Demonetization Roulette: India’s unusual approach to creating a cashless economy
On November 8, 2016, India cancelled 86% of its currency in circulation with a four-hour notice and the move pushed India into a severe currency shortage. In a country where 98% of all consumer payments are in cash, this prolonged currency shortage carries risks: economic destabilization in the short term and irrevocable damages to the vibrant informal sector in the long run. Policy analysts describe the situation as the greatest gamble undertaken by modern India.
The initial motivation behind the move was to weed out fake currency in circulation and illicit funds, called black money in India, stored in the form of cash. But within weeks, the demonetization pitch changed from eradicating black money and fake currency to accelerating India’s journey towards a cashless economy. After all, if you don’t have access to cash, it’s likely that you will at least consider using an alternative.
In addition to enacting several policies to ease the currency shortage, the Government of India has implemented several measures to encourage consumers and merchants to adopt digital payment methods. These measures include:
- Waiver of service tax on debit and credit card purchases up to Rs. 2,000 (Approx. USD 30)
- A reduction of Merchant Discount Rate (MDR) on debit card transactions up to Rs. 2,000 (USD 30)
- Public sector companies to offer discounts on particular types of recurring purchases such as fuel, railway tickets, highway tolls, insurance policies, etc. made using digital payment methods
- Free Point of Sale (POS) machines to agents in every village that has a population over 8,000
- A government sponsored lottery scheme for merchants and consumers to promote digital payments
Not the First
India is not the first country to demonetize its currency in order to combat black economy and fake currency. However, using demonetization to create a cashless economy is unprecedented.
Of course, demonetization is not the only thing the Indian government is doing to encourage the digitization of payments. Starting in 2006, the government has taken several pioneering steps to encourage digital payments. These include:
- Launching Jan Dhan Yojana, a national program to provide every household with basic banking services
- Creating a new class of chartered banks, called “Payments Banks”, that can accept deposits but are restricted from offering loans
- Designing Aadhaar, a biometric national identity system which has completed a massive task of enrolling 1.1 billion people, and enabling Aadhaar to be used by the payments industry in a variety of ways to make payments seamless, secure, inclusive and cost effective
- Introducing the Unified Payments Interface (UPI), a set of API’s to the core payments platforms within the NPCI (National Payments Corporation of India). UPI is particularly aimed at accelerating retail electronic payments with advanced features including a single interface to access any bank, access to credit-push immediate payments, a merchant “request to pay” capability, and support for virtual payment addresses.
It is quite evident that the Indian government is investing heavily not only in building out a digital payment infrastructure but is also willing to push its citizens to use it – this is the unusual aspect.
It is interesting to note that historically, governments play a direct role in managing systemically important payment systems such as financial market infrastructure, RTGS’s (real-time gross settlement systems), and, in some countries, check clearing systems and/or ACH’s (automated clearing houses). However, governments tend to let the private sector tackle payments systems that are meant to support small value retail digital payments. International card networks such as VISA or Mastercard, online payment services such as PayPal or mobile payment services such as Apple Pay or M-Pesa are all examples of the private sector “leading the show”.
Governments Manage Cash, Why Not Payments?
The one exception to this? Governments provide cash, one of the most popular payments system used in retail transactions. They do this by paying for the creation and management of cash. Although cash is introduced to the economy through private sector banks, once it is out in the economy it can circulate without banks. This is dramatically the case in countries, such as India, where there are many more unbanked than banked people.
So why do governments coldly hand over the responsibility to the private sector the moment these retail payments change in form from cash to eMoney? As Glenbrook’s Partner Carol Coye Benson observes: “Governments pay for cash, the payments system that people use. If we want to move people away from cash, why are we suddenly determined that this has to be done on a commercially viable basis?” Another problem with reliance on the private sector for digital payment solutions is that private firms may not feel the necessity to serve everyone, and as profit-maximizing entities they are bound to be selective in designing products for only profitable segments.
While unusual, India is not alone in its journey towards a cashless society. There is an emerging trend of governments becoming active sponsors of their countries’ retail payment infrastructure. Last year, Bank of Thailand launched PromptPay, a real-time instant payments service that allows fund transfer using a National ID number or mobile phone number without needing to provide a bank account number. Similarly, the Central Bank of Jordan launched JoMoPay, the country’s mobile payment platform to encourage interoperable mobile payments in the economy. Ecuador even launched the world’s first public digital cash system called efectivo.
Some may not feel comfortable with governments dominating the retail payments domain for fear of lack of innovation, destabilizing market forces or upsetting the balance of economic interest of all stakeholders. But consider that these concerns don’t bother us when governments are involved in the delivery of essential services such as health, education and clean drinking water. Perhaps, the time has come for us to deliberate whether the most basic financial and payment services that are not affordably available in the market today are indeed public goods? Should it be the government’s responsibility to deliver it in the free market without a profit motive?
The world is watching India and its dramatic attempts to tackle financial services problems through active government involvement. Will the gamble pay off? 2017 will be a fascinating year for watching.