Quick fixes for deep-rooted issues

Salman Anees Soz

Reducing corruption, illicit money and market informality are worthy objectives. But as yet, there is no road map for creating the institutional architecture needed for a cashless society

Prime Minister Narendra Modi recently announced a plan to withdraw high-denomination banknotes from circulation. He said he was launching a war on black money, corruption and terror financing. Many rushed to call this move a “masterstroke” and a “surgical strike” on black money. The conversation soon turned to India transitioning to a cashless economy. Finance Minister Arun Jaitley called the demonetisation initiative a “logical step” towards India becoming a “cashless society”. It was shaping up to be a terrific narrative. I say it was because it has since unravelled like a yarn, long and meandering much like the lines outside thousands of banks and ATMs across the country. While the disruption caused by what I believe to be a poorly planned and executed demonetisation initiative may hopefully end soon, the debate over going cashless is just getting started.

The case for cashless

Regardless of the true motives behind the Prime Minister’s announcement, he has portrayed cash as a villain. He is not the first person to do so. Most Indians probably imagine black money as bundles of cash sitting in large suitcases, waiting to be deposited with some influential person in exchange for some consideration. Undoubtedly, some of the black money takes that form. Most, however, is likely in assets such as real estate and gold. Even so, the availability of high-denomination cash can facilitate corruption and other illicit activities such as tax avoidance. Cash transactions also facilitate informality, and wouldn’t it be just so much better to use formal systems such as Visa, MasterCard, PayPal, Paytm, Apple Pay, M-Pesa, Bitcoin and the like? These transactions could be convenient, trackable and aid in controlling black money or terror financing.

Many economists believe cash creates serious problems. Kenneth Rogoff, a Harvard economist, wrote a book called The Curse of Cash. He argues that most of the cash in advanced economies is floating around in the “world underground economy”. In a recent interview, Mr. Rogoff argued that cash facilitates drug trafficking, human trafficking, extortion, money laundering and illegal immigration. In a cashless society, people would be forced to remove their savings from under their mattresses and keep them in the bank. If shopkeepers had no cash, they would remain safe from burglars. Also, more electronic transactions would be good for hygiene. We have all come across grubby banknotes that are sure to carry an assortment of germs.

With all these benefits, it would seem that the Modi government has hit upon a brilliant idea, a masterstroke if you will. It isn’t quite that simple, however. There are many reasons for Indians to be wary about going cashless.

The resilience of cash

The idea of cashless economies has been around for decades. Sweden, the leader in cashless transactions, started its cashless journey in the 1960s. According to a 2015 report of the Bank for International Settlements (BIS), banknotes and coins account for only 2.12 per cent of the GDP in Sweden. The corresponding figure in the U.K. is 3.64 per cent, 3.8 per cent in Canada, and 4.01 per cent in Brazil.

Yet cash remains resilient. A report published in 2015 by Retail Banking Research, a consulting firm, found that cashless payments were growing at “only a slightly faster rate than the number of ATM cash withdrawals, suggesting that cash is still favoured as a means of payment for a significant proportion of the global population”. Sure enough, the BIS study reports that banknotes and coins as a share of the GDP are 20.04 per cent in Japan, 15.67 per cent in Hong Kong, 12.39 per cent in Russia, 10.99 per cent in Switzerland, 10.33 per cent in the euro area, and 7.74 per cent in the U.S. In India, the share is 11.55 per cent. The value of cash in circulation in China has grown four-fold in the last 15 years. Cash in circulation has multiplied in South Korea.

There are many reasons why cash remains the dominant form of payment. It is empowering for millions of unbanked families. It is an intuitive method of exchange and acts as a store of value. It doesn’t come with the transaction fees of electronic payment methods. While most of us may not have anything to hide, cash provides a degree of privacy that more modern forms of payments are unable to guarantee. There is also the possibility of a Big Brother government getting hold of consumer data and using it for its political agenda. Also, with hackers continuously testing security systems, entrusting savings to financial institutions is not an automatic decision. There is also the issue of readiness for transition to a cashless economy. In 2014, Citibank constructed a “Digital Money Readiness Index” that assessed a country’s intensity of cash use and “cultural” barriers to transitioning from cash. India scored very low on the index. That should not surprise us since over 85 per cent of transactions are in cash and millions remain unbanked.

What India must do

Reducing corruption, illicit money and market informality are worthy objectives. However, the Modi government has repeatedly shown a complete disregard for developing credible institutions and plans to support its initiatives. There is no road map for creating the institutional architecture needed for a cashless society. There is no proposal for public discussion, which could help raise some fundamental questions. For instance, why is Japan, with its high cash-GDP ratio, not considered a haven for black money while Brazil, with its low cash-GDP ratio, has a reputation for corruption and illicit wealth? What safeguards would savings account holders have if their money was stored in banks laden with high non-performing assets? What happens if there is a Lehman Brothers-style meltdown at the State Bank of India or at ICICI? What happens if macroeconomic conditions lead to negative interest rates? Not having cash could be disempowering not just for the poor but most Indians. What about the unbanked millions?

This is not an exhaustive list of questions. There will be many more along the way. These questions require a long-term strategic approach with safeguards for millions of poor and vulnerable people and flexibility for course correction. The government’s rhetoric imagines quick fixes for deep-rooted issues. But “development by announcement” is likely to do great harm to the country. Mr. Modi and his team must do the hard work of systematic institutional, regulatory and market reforms. India’s economic situation demands risk-taking but we must be prudent. The public has been very supportive of Mr. Modi’s initiatives. But there is a rising feeling of unmet expectations. There is also a tendency to score political points at the expense of real, sustained improvements in people’s lives. Economic activity remains weak and job creation is at a standstill. With key State elections around the corner, talk of surgical strikes, black money and cashless economy could gain votes for the Bharatiya Janata Party. The question we must ask is: at what cost, and who shall bear it?

Salman Anees Soz, formerly with the World Bank, is a National Media Panellist of the Indian National Congress. Views expressed are personal.