Understanding demonetisation: The problem with the war on cash

Force marching unprepared citizens towards a cashless utopia that has little space for the informal sector is callous and indefensible.

This is the concluding part of a three-part article.

Part I: Understanding demonetisation: Why there’s a war on cash (and you are in the middle of it)

Part II: Understanding demonetisation: Who is behind the war on cash (and why)

An interesting point to note is that while the reasoning for the move towards cashless economy in advanced economies is all around the necessity of going into negative interest rates in order to rev up economies that are stuck in a low-growth mode, the reasoning for pushing the cashless economy idea in emerging markets that do not have the problem of stagnation, is a different one: it is about financial inclusion, fighting corruption and so on. This doesn’t necessarily mean that all these arguments are wrong; some arguments could be right. But this does show that the groups pushing forward the idea of cashless economy would like it to happen, irrespective of the specific reason. They just seem to have an enormous interest in driving cash out, no matter what the reason.

Why is this so? The best way to understand this is to go through a report on the great opportunity that digital finance presents in emerging economies, prepared by McKinsey and released just four months ago, in September. The report is prominently linked on the website of the Better Than Cash Alliance.

Here’s how the report begins:

“Two billion individuals and 200 million businesses in emerging economies today lack access to savings and credit, and even those with access can pay dearly for a limited range of products. Rapidly spreading digital technologies now offer an opportunity to provide financial services at much lower cost, and therefore profitably, boosting financial inclusion and enabling large productivity gains across the economy.”

The report then goes on to quantify the gains:

“Overall, we calculate that widespread use of digital finance could boost annual GDP of all emerging economies by $3.7 trillion by 2025, a 6 percent increase versus a business-as-usual scenario. Nearly two-thirds of the increase would come from raised productivity of financial and non-financial businesses and governments as a result of digital payments. One-third would be from the additional investment that broader financial inclusion of people and micro, small, and medium-sized businesses would bring. The small remainder would come from time savings by individuals enabling more hours of work. This additional GDP could lead to the creation of up to 95 million jobs across all sectors.”

The gains are seen as deriving from the following five factors:

  1. Cashless transactions reduce the cost of providing financial services by a humongous 80% to 90%, by doing away with the need for physical branches.
  2. This enables providers to serve many more customers profitably, with a broader set of products and lower prices.
  3. As individuals and businesses make digital payments, they create a data trail of their receipts and expenditures. This enables financial service providers to assess their credit risk better and provide credit where credit wouldn’t have been provided earlier.
  4. The data trail also makes it possible for banks and fintechs to devise new products and services – such as peer-to-peer lending platforms that connect borrowers and lenders directly
  5. Digital technology also makes micro-payments and on-demand services possible, leading to new products and business models.

How big a gain are these to financial services providers? This is what McKinsey has to say:

“Digital finance offers significant benefits – and a huge new business opportunity – to providers. By improving efficiency, the shift to digital payments from cash could save them $400 billion annually in direct costs. As more people obtain access to accounts and shift their savings from informal mechanisms, as much as $4.2 trillion in new deposits could flow into the financial system—funds that could then be loaned out. To unleash the full range and potential of new forms of digital finance, however, a much wider variety of players than banks will likely be involved. These may include telecoms companies, payment providers, financial technology startups, microfinance institutions (MFIs), retailers and other companies, and even handset manufacturers.”

And the gains to governments? This is what Mckinsey has to say:

“Governments in emerging economies could collectively save at least $110 billion annually as digital payments reduce leakage in public expenditure and tax revenue. Of this, about $70 billion would come from ensuring that government spending reaches its target. In addition, governments could gain approximately $40 billion annually from ensuring that tax revenue that is collected makes its way into government coffers, money that could be used to fund other priorities.“

There are also other “gains” for governments that McKinsey doesn’t talk about, but will be of concern to all citizens everywhere. For example, the fact that almost every action of the citizen will be trackable – especially since the vision for the cashless economy in India involves linking mobile numbers to bank accounts to national identities with biometric data. When you combine these three things, the ability of a government to watch over and instil fear and subservience in its citizens will be unprecedented, especially so in countries that do not already have a well-established and long tradition of privacy and data protection laws and insulation of the executive from political interference. It is no wonder therefore, the Better Than Cash Alliance has had no difficulty enrolling governments. As far as governments are concerned, what is there not to like?

McKinsey quantifies the gains to India specifically by 2025, as opposed to emerging markets in total, the following way:

  • GDP boost by 2025: $ 700 billion, or 11.8% of GDP, the highest percentage gain among the countries studied
  • Reduction in government leakage: $24 billion
  • New Deposits: $799 billion
  • New Credit: $689 billion
  • New jobs: 21 million

Putting all these together gives us a good idea of what is at stake for each of the groups executing the war on cash.

  1. Governments want more tax revenues and less leakages; and more information on and greater control over citizens
  2. Central banks in advanced economies want more efficient monetary tools that increase their ability to counter stagnation. What central banks in emerging markets such as India (which do not suffer from long-term stagnation) want is not clear – unless they have just taken on the objectives of their governments as their own.
  3. Financial services providers want to reduce their costs significantly and also expand their business.
  4. Fintech firms want to “disrupt” existing markets for financial services using their ability to track and analyse large-scale user behaviour data

Eliminating cash helps each of these groups meet their objectives perfectly.

Where does that leave the citizens?

What we know for sure is that they will have less privacy and will need to depend on one financial service provider or another to make a payment or even merely to store their money – something they can do now with cash, without paying anyone any fees. By giving up their privacy and their sense of control over their own money and also laying themselves open to open new kinds of fees, what do they gain? The proponents of the war on cash say that they may get loans more easily, that they may be able to save more easily without having to spend time at a bank branch, and that as the GDP grows and jobs increase, their job prospects may also improve.

Not all of those promises are untrue. There are benefits from having a bank account and greater benefits from having it on one’s mobile, digitally. But some of those promises are dicey. Particularly the part about 21 million new jobs. The McKinsey calculations assume a linear, unchanging relationship between GDP growth and employment growth. But this is not true – GDP growth does not always lead to commensurate job growth – as we have seen in India and in the West. And the kind of growth that will result from a forced move towards cashless is likely to be particularly weak on employment growth for a simple reason: The stated intention of the cashless push is to make it impossible for the informal sector to survive as it does today – even though it employs more than 70% of India’s labour.

In addition, banks and financial services companies are unlikely to realize the huge gains McKinsey talks about without slashing their staff numbers. Advanced economies are already in that situation (See Bank Layoffs are Coming). So one needs to take the employment figure given by McKinsey with a big pinch of salt. This will be made clear by one last quote from Mckinsey, with all the condescension and dismissiveness that it reserves for the informal sector:

“From an economic perspective, the informal economy imposes a high cost and significantly hinders growth. Many developing countries have a two-speed economy: a modern sector of healthy companies with high productivity (or output per unit of input), and an informal sector of subscale firms that drags down overall productivity and growth. Informal firms face perverse incentives and may avoid investments or growth that could increase their visibility to regulators and tax authorities. In Turkey, for instance, MGI has found that the productivity of formal companies is 2.5 times that of informal firms. The gap in productivity levels between formal and informal firms is similar in Brazil, India, Mexico, Russia, and elsewhere.

“The presence of informal firms also harms the economy by limiting the ability of high productivity, modern firms to gain market share, given the significant cost advantage informal firms enjoy by not paying taxes. MGI research has found that the cost advantage from tax avoidance ranges from 5 percent of the cost of goods sold in Mexico food retail to 25 percent in India’s apparel sector and to more than 100 percent in the case of Russian software. Formal companies also face additional costs and complexity in managing informal firms with outmoded technology in their supply chain. This dampens the healthy process of “creative destruction” in the economy in which the most productive companies take market share from less productive ones.”

The creative destruction that McKinsey talks about could involve significant loss of jobs as the formal sector with far less employment intensity drives out the informal sector that has a much higher employment intensity. The transformation of informal sector into formal sector is something that would have happened in the normal course of development with enough time for different players in the economy to adjust and evolve, but fast-forwarding this without safety nets in an economy that hasn’t taken care to provide its citizens with enough education and skills could be indefensible, especially when done in a manner that violates basic rules of trust between government and citizens.

It is not that the move towards digital cash is inherently evil – it is that forcing it down using draconian measures as was done and as is being considered could be both counterproductive and inhuman. In that sense, forced elimination of cash has much in common with forced sterilisation during Emergency. The policy of nasbandi, as sterilisation was called, tried to control population growth in a manner that violated basic human rights and caused unjust and widespread misery and still failed. Despite its failure, over a period of time, as incomes, education and standards of living improved, population growth slowed down considerably anyway. Likewise, notebandi and its package of related measures is trying to control cash usage with force, while we know it declines as incomes grow and technology spreads. May be in the interest of good sense, humanity and fair play, the government should leave it to the markets, as the proponents of cashless love to insist in other contexts. Why do you need to use force if everyone stands to gain?

This is the concluding part of a three-part article.

Part I: Understanding demonetisation: Why there’s a war on cash (and you are in the middle of it)

Part II: Understanding demonetisation: Who is behind the war on cash (and why)

Tony Joseph is a former Editor of BusinessWorld and can be reached at tjoseph0010@twitter.com

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As India turns 70, London School of Economics asks some provocative questions

Is India ready to become a global superpower?

Meaningful changes have always been driven by the right, but inconvenient questions. As India completes 70 years of its sovereign journey, we could do two things – celebrate, pay our token tributes and move on, or take the time to reflect and assess if our course needs correction. The ‘India @ 70: LSE India Summit’, the annual flagship summit of the LSE (London School of Economics) South Asia Centre, is posing some fundamental but complex questions that define our future direction as a nation. Through an honest debate – built on new research, applied knowledge and ground realities – with an eclectic mix of thought leaders and industry stalwarts, this summit hopes to create a thought-provoking discourse.

From how relevant (or irrelevant) is our constitutional framework, to how we can beat the global one-upmanship games, from how sincere are business houses in their social responsibility endeavours to why water is so crucial to our very existence as a strong nation, these are some crucial questions that the event will throw up and face head-on, even as it commemorates the 70th anniversary of India’s independence.

Is it time to re-look at constitution and citizenship in India?

The Constitution of India is fundamental to the country’s identity as a democratic power. But notwithstanding its historical authority, is it perhaps time to examine its relevance? The Constitution was drafted at a time when independent India was still a young entity. So granting overwhelming powers to the government may have helped during the early years. But in the current times, they may prove to be more discriminatory than egalitarian. Our constitution borrowed laws from other countries and continues to retain them, while the origin countries have updated them since then. So, do we need a complete overhaul of the constitution? An expert panel led by Dr Mukulika Banerjee of LSE, including political and economic commentator S Gurumurthy, Madhav Khosla of Columbia University, Niraja Gopal Jayal of JNU, Chintan Chandrachud the author of the book Balanced Constitutionalism and sociologist, legal researcher and Director of Council for Social Development Kalpana Kannabiran will seek answers to this.

Is CSR simply forced philanthropy?

While India pioneered the mandatory minimum CSR spend, has it succeeded in driving impact? Corporate social responsibility has many dynamics at play. Are CSR initiatives mere tokenism for compliance? Despite government guidelines and directives, are CSR activities well-thought out initiatives, which are monitored and measured for impact? The CSR stipulations have also spawned the proliferation of ambiguous NGOs. The session, ‘Does forced philanthropy work – CSR in India?” will raise these questions of intent, ethics and integrity. It will be moderated by Professor Harry Barkema and have industry veterans such as Mukund Rajan (Chairman, Tata Council for Community Initiatives), Onkar S Kanwar (Chairman and CEO, Apollo Tyres), Anu Aga (former Chairman, Thermax) and Rahul Bajaj (Chairman, Bajaj Group) on the panel.

Can India punch above its weight to be considered on par with other super-powers?

At 70, can India mobilize its strengths and galvanize into the role of a serious power player on the global stage? The question is related to the whole new perception of India as a dominant power in South Asia rather than as a Third World country, enabled by our foreign policies, defense strategies and a buoyant economy. The country’s status abroad is key in its emergence as a heavyweight but the foreign service officers’ cadre no longer draws top talent. Is India equipped right for its aspirations? The ‘India Abroad: From Third World to Regional Power’ panel will explore India’s foreign policy with Ashley Tellis, Meera Shankar (Former Foreign Secretary), Kanwal Sibal (Former Foreign Secretary), Jayant Prasad and Rakesh Sood.

Are we under-estimating how critical water is in India’s race ahead?

At no other time has water as a natural resource assumed such a big significance. Studies estimate that by 2025 the country will become ‘water–stressed’. While water has been the bone of contention between states and controlling access to water, a source for political power, has water security received the due attention in economic policies and development plans? Relevant to the central issue of water security is also the issue of ‘virtual water’. Virtual water corresponds to the water content (used) in goods and services, bulk of which is in food grains. Through food grain exports, India is a large virtual net exporter of water. In 2014-15, just through export of rice, India exported 10 trillion litres of virtual water. With India’s water security looking grim, are we making the right economic choices? Acclaimed author and academic from the Institute of Economic Growth, Delhi, Amita Bavisar will moderate the session ‘Does India need virtual water?’

Delve into this rich confluence of ideas and more at the ‘India @ 70: LSE India Summit’, presented by Apollo Tyres in association with the British Council and organized by Teamworks Arts during March 29-31, 2017 at the India Habitat Centre, New Delhi. To catch ‘India @ 70’ live online, register here.

At the venue, you could also visit the Partition Museum. Dedicated to the memory of one of the most conflict-ridden chapters in our country’s history, the museum will exhibit a unique archive of rare photographs, letters, press reports and audio recordings from The Partition Museum, Amritsar.

This article was produced by the Scroll marketing team on behalf of Teamwork Arts and not by the Scroll editorial team.