Cash

Despite Demonetization, Cash Still Thrives In India

In November 2016, the Indian government issued a ban on the nation’s higher denomination 500- and 1000-rupee notes, essentially deeming 86 percent of its currency invalid. But to date, India’s demonetization policy has not achieved its goals. Hugo Erken and Wim Boonstra, senior economists at Netherlands-based financial services firm Rabobank, explain how the Indian the government failed to lay the proper groundwork before implementing a nationwide cash ban.

The Indian government’s effort to demonetize has hit some speed bumps — namely, a lack of preparedness and an unwillingness among the country’s citizens to fold up their cash. It issued a ban on the nation’s higher denomination 500- and 1000-rupee notes in November 2016, essentially deeming 86 percent of its currency invalid.

Though the ban was intended to shift India into the digital economy fast lane, improve tax revenues and crack down on corruption, cash continues to play a strong role in India nearly two years into effect. In fact, the currency in circulation was valued at Rs 17.78 trillion as of February 2018  roughly 99 percent of the value of notes in circulation prior to demonetization, according to the Reserve Bank of India (RBI).

To put it mildly, India’s push to go cashless has fallen so far short of its goal. Part of the reason for that, according to Hugo Erken and Wim Boonstra, senior economists at Netherlands-based financial services firm Rabobank, is that the government did not lay the proper groundwork for the transition to digital currency before implementing the cash ban.

PYMNTS recently caught up with Erken and Boonstra for insights into India’s demonetization experiment, including the lessons the country can learn from European nations that have successfully pursued their own demonetization plans.

Cash Lessons From Around The Globe

The Indian government failed to truly understand how other nations pursued their own demonetization policies, Boonstra noted. Norway and Sweden, for example, are close to becoming entirely cashless, but their shift didn’t happen overnight. This plan has taken roughly 50 years to realize, and that longer transformation was helped by increased access to digital banking solutions.

“If [citizens] don’t have a bank account, then, by definition, every transaction will be cash-based,” he said.

According to both economists, a key problem with India’s demonetization policy was that the government’s plan was simply unrealistic. Given that India’s currency in circulation is at roughly the same levels it saw before cash ban went into effect, the term “demonetization” does not accurately apply to how the Indian economic policy has played out, Boonstra explained. 

Forgetting The Demonetization Preconditions

One of the reasons cash is still used so often in India is that the government misjudged the complexity involved in transitioning its citizens away from the payment method. Where it went wrong, in Boonstra’s estimation, was in neglecting to properly lay the foundation to prepare citizens and businesses for the shift.

For India’s demonetization policy to work, several preconditions should have been met before the note ban was implemented. The first is that more of the country’s impacted citizens should have had a digital bank account prior to the move. Roughly 40 percent of the nation’s population was still underbanked following the demonetization decision last year.

“Everyone should have a bank account,” Boonstra said. “Only then can you reduce the number of cash transactions.”

However, promoting digital bank accounts was just the first precondition. Once access to them expands, the government would have needed to urge companies to pay employee salaries using direct deposit, then gradually phase out larger denomination bills.

The Indian government didn’t succeed in meeting any of the preconditions and, ultimately, couldn’t successfully steer the country away from its affinity for cash. 

Where Cash Still Thrives

Erken correctly predicted that India’s economy would experience an economic slowdown after its demonetization policy went into effect, a forecast that was ultimately proven correct when India’s GDP growth slipped to 5.7 percent in Q1 2017.

He arrived at the conclusion by reviewing several factors influencing the country’s economy, like purchases of two-wheeled vehicles. These popular vehicles saw a decline in sales after demonetization went into effect, a downward trend, which spoke to the power of cash in India — and to the enormous challenges involved in truly getting the nation on board with the shift.

Cash transactions are still very [important] in India,” Erken said. “Many vehicles are bought with cash, and the drop [in purchases] was similar to the drop in money supply.

But the nation’s automotive market is not the only vertical in which cash is heavily utilized. It is also a crucial financial tool for India’s retailers and farmers.

“In the agricultural community, cash is important as well,” he added. “All kinds of farmers are still relying on cash to buy products like seeds, fertilizer, that kind of stuff. They also pay their employees in cash, and receive their revenues in cash.”

Farmers also tend to live in rural areas, where digital banking infrastructure is not easily available, making it more difficult to get Indian citizens to embrace demonetization.

“In that sense, the role of cash is still substantial in the Indian economy,” Erken said.

Shifting Culture Of Cash

Cash will likely continue to play a significant role in India’s economy for the foreseeable future, according to Erken, but digital financial solutions — including banking tools, business accounts and offerings to enable digital retail — are bound to become more affordable and broadly accepted in the economy.

India’s government faces an additional challenge in its quest to implement an effective demonetization policy, though, and that includes changing cultural attitudes about cash.

Erken noted that cash still plays a central role in everyday purchases in Germany, far more so than in neighboring nations like the Netherlands, Norway and Sweden. The country wants to hold onto cash to protect its financial privacy, and to avoid the unknown challenges of a cashless society.

“Germans have something with cash,” Erken said. “It’s a huge emotional thing.”

Understanding Germany’s cultural and emotional attitudes toward cash offers insight into India’s own attachments. Cultural attitudes take years to adjust, and this means cash is likely going to continue to maintain a heavy influence for the foreseeable future, Boonstra noted.

“An overwhelming part of the Indian economy is cash-based,” he said. “This cannot be changed in a couple years.”

With or without the government’s demonetization policy, it appears India’s grip on cash remains as strong as ever.

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