There is something medieval about cash: In providing the medium of exchange economies needed for transactions, rulers made a hefty profit converting pieces of paper or metal into money (this profit is called “seigniorage”). With democratically-elected governments, the extortionary nature of this activity is perhaps less obvious. But cash is a zero-cost loan for the government. If it instead issues a bond to fund its expenses, it needs to pay interest. The Rs 65,000 crore of dividend paid by the RBI to the government every year is seigniorage-related. A fall in currency in circulation would bring this down.
Despite this, perhaps the reason why cash has been successful for so long is that it is liberating; one just needs to know basic arithmetic to transact. It doesn’t need third-party validation like a card does for every transaction, which can at times be unavailable (recall the joke about a visitor to a paid toilet that only accepts online payments being asked to wait till the network comes on), expensive or intrusive. Cash also provides tremendous flexibility. Take our office pool for peanuts and biscuits (researchers get hungry). In the current cash shortage, we are transferring money online — but fear that our colleague who makes the purchases could get questioned on the dozens of small inflows into his bank account. Cash also provides anonymity and not all anonymity is bad; think of a grandmother squeezing notes into a child’s hand for chocolates, away from her parents’ eyes.
Cards (they stand for all digital payments in this article) provide better security (for all the risk of digital fraud, statistically, they are an improvement over misplacing cash or getting pickpocketed), are easier to carry, hygienic and don’t face the problem of providing change.
A transition to cards holds great promise at a broader level too. India is stuck in two vicious cycles. About 70 per cent of our non-agricultural workforce is in enterprises with less than five employees, nearly all of them informal. These enterprises cannot save enough to invest in growth and formal loans are difficult without collateral or evidence of steady cash flows. So, they stay small with low productivity; a vicious cycle.
A second vicious cycle is of a small government. Contrary to popular perception, India’s government is too small. It cannot be larger because India’s tax to GDP is among the lowest in the world due to high informality (nature of the economy). Developed economies are on a higher equilibrium; high tax to GDP, larger governments, high formality — and therefore, high tax to GDP.
A substantial improvement in formalisation or documentation of transactions is critical for breaking out of these vicious cycles. A transaction trail for smaller enterprises can be the evidence of cash flows that the formal financial system needs to lend against, helping break the first vicious cycle. Greater visibility of transactions can also help improve tax to GDP and enhance state capacity.
A third vicious cycle is in card usage. Due to low usage of debit cards for purchases (85-90 per cent of debit cards in India are only used for ATM withdrawals), banks charge a higher Merchant Discount Rate (MDR) — the fee the merchant pays the bank as their cost of merchant acquisition must be amortised over fewer transactions. Higher MDR makes debit cards less attractive for merchants, limiting their usage. More debit card transactions can bring down the MDR; this would boost transactions. The lagging issuance of card readers has been a concern for policymakers; the RBI issued a concept paper earlier this year.
For the economy as a whole, even at a 0.75-1 per cent MDR on debit cards, the costs are not that different from the 0.7 per cent cost of ATM withdrawals (it costs Rs 20 per ATM transaction, with average withdrawal Rs 2,900). In fact, beyond a tipping point, already crossed in some Nordic countries, but which for India would be several years away, a decline in cash usage drives up the cost of cash handling, making card payments even more attractive.
There is an opportunity for India to leapfrog the card/POS machine network problem with superior, lower cost, next-generation payment systems. However, the network effects in these appear harder for policymakers to crack. For example, despite its low costs, a key reason for the slow ramp-up of Unified Payments Interface (UPI) appears to be reluctance among major banks to promote it as it would hurt their fee income. Further, given natural network effects, digital payment modes become “winner take all” markets that slow down change. Other challenges of the transition from cash to card are well-known; security, privacy and education, needing significant work.
On the whole, viewing cash and card as competitors is unproductive; they are likely to coexist for a long time. “Cashless India” is a catchy slogan, but regulators are aware that cash will continue to be used for more than two-thirds of purchases, even if the share of cards grows five times. It should, given demonetisation, pick up in smartphones and internet usage, compounded by natural network effects. Regulatory focus should therefore be on inter-operability — the easier it is to get cash when needed, the less the need to hold it all the time.