Moving towards a cashless economy

In any transaction, the process of payment is a pain. It is a necessary step, of course, in that payment is what completes the transaction, but the process of payment is not something that adds any value to the transaction. If money could be magically be transferred from buyer to seller at the end of a transaction, both transacting parties would be happy.

In this context, any chosen method of payment, be it cash or credit card or cheque or bank transfer, involves some degree of pain for the transacting parties.

In case of cash, there’s the problem of counting out the money, cross checking it, finding exact change, being able to handle currency without the fear of being robbed, and making sure the currency is not counterfeit. Cheques have a credit risk, since they can bounce, not to speak of the time it takes to write one, and the time it takes for the money to get transferred.

Bank transfer requires parties to have bank accounts, and the ability of transacting parties to tell each other their account details. Credit cards have the most explicit pain of transaction – the transaction fees the merchants need to pay the acquiring bank – apart from the time and pain of swiping, entering the PIN, etc.

The reason India has so far been a primarily cash economy is that the pain of transacting through cash has been far lower than the pain through other means. Apart from the pains mentioned above, cash also has the advantage of anonymity, speed of transaction and ability to hide from the tax authorities.

So if we have to turn India closer to a cashless economy, as the current union government plans to do, we need to either increase the pain of transacting in cash, or reduce the pain of transacting through another means. The Unified Payments Interface (UPI), which was launched with much fanfare earlier this year but has spectacularly failed to take off, seeks to reduce pain of cashless transactions. The government’s efforts to get people open bank accounts through the Pradhan Mantri Jan Dhan Yojana (PMJDY) also seeks to reduce pain in non-cash transactions.

The government’s recent effort to withdraw legal tender of Rs. 500 and Rs. 1000 notes, on the other hand, seeks to increase the cost of transacting in cash – 85% of the current stock of cash in India needs to get banked in the next 50 days. This, however, is not a repeatable exercise – it can simply remove confidence in the rupee and drive people to alternate (formal or informal) currencies.

So what can be done to move India to a more cashless economy? The problem with small change has already played its part, with most auto rickshaw and taxi drivers in Mumbai supposedly willing to accept payment in digital wallets such as PayTM. If the stock for the new Rs. 2000 and Rs. 500 notes released is low, and most people have to transact using Rs. 100 notes, that will again increase the pain of transacting in cash, since the cost of handling cash might go up.

Perversely, if crime and robberies increase, that will again make people wary of handling cash. In fact, as this excellent piece in the New Yorker claims, the reason Sweden has moved largely cashless is that people got scared of handling cash after a series of cash robberies a few years ago. The cost of higher crime, however, means this is not a desirable way to go cashless.

It’s been barely three days since the new Rs. 500 and Rs. 2000 notes have been released, and there are already reports of counterfeiting in these notes. Given the framework I’ve proposed in this blogpost, it is not inconceivable that these rumours have been planted – when people become more wary of receiving large currency (thanks to the fear of counterfeiting), they want to reduce the use of such physical currency.

It’s perverse, I know, but nothing can be ruled out! As I’ve repeatedly pointed out, increased use of cash has a fiscal cost (in terms of printing and maintaining currency, apart from people not paying taxes), so the government has an incentive to stamp it out.



Dealing with loss of cash

Ever since Rs. 500 and Rs. 1000 notes ceased to be legal tender on Tuesday night, the internet has been full of “human stories” of people for whom tragedy has struck because they are not able to transact.

This is a valid concern – for there is a significant portion of the population without access to banking (numbers in a Mint piece I’ve sent but they’re yet to publish), and access to banking is necessary to do any transaction of reasonable size (there’s only so much you can pay with 100 buck notes).

One fallacy, though, is that people in rural areas, where access to banks and ATMs is lower compared to urban areas, are going to have it harder till the cash gets adequately replaced. While these places may be out of the way, what will help them tide it over is that everyone pretty much knows everyone else.

In Money: The Unauthorised Biography, Felix Martin argues that money is neither a store of value nor a medium of exchange. Instead, it is simply a method to keep track of debts, with the elegance being offered by the fact that money is “negotiable”. If I have a 100 rupee note, all it says is I’m owed 100 rupees. Who owes me those 100 rupees doesn’t matter. “I promise to pay the bearer the sum of one hundred rupees”, the front of the note declares. It just doesn’t matter who the “I” in question is.

In order to illustrate his theory of money, Martin gives the example of Ireland around 1970, when a six-month banking strike left the country’s financial system in tatters. Life didn’t come to a standstill, though, as people figured out ways of maintaining their credits and transferring them.

Initially, people wrote each other cheques. Despite the inherent credit risk, and the fact that they couldn’t be encashed in near future, people accepted them from people they knew. Then the cheques became negotiable, after “reputed community people” such as barmen started vouching for people’s creditworthiness. And so the economy moved along.

Debts were finally settled many months later when the banking system reopened, and people could cash in the cheques they held. A similar story played out in Argentina in the early 2000s when rampant inflation had rendered the currency useless – cities managed to invent their own currencies and life went on.

In a similar fashion, in small towns, and other communities where most people tend to know one another, people are unlikely to face that much trouble because of the cash crunch. Credit is already fairly common in such places, except that it will have to be extended for a longer period of time until the cash supply returns. It is similar in other remote unbanked areas, and perhaps even among tightly-knit communities of businessmen. Systems will spontaneously come up to extend and exchange credit, and life will go on.

The concern, however, is for the urban poor, since they tend to do a large number of transactions with people they don’t know well. In such situations, extension of credit is impossible, and people might find it hard.