Will demonetisation help the move to a cashless economy? It's not that simple

With its announcement that it was withdrawing Rs 500 and Rs 1,000 notes from Thursday midnight, the government rendered almost 86% of the current cash in circulation illegal tender. As people deal with the difficulty of transacting in cash in the next few days, there is expected to be an increase in electronic payments – through cards, micro-ATMs, pre-paid mobile wallets, payment banks and United Payment Interface. Finance Minister Arun Jaitley reiterated this when he said the demonetisation decision was aimed at making India “a cashless economy”, which may potentially expand the tax base and reduce the costs of printing currency.

Within hours of the announcement, some electronic financial service players such as Paytm recorded higher than usual transactions from existing users. But experts are divided on the switch to electronic payments among new users in the country’s semi-urban and rural areas.

Cash economy

India is almost entirely a cash economy. Over 92% of its workers belong to the unorganised sector and earn in cash. Cash powers the rural economy.

Also, 97% of retail transactions are done in cash, with only 6% of retailers accepting digital payments. India has 10 lakh point-of-sale machines, or compterised cash registers, one-tenth the number in the United States and China.

But the number of cashless transactions could rise significantly given the rapid increase in the number of people owning mobile phones and using the internet. The World Bank estimates there are 33 crore internet users in India, which makes it the second largest internet market. Mobile phone subscriptions went up from 23 crore to 96 crore between 2007 and 2015.

Several of these mobile and internet users now have a bank account under the Pradhan Mantri Jan Dhan Yojana, a scheme to link every household to a bank account. Under the scheme, 25.4 crore accounts exist and 19.3 crore RuPay debit card have been issued.

In addition, over 127 crore Indians are enrolled in Aadhaar, a biometrics-based digital identity database that has become mandatory for anyone who wants to continue to be part of food or pension schemes.

Therefore, as more people start using their RuPay debit cards and Aadhaar for digital payments, in the long term, this is expected to facilitate a switch to an economy that uses less cash.

Primed for a switch?

Development finance experts say we may see a trend towards this in the coming weeks, since the government has restricted cash withdrawals from banks as well as ATMs.

“Digital payments will be the positive effect of the demonetisation of Rs 1,000 and Rs 500 currency notes,” said Varad Pande, a partner at Dalberg Global Development Advisors, a consulting firm. He said a majority of those who use cash do so because they do not have a need to switch to digital, and are stuck in a cash economy. “Over the next few months, as cash becomes less convenient to use, a lot more people may be willing to try digital payments. This window of ‘trialibility’ is very important for carving behavioural change, for a switch from physical cash to digital payment options.”

Pande referred to a study led by the United States Agency for International Development at six locations in Kota, Guntur, Visakhapatnam, Mumbai, Hyderabad and Jaunpur in 2015. Researchers interviewed 2,400 merchants and consumers. Nearly 77% of respondents received their income in cash and 79% made savings in cash. Further, among consumers, the 90% who used debit cards did so only to withdraw cash from ATMs and not to make payments.

But, the researchers found, those who earned and saved their income digitally – their number was less than 25% of the sample size – were two times more likely to be active digital payment users than those who earned and saved in cash.

It is this segment that is “digitally ready”, as they own debit cards and are comfortable using them at ATMs, but is not yet “digitally active”, as they do not use the debit cards for online payments yet, that is most primed to make the switch from cash to digital, Pande added.

Limited access

Many agree that the current moment offers a reason to move to digital payments. But they also point out that problems of access and infrastructure remain.

“The demonetisation of high currency strengthens the case for digital payments, but in semi-urban and rural areas, issues of access remain,” said Manoj Sharma, managing director (Asia) of Microsave, a financial inclusion consulting firm. “Banking agents are not available in adequate numbers, they do not earn enough. There are server and connectivity issues as well.”

Sharma pointed out that according to the Pradhan Mantri Jan Dhan Yojana website, 85% of accounts opened were issued debit cards, but beneficiaries got only half of these.

Microsave did an assessment of the scheme in November-December 2015 by interviewing 5,000 bank mitra (banking correspondents) and over 18,000 clients, at a time when 19.8 crore bank accounts had been opened and 16.8 crore account holders had been allotted RuPay debit cards. It found that only 33% of customers in the sample had activated their RuPay cards, and that only 26% had used it even once.

“People are likely to withdraw from ATMs if the machines are close by, but the infrastructure and access is not available,” Sharma said. He added that in India, there are 200 ATMs for a population of 1 lakh, while in developed countries, this number is around 10 times. “People find cash friction-less and hold on to cash. In December 2015, one banking agent was doing about 128 cash withdrawals and 173 cash deposits for clients, so the agent too is not earning well.”

He added that while there may be cases where people leapfrog to mobile payments, “not all mobile phone users own a smart phone or have high-speed connectivity, and a familiarity with the system”. He added, “There is a learning curve that takes time, but I am hopeful we will get there.”

By October 2016, 19.3 crore RuPay debit cards have been issued. Taking the Microsave study as an indicator, if 25% to 26% of this number were to use their cards, it would mean that nearly 5 crore people may be primed for the transition to digital payments – a significant number.

But in the USAID study, among the respondents who used their debit cards only to withdraw money at ATMs, 81% said they did not know how to use the cards for digital payments, 60% did not think such payments were secure, and 48% said there were no places close to where they lived where they could exercise this option. Only 22% said they did not use their cards for digital payments because merchants do not accept it. This means that besides non-use by merchants, there are other major factors stopping people from making digital payments, which may continue to exist.

Immediate chaos

An entrepreneur who runs a mobile wallet and banking correspondent company in the National Capital Region said it would be “simplistic” to assume a transition to digital would follow just because both physical and digital options exist for a greater number now.

“The demonetisation of high currency may make some employers move to digital money, as this has created uncertainty around cash, and it may curtail fake currency, but among low-income workers, there is still apprehension about whether they will be entertained at banks, and they have limited avenues to spend digitally,” said the entrepreneur who did not wish to be identified.

He said the move from physical to greater use of digital options had been achieved in other developing countries, such as Kenya, but the process had been gradual and not knee-jerk. “The switch from purely physical to digital happens very gradually when “fungibility”, or mutual substitution of both, exists seamlessly and a user is able to appreciate the convenience of this, which will not work immediately in this scenario.”

He added that his own mobile wallet company was unable to accept cash from subscribers a day after the demonetisation was announced. “Only hospitals and transport institutions were listed for exceptions in the government guidelines, and there were no clear instructions on what wallet companies or banking correspondent companies could do,” he said. “So, as a regulated entity, we had to turn people away when they approached us to convert cash to digital.”

He said that of his company’s 1.6 crore clients, including several people working as security guards and drivers, 50% owned mobile phones.

Several hundred kilometers away in Jharkhand, too, banking correspondents said they had turned away users who had approached them for help. “Halchal macha hai. There is chaos,” said Morpant Chaudhary, a banking correspondent in Tarup panchayat, 30 km from Ranchi. “It is paddy harvesting season and people have to pay the workers they hire weekly to cut the crop, which comes to Rs 1,400. They are feeling harassed. The bank gave us no instructions on what to do, and we are not able to help.”

Chaudhary added that though an optical fibre network had been laid in the panchayat three months ago, it was not yet functional. “There is only 2G network in the panchayat and it is routinely slow,” he said. “Some young people download songs and listen to music, but even they make transactions like mobile recharges at shops in cash.”

Many hurdles

Nikhil Pahwa, founder of Medianama, a news portal focused on the digital ecosystem, said that in the one-and-a-half-month window set by the government for people to exchange their old currency, even though large value transactions may move online, it was not clear whether this would happen with a majority of routine transactions, and whether the digital industry was ready for the transition.

“How many mobile users have smart phones and how many payment applications are available in languages that people can understand?” he asked. “This is a potential inflexion point, but people are not comfortable yet and I do not think the industry is ready to exploit it.”

Pahwa said that while an estimated 60 million people use e-commerce to shop and a lot of wallets have been created as a result of cashback offers, many urban consumers still do not know how to use these.

He also cited privacy concerns with going cashless, as all transactions would be digitally recorded and traceable, while there is no law in India on how data on such transactions may be stored and privacy protected.