This is the first part of a three-part essay
We can’t understand demonetisation and its aftermath if we don’t locate it within the global offensive against cash.
by Tony Joseph
Published Jan 28, 2017 · 09:00 am. Updated Jan 30, 2017 · 12:31 pm.
There is a global war on cash.
What we have seen in India in the last couple of months is part of that war. This is a difficult point for many opponents of the demonetisation exercise to accept because it interferes with the narrative that demonetisation is a story of political malice marrying incompetence. Suggesting that there were other motives too, whether good or bad, is seen as diluting the charge of incompetence. But we have to take facts as they come. If we do not do that, we will not be able to grapple with the real issues or understand what is going on.
The timing and reasoning for demonetisation may have been shaped by political opportunity and the schedule of the Assembly elections, but the move towards cashless economy was happening anyway. And demonetisation did give it a big push. At a very high human cost, of course. (Please click here for an explanation of how different threads/initiatives came together to cause an explosion on November 8.)
Who is waging the war?
But who is waging the war, and why? And thereby hangs a long tale. For ease of articulation, first the summary, and then the substantiation.
The war on cash is being waged by four major groups. One, existing financial services providers such as banks and credit card companies. Two, technology companies, including start-ups, with financial services ambitions (known as Fintechs in current terminology). Three, governments. And four, Central banks. It is difficult to imagine a more powerful combination of forces.
It is not that they have the same objectives. In fact, they have different objectives that sometimes conflict. But their interests are complementary when it comes to driving cash out of existence. For example, new start-ups like PayTM may take away business from existing financial service companies and ruin some of their business models, but for both groups, physical currency is either a mortal enemy or is of little use. There is little profit to be made from it and, for banks, it costs money to count, manage, store and move cash. But the moment currency turns into digital bits, two opportunities present themselves – one, to charge tiny little fees on every single transaction and two, to create a data trail of income and expenditure of customers that would come in handy to sustain new services and business models. So it makes sense for banks and fintechs to join hands to chase cash away.
India is right in the middle of this battleground, for two main reasons. One, India is seen as having the basic infrastructure in place – in terms of bank accounts and mobile penetration – to be able to take the jump to a cashless economy. Two, it has also been identified as a country with very large potential gains from the war.
But as in all wars, the question arises: how will the booty from this war be distributed? The summary answer is that while the gains for the initiators of the war on cash are tangible and immediate (think of the video of the PayTM chief executive officer’s celebratory dancing), for others caught in it, the gains are amorphous. So how do we weigh the overall costs and benefits, and equally importantly, how do we know how the pain and the gain are going to be distributed?
The best way to understand the war and to find answers to the questions raised above is to see how the idea of a cashless economy developed. Such a chronology will allow us to grasp how the war was conceived and who joined the battle when and why.
We know that plastic has been replacing cash worldwide in a slow and steady manner for decades, causing many to predict the death of cash prematurely. Cash today forms only 22% to 68% of transactions by volume in advanced economies. Norway, Australia and Denmark lead the digital pack while Japan, Germany and South Korea are among those who still prefer cash to cashless, with the United States falling somewhere in between, with a figure of 49%. But the theoretical scaffolding and reasoning for eliminating cash altogether began being put together only after the financial crisis of 2008.
The Great Recession
As we know, the Great Recession that began in 2008 pushed advanced economies into a long-term situation of low growth, low investment and low inflation, and central banks in these countries began to cut interest rates down to zero to stimulate investment and spending. But they found to their horror that zero or near-zero interest rates were not enough to get their economies humming again. In fact, some countries went even marginally lower than Zero, with Denmark being the first in 2012, followed by several of Europe’s central banks in 2014 and Japan in 2016.
Interest rates are the single most powerful tool that Central banks have, to control inflation or stagnation. If the economy is heating up and inflation is going beyond the targeted rate, central banks raise interest rates thus cooling down investment and consumer spending. People save more and spend less, bringing down inflation and along with it, growth. But if the economy is stagnant and inflation is lower than targeted, with not enough investment or consumer demand, central banks reduce interest rates to stimulate demand. Economic theory suggests that pushing interest rates significantly below zero might have been necessary to pull many advanced economies out of the funk they have been in since 2008.
A negative interest rate means that if you keep Rs 100 with your bank for a year, instead of getting back, say Rs 105 including a 5% interest, you may get back only Rs 99.90 – the rest being taken as, say, 0.1% negative interest rate. The expectation is that negative interest rates will force banks, businesses and individuals to lend, invest or spend their money rather than keep it idle, because there’s a cost to keeping it idle.
The lower a negative interest rate is, the higher the stimulus to spending and growth, just as the higher a positive interest rate is, the greater the restraint on spending. Now this is great in theory, but there is a practical problem. Central banks can take interest rate as high as they want without limit, but they cannot take it into seriously negative territory for a simple reason: if it goes there, everyone would just take their cash out of the banks and keep it in safe deposit boxes. No spending happens, and the central bank objectives are not met. In other words, economists argue that there is an asymmetry in the way central banks can use interest rates. They have immense power to cool down an overheating economy, but only limited power to stimulate a stagnant economy by bringing down interest rates sufficiently.
The technical term economists use to describe this situation is Effective Lower Bound, or ELB – the negative interest rate below which people will just withdraw their money from banks. Since there is a convenience to keeping money in the bank, the ELB is usually not exactly zero, but a little below zero – say, - 0.5% or -1%. People don’t mind keeping their money in the bank if the negative interest rate is a minor annoyance, because there is a convenience to operating with a bank account and say, a debit card.
After the Great Recession, this is the situation that central banks found themselves in: operating close to ELB. And it is in this situation that some economists started pushing a new idea that sounded horrendous to many: eliminating cash altogether. If there is no cash, people cannot take their money out of banks, and central banks can take interest rates as much below zero as needed. In other words, eliminating cash will improve the ability of central banks to fight stagnation and improve growth. Of course, this is like a forced appropriation of people’s savings and many would find it outrageous. But the economists would counter: so what’s new? People today hold cash even when there is inflation, knowing that the value of their holding is decreasing every day, and this is merely the opposite situation: there is no inflation or very low inflation, and instead there is a negative interest rate on your savings that you can’t escape.
Understanding demonetisation: Who is behind the war on cash (and why)
This is the second part of a three-part essay.
The cashless idea went from theory into practice when businesses and governments funded the Better than Cash Alliance in 2012. India joined it in 2015.
by Tony Joseph
Published Jan 29, 2017 · 08:00 am. Updated Jan 30, 2017 · 12:30 pm.
There are two well-known economists who pushed forward the idea of eliminating cash initially: Willem Buiter, now Chief Economist at financial services behemoth Citigroup and Professor Kenneth Rogoff of Harvard University. (Buiter was a thesis advisor to current Reserve Bank of India Governor Urjit Patel, and they have authored many papers together.) Willem’s 2009 piece titled “Negative Nominal Interest Rates: Three Ways to Overcome the Zero Lower Bound” came exactly at the right time, when many advanced economies were grappling with the issue of low growth, lower-than-targeted inflation and interest rates that were close to zero, and it got much attention. I can’t resist quoting the part where Buiter shows he is aware of the reaction his proposal would cause, and then suggests how to deal with it:
“But politically, the abolition of currency would run into opposition from some of the legitimately cash-dependent poor and elderly, from those for whom the anonymity of cash is desired because they are engaged in illegal activities, and from libertarians. The first constituency can be helped, the second can be ignored and the third one should take one for the team”!
Rogoff presented his paper, “Costs and benefits to phasing out paper currency in 2014” at the National Bureau of Economic Research’s Macroeconomics Conference at Cambridge, Massachusetts, and I must quote him:
“Paying a negative interest rate on currency, or on electronic reserves at the Central bank, may seem barbaric to some. But it is arguably no more barbaric than inflation, which similarly reduces the real purchasing power of currency.”
Rogoff’s special contribution to the debate was to flesh out the idea that currency is tainted and dirty, facilitating tax evasion and illegal activity. He ended his paper thus:
“Given relentless technological advance, embodied in everything from mobile banking to cryptocurrencies, we may already live in the twilight of the paper currency era anyway. Nevertheless, given the role of paper currency (especially large denomination notes) in facilitating tax evasion and illegal activity, and given the persistent and perhaps recurring problem of the zero bound on nominal interest rates, it is appropriate to consider the costs and benefits to a more proactive strategy for phasing out the use of paper currency.”
Since these two men made their case, others have added their own powerful voices to the chorus, including former US Treasury Secretary Larry Summers (who was considered for appointment as the Federal Reserve Chairman) and Nobel Laureate Paul Krugman. Both Krugman and Summers argue that in the situation that advanced economies are faced with, there are only two choices: either have negative interest rates (along with its inescapable corollary, currency elimination), or tolerate much higher levels of inflation, so that real interest rates can be negative, even if nominal interest rates are not. Both of them prefer currency elimination to much higher levels of inflation.
Krugman foresaw the outrage these suggestions will cause, and countered it this way:
“Any such suggestions are, of course, met with outrage. How dare anyone suggest that virtuous individuals, people who are prudent and save for the future, face expropriation? How can you suggest steadily eroding their savings either through inflation or through negative interest rates? It’s tyranny!
“But in a liquidity trap, saving may be a personal virtue, but it is a social vice. And in an economy facing secular stagnation, this isn’t just a temporary state of affairs, it is the norm. Assuring people that they can get a positive rate of return on safe assets means promising them something that the market doesn’t want to deliver – it’s like farm price supports, except for rentiers.”
From left to right: Willem Buiter, Kenneth Rogoff, Paul Krugman, Larry Summers
Advanced economies
This chronology of how the idea developed also gives us a good window to where one of the primary drivers in the war on cash, Central banks in advanced economies, are coming from. They are trying to perfect the primary tool they have, so that they can use if effectively in the current situation they are faced with – as well as in similar situations that may arise in the future. In fact, many are comparing the idea of currency elimination to the giving up of the Gold Standard during the Great Depression of the 1920s, which helped many economies revive.
These ideas are gaining momentum. Denmark, for example, is predicting that it will eliminate cash by 2030. In Italy and France, it is illegal to make purchases exceeding 1,000 Euros in cash. In Spain the limit is 2,500 Euros. Last year, European Central Bank decided to stop printing and issuance of the 500 Euro note, though already existing notes will continue to be legal tender for ever.
At a conference that was held in London on May 18, 2015 titled “Removing the Zero Lower Bound on Interest Rates”, Buiter and Rogoff were the keynote speakers, and other speakers represented the central banks of Switzerland, Europe, US, Denmark and Sweden, Soros Fund Management, insurance company Generali, Asset Management Company Brevan Howard and so on. So by 2015, the war had already been joined by many financial service behemoths who had begun to see the gains to be had from pushing currency out of the system. And by October 2015, the International Monetary Fund itself had released a paper titled “Breaking Through the Zero Lower Bound.”
Emerging economies
However, a key part of the war on cash will happen not in advanced economies, but in emerging markets in Africa such as Nigeria or in Asia such as India. This is because these markets are seen as holding the biggest potential for business gains and gross domestic product growth. There is also a belief that emerging markets are where new digital financial technologies will evolve, by leapfrogging the stages that the advanced economies had to go through. This possibility exists because while the difference in income levels between advanced economies and emerging economies is impossibly high, the difference between them in terms of mobile penetration levels and availability of bank accounts is much less, and these two are the essential infrastructure necessary for the move towards cashless. In the words of Bill Gates:
”One interesting feature of digital financial innovation is that some of it is happening in poor countries first… entrepreneurs in developing countries are doing exciting work – some of which will “trickle up” to developed countries over time.”
One could say the first concrete expression of this belief was the creation of an organisation called the Better than Cash Alliance in 2012, hosted at the United Nations in New York and funded by the United States Agency for International Development (commonly known as USAID), Bill and Melinda Gates Foundation, Citi Foundation, Ford Foundation, Mastercard, Omidyar Network and Visa Inc. The United Nation’s Capital Development Fund serves as the secretariat. The Alliance states its goals as advocating for the transition from cash to digital payments; conducting research; and catalyzing the development of inclusive digital payments ecosystems in member countries. What is worth noting is that the Alliance has 24 member countries, ranging from Kenya to the Philippines to Vietnam. India joined it on September 1, 2015.
Why 2015? Because in the previous year, during their bilateral meeting, Modi and US President Obama had discussed solutions to financial inclusion and the decision to join the Alliance can be seen as one result of that discussion. It was announced in the January 25, 2015 Joint Statement by the two, during Obama’s visit for the Republic Day.
Prime Minister Narendra Modi and the Chief Guest US President Barack Obama at the 66th Republic Day Parade 2015, in New Delhi on January 26, 2015.
But there were other steps too. 2015 in fact can be seen as a major watershed in India’s move towards cashless, in terms of acceptance of the principle. In his Union Budget speech in 2015, Finance Minister Jaitley said:
“One way to curb the flow of black money is to discourage transactions in cash. Now that a majority of Indians have or can have, a RUPAY debit card, I propose to introduce soon several measures that will incentivise credit or debit card transactions and disincentivise cash transaction.”
In June 2015, the finance ministry put up a draft proposal on its website, recommending tax concessions to reduce the cost of credit, debit and online payments. In July 2015, 11 new payment bank licences were given out, including one for PayTM. In November 2015, a Memorandum of Understanding was signed between the Ministry of Finance and USAID – the same agency behind the Alliance – to start working on interoperable digital payment models to drive transactions that involve small businesses and low-income consumers.
If 2015 was a year when the idea of a cashless economy was wholly accepted, much of the real action started in 2016. In February 2016, the prime minister chaired a Cabinet meeting that decided to “discourage transactions in cash”, and “shift the payments ecosystem from cash-dominated to non-cash/less cash payments”. The Cabinet decision was followed by the establishment of a task force in April 2016, which was asked to recommend short-term measures to promote payments through cards and digital means. In his Mann Ki Baat address in May 2016, the prime minister even made a call for a move towards a cashless economy – as the “whole world” was doing. The task force made its recommendations within three months, in July 2016. The very next month, August, saw the creation of the Committee on Digital Payments headed by former Finance Secretary Ratan P. Watal.
On October 14, 2016, USAID, one of the founding partners of the Better Than Cash Alliance, announced the launch of a new initiative called Catalyst to drive cashless payments in India. According to the USAID press release:
“This launch marks the next phase of partnership between USAID and India’s Ministry of Finance to help catalyze the rapid adoption of digital payments in India as a step towards achieving Prime Minister Narendra Modi’s vision of universal financial inclusion to end ‘economic untouchability’ in India.”
The CEO of Catalyst, Badal Malick, described the organisation’s objective this way: “Catalyst’s mission is to solve multiple coordination problems that have blocked the penetration of digital payments among merchants and low-income consumers…”
“The rubber is about to hit the road,” Malick said during the launch of Catalyst.
And it did.
Less than a month later, Modi announced demonetisation, the kind of push to cashless economy that no government anywhere had so far given.
Understanding demonetisation: The problem with the war on cash
Force marching unprepared citizens towards a cashless utopia that has little space for the informal sector is callous and indefensible.
by Tony Joseph
Published Jan 30, 2017 · 08:00 am. Updated Jan 30, 2017 · 06:17 pm.
Image credit: AFP
This is the concluding part of a three-part article.
An interesting point to note is that while the reasoning for the move towards cashless economy in advanced economies is all around the necessity of going into negative interest rates in order to rev up economies that are stuck in a low-growth mode, the reasoning for pushing the cashless economy idea in emerging markets that do not have the problem of stagnation, is a different one: it is about financial inclusion, fighting corruption and so on. This doesn’t necessarily mean that all these arguments are wrong; some arguments could be right. But this does show that the groups pushing forward the idea of cashless economy would like it to happen, irrespective of the specific reason. They just seem to have an enormous interest in driving cash out, no matter what the reason.
Why is this so? The best way to understand this is to go through a report on the great opportunity that digital finance presents in emerging economies, prepared by McKinsey and released just four months ago, in September. The report is prominently linked on the website of the Better Than Cash Alliance.
Here’s how the report begins:
“Two billion individuals and 200 million businesses in emerging economies today lack access to savings and credit, and even those with access can pay dearly for a limited range of products. Rapidly spreading digital technologies now offer an opportunity to provide financial services at much lower cost, and therefore profitably, boosting financial inclusion and enabling large productivity gains across the economy.”
The report then goes on to quantify the gains:
“Overall, we calculate that widespread use of digital finance could boost annual GDP of all emerging economies by $3.7 trillion by 2025, a 6 percent increase versus a business-as-usual scenario. Nearly two-thirds of the increase would come from raised productivity of financial and non-financial businesses and governments as a result of digital payments. One-third would be from the additional investment that broader financial inclusion of people and micro, small, and medium-sized businesses would bring. The small remainder would come from time savings by individuals enabling more hours of work. This additional GDP could lead to the creation of up to 95 million jobs across all sectors.”
The gains are seen as deriving from the following five factors:
- Cashless transactions reduce the cost of providing financial services by a humongous 80% to 90%, by doing away with the need for physical branches.
- This enables providers to serve many more customers profitably, with a broader set of products and lower prices.
- As individuals and businesses make digital payments, they create a data trail of their receipts and expenditures. This enables financial service providers to assess their credit risk better and provide credit where credit wouldn’t have been provided earlier.
- The data trail also makes it possible for banks and fintechs to devise new products and services – such as peer-to-peer lending platforms that connect borrowers and lenders directly
- Digital technology also makes micro-payments and on-demand services possible, leading to new products and business models.
How big a gain are these to financial services providers? This is what McKinsey has to say:
“Digital finance offers significant benefits – and a huge new business opportunity – to providers. By improving efficiency, the shift to digital payments from cash could save them $400 billion annually in direct costs. As more people obtain access to accounts and shift their savings from informal mechanisms, as much as $4.2 trillion in new deposits could flow into the financial system—funds that could then be loaned out. To unleash the full range and potential of new forms of digital finance, however, a much wider variety of players than banks will likely be involved. These may include telecoms companies, payment providers, financial technology startups, microfinance institutions (MFIs), retailers and other companies, and even handset manufacturers.”
And the gains to governments? This is what Mckinsey has to say:
“Governments in emerging economies could collectively save at least $110 billion annually as digital payments reduce leakage in public expenditure and tax revenue. Of this, about $70 billion would come from ensuring that government spending reaches its target. In addition, governments could gain approximately $40 billion annually from ensuring that tax revenue that is collected makes its way into government coffers, money that could be used to fund other priorities.“
There are also other “gains” for governments that McKinsey doesn’t talk about, but will be of concern to all citizens everywhere. For example, the fact that almost every action of the citizen will be trackable – especially since the vision for the cashless economy in India involves linking mobile numbers to bank accounts to national identities with biometric data. When you combine these three things, the ability of a government to watch over and instil fear and subservience in its citizens will be unprecedented, especially so in countries that do not already have a well-established and long tradition of privacy and data protection laws and insulation of the executive from political interference. It is no wonder therefore, the Better Than Cash Alliance has had no difficulty enrolling governments. As far as governments are concerned, what is there not to like?
McKinsey quantifies the gains to India specifically by 2025, as opposed to emerging markets in total, the following way:
- GDP boost by 2025: $ 700 billion, or 11.8% of GDP, the highest percentage gain among the countries studied
- Reduction in government leakage: $24 billion
- New Deposits: $799 billion
- New Credit: $689 billion
- New jobs: 21 million
Putting all these together gives us a good idea of what is at stake for each of the groups executing the war on cash.
- Governments want more tax revenues and less leakages; and more information on and greater control over citizens
- Central banks in advanced economies want more efficient monetary tools that increase their ability to counter stagnation. What central banks in emerging markets such as India (which do not suffer from long-term stagnation) want is not clear – unless they have just taken on the objectives of their governments as their own.
- Financial services providers want to reduce their costs significantly and also expand their business.
- Fintech firms want to “disrupt” existing markets for financial services using their ability to track and analyse large-scale user behaviour data
Eliminating cash helps each of these groups meet their objectives perfectly.
Where does that leave the citizens?
What we know for sure is that they will have less privacy and will need to depend on one financial service provider or another to make a payment or even merely to store their money – something they can do now with cash, without paying anyone any fees. By giving up their privacy and their sense of control over their own money and also laying themselves open to open new kinds of fees, what do they gain? The proponents of the war on cash say that they may get loans more easily, that they may be able to save more easily without having to spend time at a bank branch, and that as the GDP grows and jobs increase, their job prospects may also improve.
Not all of those promises are untrue. There are benefits from having a bank account and greater benefits from having it on one’s mobile, digitally. But some of those promises are dicey.
Particularly the part about 21 million new jobs. The McKinsey calculations assume a linear, unchanging relationship between GDP growth and employment growth. But this is not true – GDP growth does not always lead to commensurate job growth – as we have seen in India and in the West. And the kind of growth that will result from a forced move towards cashless is likely to be particularly weak on employment growth for a simple reason: The stated intention of the cashless push is to make it impossible for the informal sector to survive as it does today – even though it employs more than 70% of India’s labour.
In addition, banks and financial services companies are unlikely to realize the huge gains McKinsey talks about without slashing their staff numbers. Advanced economies are already in that situation (See Bank Layoffs are Coming). So one needs to take the employment figure given by McKinsey with a big pinch of salt. This will be made clear by one last quote from Mckinsey, with all the condescension and dismissiveness that it reserves for the informal sector:
“From an economic perspective, the informal economy imposes a high cost and significantly hinders growth. Many developing countries have a two-speed economy: a modern sector of healthy companies with high productivity (or output per unit of input), and an informal sector of subscale firms that drags down overall productivity and growth. Informal firms face perverse incentives and may avoid investments or growth that could increase their visibility to regulators and tax authorities. In Turkey, for instance, MGI has found that the productivity of formal companies is 2.5 times that of informal firms. The gap in productivity levels between formal and informal firms is similar in Brazil, India, Mexico, Russia, and elsewhere.
“The presence of informal firms also harms the economy by limiting the ability of high productivity, modern firms to gain market share, given the significant cost advantage informal firms enjoy by not paying taxes. MGI research has found that the cost advantage from tax avoidance ranges from 5 percent of the cost of goods sold in Mexico food retail to 25 percent in India’s apparel sector and to more than 100 percent in the case of Russian software. Formal companies also face additional costs and complexity in managing informal firms with outmoded technology in their supply chain. This dampens the healthy process of “creative destruction” in the economy in which the most productive companies take market share from less productive ones.”
The creative destruction that McKinsey talks about could involve significant loss of jobs as the formal sector with far less employment intensity drives out the informal sector that has a much higher employment intensity. The transformation of informal sector into formal sector is something that would have happened in the normal course of development with enough time for different players in the economy to adjust and evolve, but fast-forwarding this without safety nets in an economy that hasn’t taken care to provide its citizens with enough education and skills could be indefensible, especially when done in a manner that violates basic rules of trust between government and citizens.
It is not that the move towards digital cash is inherently evil – it is that forcing it down using draconian measures as was done and as is being considered could be both counterproductive and inhuman. In that sense, forced elimination of cash has much in common with forced sterilisation during Emergency. The policy of nasbandi, as sterilisation was called, tried to control population growth in a manner that violated basic human rights and caused unjust and widespread misery and still failed.
Despite its failure, over a period of time, as incomes, education and standards of living improved, population growth slowed down considerably anyway. Likewise, notebandi and its package of related measures is trying to control cash usage with force, while we know it declines as incomes grow and technology spreads. May be in the interest of good sense, humanity and fair play, the government should leave it to the markets, as the proponents of cashless love to insist in other contexts. Why do you need to use force if everyone stands to gain?
This is the concluding part of a three-part article.
Tony Joseph is a former Editor of BusinessWorld and can be reached at tjoseph0010@twitter.com
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