Cashless economy not happening in India yet but the groundwork is laid

A man gets fingerprinted in Kolkata for the 'Aadhaar' biometric data collection project, which can now be linked to a person's bank account. (Credit: Biswarup Ganguly / Wikimedia)

Nearly eight months after India’s Prime Minister Narendra Modi shocked the economy by banning 86 percent of the country’s currency, business has more or less returned to usual.

On the one hand, that’s a testament to the Indian economy’s resilience. On the other, it also means that Modi’s hopes of creating a cashless economy will not be immediately realized. One piece of evidence: ATM withdrawals are back up and mobile transactions are down.

Still, some experts say Modi’s disruptive attempt has laid the groundwork for all Indians, even the rural poor, to soon have access to financial services through digital banking.

On November 8, Modi sent shockwaves throughout the country when he announced that the two largest cash denominations, the 500- and 1,000 rupee notes, would be pulled from circulation within four hours. Demonetization, he said, would root out illegal and undeclared “black money,” counterfeits and terrorism financing.

The decision drew immediate criticism. Indians emptied out ATMs after waiting – and sometimes fainting – in line for hours. Retail businesses, largely run on cash only, ground to a halt. Many of the poor without access to banks lost their savings overnight. In addition, media outlets soon reported that the move had done little to nothing for the intended goals.

However, within a few days, street vendors, taxi cab drivers and other businesses began to resume their operations using mobile wallet apps like Paytm and Ola Money. Digital transactions spiked and soon, what was a matter of survival for most, became a selling point for Modi.

But according to recent report by the financial services firm Motilal Oswal, cash withdrawals, which fell 60 percent in the final months of 2016, have now returned to pre-demonetization levels. The value and volume of digital transactions have also failed to experience a significant increase even six months after the initial surge.

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Some experts say that’s not surprising though. Cash was sucked out of the economy for about three months. So when things returned to normal on the cash side, people went back to using it as before.

“Behavior changes don’t happen so quickly,” Anit Mukherjee, a policy fellow at the Center for Global Development, told Humanosphere.

There have been some significant changes, though, Mukherjee noted. For example, most cab drivers now accept digital payment instead just cash like before. However, especially because the Indian economy relies heavily on the informal sector – 70 to 90 percent by some estimates – it relies heavily on cash. That won’t change overnight.

Additionally, the explicit costs of digital finance, such as surcharges, will take time for users to accept. Cash has costs, too, in the form of time, less interest accruing in the bank and risk of loss or theft. They’re just less obvious.

“What is interesting, though, is that there are a lot more options in digital finance today because of the phase of demonetization and this upsurge from the private sector and the government to build new tools to support digital finance.” Divyanshi Wadhwa, a research assistant specializing in anti-money laundering legislation also at the Center for Global Development, told Humanosphere.

According to Mukherjee and Wadhwa, demonetization drove the supply side of digital finance, especially from the government, which pushed tools like the Unified Payments Interface and linked a biometric identification system called “Aadhaar” to bank accounts.

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With the government in the mix, financial inclusion has become a leading priority. For example, the government is leading the way in establishing the interoperability of financial tools across banks and digital providers. Whereas the private sector would not otherwise profit from interoperability, it is now the industry standard in India, because the government said so.

Mukherjee is optimistic that perhaps it won’t even take a full generation for India’s economy to move to a digital platform, so long as the financial sector continues to give people choices and incentives.

“Demonetization proved that the Indian economy is somewhat close to ready for digital finance, because people did adjust very, very quickly,” Wadhwa said. “People moved to digital transactions very quickly, so it means the environment is there.”

But what is the verdict on the demonetization policy itself?

“The demonetization exercise was a stress test on the Indian economy, especially on its banking sector,” Mukherjee said. “It could have broken it completely, but it didn’t.”

Wadhwa noted while the policy did push out a lot of counterfeit currency, “black money” was largely deposited back into the central banking system. Still, she said, at least it’s in the formal sector now. According to Mukherjee, the policy also drove most households across the country to open bank accounts that didn’t previously have one.

“That’s an incredible base to build on,” he said.

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Joanne Lu

Joanne Lu is a South Carolina-based writer and editor dedicated to global development, poverty alleviation and social justice. After a year in Rwanda, she now covers the Asia-Pacific and economics. Find her on Twitter @joannelu or email joanne@humanosphere.com.