Finally, the RBI gave us the estimates all of us were waiting for. With 99% of the banned notes being back in the banking system, the reactions from the supporters of demonetization and those who opposed it are as expected and as partisan as ever. While the Finance Minister was quick to hail demonetization as a success based on rather fluid objectives, those who opposed the idea, now claim the data proved what they suspected all along. However, with the numbers on the table, what seems irrefutable is that almost all the stated initial objectives of demonetization as put by the PM are now not met. These objectives, were invented throughout the period of demonetization-from a crusade against black money, to detecting counterfeit notes, to curbing terror funding and move towards digital payment systems. Thus, it is not surprising that Economists are hailing this as a colossal waste and a cost on the country which has now translated into a 2% drop in GDP growth rate. The Government may still invent and claim new objectives that this grand exercise has achieved, but it will be well advised to review if there were some positives that were emerging and find a road map on how to leverage them.
On hindsight, the fact that 99% of the banned currency is back in the system is not surprising. For any individual, irrespective of the source of the funds accumulated by him, not returning the cash would have meant a 100% loss while returning it would have meant paying a high penalty with some probability. Clearly, given the history of lack of punitive measures taken in the past against individuals with dubious sources of wealth accumulation, this probability was inferred to be low and hence, most settled for the latter. However, the Government now has the records of all deposits and as it claims, it can employ big data analytics to flag accounts to investigate. Hopefully, this will win it back some of its credibility that it may have lost in the war against corruption. However, using big data analytics is the easier part. The challenge ahead is how to initiate action based on these flags and demonstrate quick actionable results. Perhaps the way to go about it is to start with a random sample of some accounts and then demonstrate the actions taken. But again, such random selections by Governments are usually not random to begin with and is often viewed skeptically. Currently, the Government is facing a problem of perception-some doubting the intention and many more doubting its execution capabilities. How quickly the Government delivers on corruption depends upon how many steps it is thinking ahead. If the other objective of demonetization that was initially harped upon and perhaps the only one that is still pursued is anything to go by, it doesn’t tell a convincing story. Let us now look at how the migration to digital payments via demonetization was handled.
While the data on all cashless transactions are not yet fully available, nonetheless let us look the cards (both credit and debit) data available with RBI. Analyzing card usages gives us an important insight- an instrument that can be used to either withdraw cash (through ATMs) or to make retail payments at POS allows us to infer how individuals respond to cash versus cashless transactions.
In figure 1, we plot the aggregate cards usage during the period April 16 to June 17, approximately six months on either side of demonetization.
What is evident is that the number of transactions involving cards did not significantly change during the period. However, both the aggregate transaction volume (in INR) as well as amount per transaction (in INR) saw a sharp decline by more than 50% during the demonetization period. This clearly suggests two things. One, monetary volumes (both aggregate as well as per transaction) have a steady state but for a temporary sharp dip during the three months of demonetization and most importantly two, cards are primarily used for cash withdrawals than for retail payments. This is much more evident in figure 2.
In figure 2, we plot the card usage in terms of POS versus ATMs. In particular, we focus on the debit cards because credit cards constitute less than 4% of all cards in India. What emerges from figure 2 is interesting. The frequency of using cards at POS vis a vis at ATM during the demonetization period showed a sharp increase, but then fell as soon as money was being pumped back into the system. However, as is evident from the chart, the new levels post March 17, is showing higher usage of cards at POS vis a vis ATMs (both in terms of frequency and money) implying that perhaps we are moving towards digital payments. But closer inspection reveals, we are where the trend would have taken us anyway! Did we need a grand exercise to get there? This is the important question that is being missed by both sides in the debate.
As often argued by many, moving to cashless economy from cash economy needs two things. One, a ‘shock’, especially as it involves developing the network on both sides of the market (buyers and sellers both signing up for cashless instruments). This is what the demonetization initially achieved. Two, most importantly it needs interventions that make individuals stay with the new network. The second part is lacking. There is any lack of visible effort that will make individuals or enterprise stay in the network. A simple example of how the incentives are perverse currently, consider the case of online LPG booking. A cashless booking attracts a discount of Rs 5 while the bank charges Rs 8 as processing fees! Clearly, the advantages of going cashless is not shared by all-certainly not between the Government and the Financial sector. As a result, the growth in cashless payments are moderate and is happening because individuals find it beneficial acting in their self maximizing way, not necessarily as an outcome of an aggregate welfare exercise. Policy announcements have to be more carefully thought out and played.
Policy making is akin to a game of chess-people will often anticipate the Government’s next move, or at the least will observe them and act accordingly. Currently, the Government is in the game but playing with a strange objective-hopping and thumping to cover as many boxes as it can without consolidating on any!