Demonetisation: Any effect on use of cash?

Immediate impact aside, will it increase use of non-cash transactions?

The spot impact of demonetisation has been analysed to no end, and perhaps to no avail. Immediately as it occurred, I too laid my view bare in this column, indicating that there could be little contractionary impact if cash retraction by the Reserve Bank of India (RBI) was exchanged with injection of counterpart public finance into the economy, though I did critique the costly flaw in government perception on what denominations comprised the big bills. The RBI’s subsequent announcement that the cash withdrawn had returned to banks was newly critiqued since, in that case, non-tax paid cash must have found its way comfortably into the tax-paid economy without adequate penalty.

Even this cannot be perceived offhand as an adverse development if the effective cost to depositors was 30 per cent, or the marginal income tax rate. Circulation of cash through banks is certainly better than through hawala or returning back into India through tax havens. Of course whether banks deserve to receive more cash whenever they need recapitalisation to obviate bad loans to the high and mighty, revealing bank incompetence if not coercion with the political and administrative systems, is a separate aspect. That is not today’s focus.

One important effect of demonetisation that should be analysed is whether the use of cash will lessen and the use of non-cash transactions increase. In other words, though ‘old habits die hard’, will they nevertheless change? Since India’s use of non-cash transactions is low in a cross-country comparison, anticipating some success may not be erroneous. Some recent indicators would be helpful perhaps. I use data from the Bank of International Settlements Red Book, December 2016, the latest available. The final year of all reported data is 2015. I analyse data for three comparable countries, Brazil, China and India.

Illustration by Binay Sinha

To begin, cash in circulation in terms of gross domestic product (GDP) has been surprisingly lower in India (12.3 per cent) than in China (13.3 per cent) though in Brazil it has been much lower (3.8 per cent) reflecting a mammoth successful attempt in the 1990s towards non-cash use. One could speculate on the reasons of China being higher than India. For example, China’s transactions volumes are so high compared to India’s that the cash component could be higher. Second, one explanation could be that a portion of India’s unorganised economy could still be using barter.

Of course, as might be expected, non-cash use in India trails that of China as Table 1 reveals. First, in 2015, in terms of number of non-cash transactions, India’s was about one-third that of China though, in 2011, the numbers were pretty close. The change reflected a massive improvement in China by 2015. Thus, second, between 2011 and 2015, improvement measured in percentage terms was about one-fifth that of China. And, third, in per-capita terms, increase in India was about one-quarter that of China. Clearly, during 2011-15, India lagged behind China significantly in moving to non-cash transactions. Note that, reflecting the early reform in Brazil, the numbers and increases thereof had already stabilised over the years considered.

Non-cash transactions have various forms. Table 2 reveals their percentage distribution and change during 2011-15. An examination of their distribution in 2015 reveals some oddities. Brazil clearly uses cards and credit transfers highly. India’s use of cards, at three-quarters share — appears overwhelming compared to other forms. And since China reports no direct debits at all and little use of cheques, its use of cards represents four-fifths of total non-cash.

A comparison of the movements during 2011-15 shows different trends. First, the use of cards in Brazil has overtaken those of cheques and transfers. In China, credit transfers and cards have grown and cheques have become almost insignificant and, of course, there is no reported direct debit at all! In India too, the use of cheques and direct debits has reduced, the only increase being credit transfers. What is important to note is that the share of cards, too, has diminished, though slightly. If Brazil can be taken as a hallmark for non-cash use, then both India and China’s future experience would be in the direction of higher shares for credit transfers and direct debits. Perhaps this could be buttressed by increased use of net banking. This will need not only more education in how to use it but also confidence building.

What measures should India take? First, track, for the next five years, its cash in circulation in terms of GDP, the objective being an observable decrease. Second, track the number of non-cash transactions and whether their growth is approaching the gigantic leaps that China has achieved. Third, among non-cash components, are Indians using more net banking and increasing the use of credit transfers and direct debits. Banks should implement helpful programmes to educate even zero balance accountholders to use net banking — perhaps they will need it soon. Without these changes, a salient ramification of any demonetisation – to quickly move from cash to non-cash use – will remain unachieved.