Are less-cash economy and more people in banking system just ‘side effects’ of demonetisation?

It is widely believed and acknowledged that the demonetisation programme was announced to curb black money (and thus curb corruption) and to curb counterfeit notes (that often form the shadow economy supporting insurgency and crime).

And we are seeing those effects too. While black money is getting unearthed, there are reports of insurgency too getting hit.

The side effects of demonetisation of course is the cash crunch, which is causing myriad of short term problems. Due to this cash crunch, a lot of people are moving towards using netbanking and mobile wallets i.e. people are being “pushed” towards a cashless economy, or better, “less cash” economy.

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But is that just a side effect? An unintended outcome? Or the government actually wanted and planned this push?

First let’s focus on the cash that is impacted by demonetisation. This can broadly be divided into three parts:

  1. Black Money generated via tax evasion or via over/under invoicing by various entities.
  2. Black Money generated via illegal activities like drugs, counterfeit notes trafficking etc.
  3. Legitimate cash used by formal as well as informal economy.

Demonetisation seems to be addressing all three aforementioned aspects of money circulation in the following manner respectively:

  • Strategy 1: Income Disclosure Scheme (IDS), GST, Aadhar/PAN Based data collection, monitoring and compliance, rationalising provisions of withholding tax, capital gains, etc. Setting up of International Financial Services Centre (IFSC), Country by Country Reporting, Revision of DTAA agreements with Mauritius, Cyprus and Switzerland.
  • Strategy 2: Demonetisation has already made the old counterfeit notes invalid as they can’t be deposited or exchanged. The ill-gotten money is being recovered through income tax assessments/raids across the country. Some are destroying their ill-gotten money that helps RBI remove its liabilities.
  • Strategy 3: A move towards “Less Cash Economy” by encouraging adoption of mobile/net banking and other E-Payment options.

But are we sure that it was one of the central strategies?

Let’s look at some data which provides a very important background to the whole affair.

Firstly, online transactions and cashless transactions have been growing in India at a rapid pace; be it in common known modes of fund transfers like NEFT or the transactions via Point of Sale machines (the monitor that the cashier bangs at the payment counters in supermarkets), Debit Cards, Credit Cards and ATM machines:

  • The number of NEFT transactions saw a stunning 1412.07% rise from 8.28 crores in 2013-14 to 125.2 crores transactions in 2015-16
  • The number of RTGS transactions saw a huge rise of 1039.53% from 86.4 lakhs to about 9.8 crores transactions in 2015-16.
  • Number of ATM’s saw a rise of 25% from 1,70,473 units in 2014 to 2,15,039 unit in 2016.
  • Number of POS machines grew from 10,18,264 machines in August 2014 to 14,61,972 machines in August 2016. It should also be noted that all these machines except for 300 of Bank of India are online while the number of offline machines in 2014 stood at 7566. As per few news reports the demand post Demonitisation has shot up to 5000 machines daily for just 1 bank.
  • The number of transactions via credit cards rose by 66.54% from about 5.08 crores in 2014 to about 8.46 crores transactions.
  • The number of transactions via debit cards rose 32.42% from about 65.49 crores in 2014 to about 86.72 crores transactions.

All the data and more can be read in more detail by checking out this twitter thread.

In all, the total volume of transactions involving a bank saw a growth of about 1521.22% from 933.15 million transactions in year 2013-14 to 15,126.04 million so far in 2015-16.

If cashless transactions were already growing, why should the theory that demonetisation was brought in to purposely ensure more people move towards less-cash economy have any credence?

That’s where another set of data becomes critical: While the digital form of online transactions has been increasing, so has been the amount of cash with the public in the now defunct denominations. The total amount in these notes rose from about 1073800 crores in 2013-14 to 1417800 crores in 2014-15, or near about a staggering 50% increase in just two years.

So the cash in the economy was not going down, even though as pointed above, there has been a very substantial growth in the amount of digital non-cash dealings during that period.

A cash based economy is expensive. Currently it costs about 0.25% of India’s GDP. Excess cash in the market is not just difficult to track for taxation purposes, such a high amount of currency printing, bulk of which happened during the UPA period, might also have seriously depreciated the value of the currency and in the worst case led to hyperinflation.

A less-cash economy comes with its own advantages. Cost of transactions goes down, time and cost of accounting goes down, and of course, costs of printing currency  goes down. Compliance is better as there is better documentation. Better documentation and compliance plugs loopholes in public distribution system. And there is better tax monitoring, and better revenue collections.

Thus looking at the above points it will not be unwise to conclude that one of the reasons demonetisation was brought in was to ensure that more people took to banking, and that the cash in people’s hand, which rose so alarmingly, could be reduced.

It is not just a “side effect” but one of the main objectives. Though the objective is not easy to achieve.

One of the main reasons why people prefer cash over e-payments is that cash gives ease of use. If a big chunk of the legitimate cash is out of banking system as people still prefer to keep physical cash, it is something to ponder about. Cash brings parity and there is no case of “rejections”. With penetration of mobile telephony, POS, and bank accounts in both rural and urban areas as highlighted above, the difference of “Cash in hand” and “Cash at bank” will become narrower and this move shall keep a check on future generation of black money.

Some signs are already starting to show as total deposits and exchanges in the demonetisation period from 10th Nov to 18th Nov stood at Rs. 5,44,571 lakh crores while withdrawals stood at only 1,03,036 lakh crores. Even though this number may go up in the future as the restrictions are eased.

Getting masses into the banking system will need a major change in attitudes and spending patterns in our country where more than 90% of the transactions happen in cash.

Prime Minister’s Jan Dhan Yojana and its outreach was a part of this. Ministers also have been talking about cashless economy. Recently, the government announced special drive to bring more people into the banking system. And today, the Prime Minister in his Mann Ki Baat radio address, talked at length about moving towards cashless economy and how the youth should help older generations and poor people to adopt technologies that enables this transition.

However, getting people into the banking system is just the beginning; they will have to be sensitised and educated about digital transactions and convinced that it was easier and safer.

The transition from Demonetised India to Digital India will have to be a special project in itself.

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