of certain wallets cannot make transfer to other wallets and similarly, cannot pay certain merchants.

For a true network effect to occur, any customer of any service provider must be able to pay anyone in the market. That should be the way forward and that is when the network effect would come in leading to rapid adoption of digital payments.

4. Dispelling Fears through Insurance

An average user in India who uses digital payment services is still apprehensive of the safety of doing transactions digitally, especially the non tech savvy ones.

With digitization, the stakeholders involved be it e-wallet companies, payment banks, technology and service providers are more vulnerable to cyber attacks resulting in data and monetary loss.

All it takes is one hack/one crime for a customer to lose faith and avoid digital payments incessantly. So, an insurance system in place that guarantees payments to users up to a certain amount would provide sufficient cushioning for existing and prospective users to have confidence in the digital payments services.

Now, more than a year since demonetization and after herculean efforts by RBI to re monetize the new currency into the system, cash has indeed made a comeback.

Currently, as I stated earlier in this article, cash still remains salient and critical to the economy. For now both cash and digital payments will continue to co-exist. For digital payments to really take off and for us to become a completely cashless economy we need to cross something called as Chasm.

In the language of product and customer adoption lifecycle, Chasm can be defined as a point that a product or technology needs to cross to move from early adopters to a mass market segment consisting of majority users.

Crossing the Chasm will lead to rapid adoption of digitization by the masses and will result in complete formalization of the economy, benefiting the country as a whole.

But, it remains to been seen whether such a behavioral change will indeed take place.