<b>A V Rajwade:</b> Awaiting a feedback loop

A virtuous cycle has to take take off if electronic transactions as a medium of exchange is to soar in India following demonetisation

Over millennia, economies developed with more and more production of goods and services for exchange, rather than consumption by the producer himself. In an earlier era, the exchange took the form of barter, but the real growth of exchange came through evolution of “money” as a medium of exchange. Initially, after the era of cows and cowries, precious metals such as silver and gold became the medium; later, under the gold standard, paper money backed by precious metal became the medium of exchange. The latest and current avatar of money is paper currency backed only by the central bank’s “promise to pay the bearer the sum of….”

 
Kenneth Rogoff, the former chief economist of the International Monetary Fund, has recently written a book, The Curse of Cash, arguing that a large part of paper money is feeding tax evasion, corruption, terrorism, the drug trade, human trafficking — in short, a massive global underground economy. He argues that paper money can also cripple monetary policy. Will the next stage be paperless, electronic money? The Swedish Central Bank seems to be investigating the possibilities.
 
In many ways, Sweden’s political economy is a strange combination among the advanced countries. It is one of the richest in terms of per capita income, with one of the lowest levels of income inequality as measured by the Gini coefficient; a strong social democratic tradition even as its central bank, the world’s oldest, has sponsored the Nobel Prize in economics, which has honoured so many neoliberal economists from the US, the home of the “Chicago School” of laissez-faire ideology. Sweden is not a member of the Nato or the euro zone. There has been a dramatic drop in the use of cash in Sweden, and the number of notes and coins in circulation has dropped by 40 per cent in the last seven years. Will total “demonetisation” work, making all transactions traceable?

 

Coming to India, it seems one of the reasons that led to last month’s demonetisation of Rs 1,000 and Rs 500 currency notes was a dramatic increase in the number of currency notes in circulation over the last two years. In our country, almost 80 per cent of the transactions (by number) get settled in cash — in Brazil and China the number is less than 50 per cent, and around 20 per cent in most advanced economies. Since November 8, the use of electronic money in India, whether through mobile phones or credit/debit/prepaid cards, has gone up. Whether it will continue to expand in the years ahead remains to be seen. The key may well be whether we will witness a “positive feedback” loop in the real economy. (This phenomenon, also known as “reflexivity”, is common in asset markets. The price of a share goes up; it attracts other investors; the price goes up further; and so on.)

 
We need a feedback loop if the use of electronic transactions as a medium of exchange is to increase significantly. Most people do not use such money because it is not accepted by sellers. We need a virtuous cycle in which:

•         more and more individuals subscribe to mobile payment systems or wallets or cards;
•         more sellers subscribe to it — or buy/rent point-of-sale swipe machines — as they see business going to           sellers providing the facility;
•        and this persuades more and more consumers to resort to electronic money systems 

The introduction of a uniform goods and services tax may also help the phenomenon. The other side is that, once the supply of notes becomes normal, will we go back to our customary ways of making purchases? Then the feedback loop will cease to spin — and could go into reverse. What is likely? Toss a coin!

 
But if the experience of some East African countries is any guide, we could well see a virtuous feedback, particularly if the transaction costs are negligible. A mobile payment system, m-pesa, was launched by Vodafone in Kenya and Tanzania almost a decade ago. Now it has around 17 million users in Kenya (population 47 million) and seven million in Tanzania (55 million). Clearly, the pace of growth varies widely — even in two otherwise similar countries.
 
But to come back to India, digital money has as much potential to change the way our consumer markets operate, as the National Stock Exchange did two decades back in terms of the share (and derivatives) market. To be sure, no electronic system is hacker-proof, not even the Central Intelligence Agency’s (as WikiLeaks proved). But are not pockets picked in today’s currency notes-based system?

  The author is chairman, A V Rajwade & Co Pvt Ltd; avrajwade@gmail.com