Reality Check India

Demonetization as a window to force a Digital flip

Posted in Uncategorized by realitycheck on December 25, 2016


Kayyila Kaasu  Vaayila Dosai !

(Old Tamil Saying : Cash in hand  Dosa in mouth)

If something persists for a long long time despite multiple attempts to defeat it – it is always wise to step back and see if there is a reason for why it is persisting. This catchy aphorism ” Cash in hand = Dosa in mouth” may seem too simple but it captures the essence of what people are expecting from a settlement system.Cash OUT Dosa IN. End of story. Captures the beginning, the middle, and the end of the transaction. No intermediaries as facilitators (telcos) as final approvers (banks, wallets)  loggers (govt, authenticators) or commission brokers (cards). As Prof Jayant R Varma puts in so eloquently in his article A Digital Device for every Indian  he says  “Cash gives the poorest of the poor access to a retail payment system that meets the gold standard for payment systems: real time gross settlement in central bank money. It is unacceptable to give them anything less than this in a digital solution”

An instant bilateral settlement of Dosa eating at zero cost  with no third party who holds a veto power over this.  Bank deposits and Wallets are comparable to ‘tokens’ –  inferior forms of money.  You can only access bank money through a particular bank, with their tools, through your specific type of account, tier of service. You can only access Wallet money in certain situations.  Access to this gold standard settlement with cash is what the poorest of the poor had at exactly the same level as the richest. Pardon me for dwelling a bit more on this because it is important to set the framework for the rest of the article.

This super slick transaction mechanism  described above of course has its well known downsides. The costs of machines to detect counterfeits are high,  cash is unwieldy to carry around in large amounts, the test of ownership is “possession”. This means if a robber takes your cash it is his (generally).

Transactions are invisible to government authorities and they have to rely on ever smarter Financial Intelligence (FININT) systems to detect these.  The first three drawbacks are not real  because people factor those into their usage patterns. Very few people go any buy a car or even a TV with a suitcase of cash.  The risk of getting mugged or pickpocketed is real so people are wary of crowded or iffy places when carrying cash. The last drawback : the invisibility of the transaction from a government point of view is the main criticism of cash.  If sufficiently large number of these invisible transactions take place over a long time period, they can lead to build up of an alternate “overlay” economy called the Black Economy.   Cash can move at ease between the two layers testing and teasing the various Financial Intelligence, NMS (Non Filer Monitoring systems) and Bank Analytics systems that exist at this boundary.  This was the state of cash India. A super efficient settlement tool that supported a  level of transactions amounting to about 55% of all economic activity by value and 95% by volume. But also one that was being exploited by tax evaders and other nefarious elements.

On Nov 8 2016, Prime Minister Narendra Modi shocked the nation by taking a very audacious move.  Over 85% of all currency , those held in Rs 500 and Rs 1000 denominations roughly 16 Lakh Crores of paper was declared invalid except for the purpose of depositing at a bank.  At that time I had immediately hailed the move saying “Modi has belled the black money cat“.  It is remarkable and a tribute to the man that he would take such a decision that would disrupt his own party and a large part of this support base.   I hailed then and continue to hail now : Demonetisation as a truly fundamental and necessary disruption. My position is in contrast to people like P. Chidambaram who view the demonetisation itself as a bad move.

But from Day one,  I and some allies on  twitter have been warning that to pull this off we need a war like effort. An effort whose main thrust would be a frictionless swap of new tender and that needed a full time focus with a war-room-dashboards approach. This was not to be.  Today is Dec 25 2016 with only 6 days to go for the Prime Minsters 50 day deadline.  The overwhelming majority of ATMs (keep in mind these ATMs are part of the white economy) are still closed even with very low withdrawal limits at 10% of earlier limits. Authoritative figures are hard to come by but it appears only about 30% of the notes have been replaced with a large number of them being siphoned off.  The government has long pivoted from “War on black money” to  a “Cashless” economy.  This is where I part from most of the Right Wing and Center Right supporters.  Demonetization YAY. Cashless NAY.

The first step to recognize is that these  are two independent campaigns.  If you do them simultaneously it just means you have sucked in the peoples cash – which continues to be their  settlement mechanism of choice –  and are not going to return it.

How would a demonetization exercise but without the Cashless hoopla look like?

Step back a minute and understand the main issue here. The Black Economy and the White Economy are not isolated. They are overlay economies. Say you are hoarding a stash of cash, you can cut off a slice and buy your son a Bajaj Pulsar. You have just effected a cross-layer transaction. The income shows up in the Bajaj dealers books but if you are lucky it never showed in yours.  The government is not stupid either, they have complex Financial Intelligence, Anti Money Laundering (FININT) software at key points where the black and white layers collide ( auto dealers, jewellers, real estate, banks etc). On the other hand they turn a blind eye to other places where the layers collide (political parties,  and in general allied activities of politicians like education,mining,campaigns, lending).

A prolonged expansion of the black economy created pockets of very high capital accumulation (cash hills) that made FININT systems harder and harder to work effectively because there were fewer transactions crossing the boundary. An entire ecosystem of credit, financing, property registrations that in turn fueled growth segments construction, commercial rentals, political initiatives, meant that you could stay completely within the Black Economy and rarely cross the line.  Particularly the borrowing and lending of black money meant the you could make your Black money work for you just as hard as the White (via Capital Markets, FDs, etc).  The intertwining of political muscle with black capital was doubly potent. A thuggish politician could count on recouping any outstanding loans by leveraging muscle power and that also neatly ensured his ascendancy in the political arena.  So what do you have here. Emergence of an almost stand alone economy increasingly harder for FININT to detect when crossing the checkpoints. A situation hard to reform due to involvement of politicians and corrupt govt officials.  This was the state of things.

What demonetization did was wreck this.

It would destroy the Black Capital held as cash and would put all outstanding loans in jeopardy thereby destroying the Black Credit sector. Why? because loans availed in black would have to be paid back in white. Not going to happen. By forcing everyone into the White Layer they would have to meekly surrender to FININT . A brilliant move. So all you had to do was to recall the old notes and hand out new ones at a rapid pace.  I view the friction caused by paperwork in the first week of note swap, the unnecessary change of currency sizes, the chaotic and unplanned printing process, the headroom given to bank staff causing loot of new currency notes, a near total shift of focus to e-Payment, were all avoidable errors.

The next step is the tricky one. Say you had the entire black layer cross the perimeter and FININT systems alerted and lit up like a Christmas tree. Does the state have the capacity to follow it up?  Mr Ravi here just plonked 20L in his ICICI account – what next?  If the state doesnt even have this capacity then think about it. How can it have the capacity to detect and respond to frauds in any situation – cash or cashless? This is exactly the same tragic situation in Police capacity  with Sec 13(1) of the Prevention of Corruption Act – the Disproportionate Assets clause.  Once people wisen up to it, the cases get harder and harder to prosecute and the Police get more and more complacent. This is what some people say when they mean ‘failing institutions’.

In summary, Demonetization by itself would have wrecked the black economy, primed the FININT systems to the brim, and yet left the power of the ‘golden cash settlement’ option back in the peoples hands.  If this had been done, by this time of late December we would be on our way – moving on to bigger battles like the Core Right Agenda.

What is wrong with cashless?

There is absolutely nothing wrong with cashless. It is a perfectly valid payment option in certain circumstances in certain tiers.  I use it in many situations and fall back to cash in many other situations.  It also depends on the tier of service and the product.I would not use a credit card that has a annual fee for instance or one that needed a security deposit in the form of a FD. I try to use credit cards over other options due to ease of chargebacks and returns.  It all depends.  The movement to cashless is linked to increasing trust in government and society.  People quote Sweden as the ideal here – but forget that Sweden and Norway janta also get drinking water on tap.  The challenges of a First World country with very high trust in government and very high respect for the ruling elites is different from a Third world country that has a mountain to climb.  Then they switch the comparison to Kenya and cite the success of m-PESA. They forget that m-PESA has limited success outside of Kenya.  In fact it was rolled out in India too by Vodafone. Failed.  This is not to say that cashless has no chance to succeed but that in both Sweden and Kenya , cashless won over the people from cash. In Sweden, people just moved to less and less cash rendering banks pulling back cash operations due to low volume. In Kenya, poor access to ATMs and violence was the factor.

The real problem here is the forcing of cashless options – not for high value (car, house) or even medium value (TV, insurance) but for petty transactions. The messaging led by Modi’s advisors in Niti Aayog  is how the providers on the other side of the middle class interface  – the subji (vegetable) wala, the doodh (milk) walla, some maids, servants, paan walla are moving to cashless. The Middle Class : Service Provider interface can be loosened up if the main objective was to ease the pain of the middle class side.  Many provided their  servants with a take it or leave it option and they opened a bank account.  But that is not the only interface. The “servant” also have payables to others – like the slum lord or the pawn shop or the informal chits. At this point – we usually say. Its their problem.

In India, there are a number of cashless options available today and have been for a very long time. In spite of massive venture capital leveraged cashbacks and discounts  there is still not a winner over cash. The underwriters factor the risk that if the cashbacks stop, people might just  revert back. The range of products are not all comparable in quality, speed, security, or access.

One of the most exasperating arguments put forth by NITI Aaayog goes  like this “Cant do Wallet , then do UPI, no smart phone, then do USSD, nothing use Aadhaar app (to be launched)”. The problem is this is not equivalent to “Dont want Pepsi drink Coke”. The alternatives offered are not identical replacements ie. not fungible.  People using USSD will go through a much poorer, slower, intrusive (having to interact with humans) than upscale options.  This comes back to Prof Jayant Varma’s point. The access is tiered.  This tiering was  not a problem as long as the gorilla sized competitor to all of these systems – the cash settlement – was around. But when by Govt policy the main competitor is knocked out  (or crippled to a great extent) then you enter into a very inequitable situation.

Even within what I call the corporate Right Wing , the tiering is present but not involving matter of dignity.  So I can have a personal banker and a Amex Centurion card and someone else has a ICICI Coral Card – it doesnt make much difference. My experience is going to be uniformly superior to yours but yours is not too bad either. You know English and can call a Toll Free number and smash the customer support rep and get any perceived injustice (eg late charges, fees, fines, etc) waived while I may never have to pay these things.

On the other side of the divide things are not that rosy.   Semi literate people with hand down barely working feature phones with a solitary bank within 10Km are not going to be so lucky.  Cash was the ultimate equalizer in this situation. A rich guy is unlikely to be able to wave his 20 Rs note and cut the line for a Vada Pav over a coolie who also has a 20 Rs note.  I could go on , as long as you are able to role play or empathize with unfamiliar situations, you will  get this part. If not, stop reading here.

Then the issue shifts to – ‘look its not cashless but less cash”.  No one really believes cashless means a ban on cash. These two are synoyms referring to the same policy.

Cash supply held at a crippling low level so people are forced to adopt inferior products which they otherwise would not were the supply to be were increased.  A new phrase “Digi-monetisation” is now doing the rounds.

What would a cashless, sorry less cash economy look like ? I predict the first changes would be a dramatic roll back of the ATM network – if the caps are held so low and supplies crunched, the cash management company model will no longer be viable.  You may well see the ATMs that are closed since Nov 8 2016, may never re-open again.  This could mean a comeback of human tellers  which are a throwback to the 70s to 90’s are back.  I am not saying any of these are wrong but pointing out these are not emerging naturally but by force.

Another aspect of Niti Aayog PR blitz that is distressing is the concealing (innocent for sure) of the charges involved in each of these methods. They temporary waivers of charges are not highlighted, there is no legal framework of regulation which would guarantee the charges cannot be slided up or down at will, to all or to some segments of the population.  It is also odd that people like S Gurumurthy and Prof R Vaidyanathan who are very familiar with the efficiency differences in informal lending vs mainstream bank lending are not speaking up on the forcible switch to bank credit system. The replacements for chit funds, pawn brokers, are not there yet.  No doubt these activities could be tax evasive but will the banks then provide the same efficiencies?  Remember the previous government even instituted sectarian lending targets based on religion caste etc euphemistically known as “Priority Sector Lending” – this is of course in #core2 territory and is continued by Modi govt.  The informal sector treats such distinctions with disdain. Should we ignore this?


The cashless campaign is an un-necessary distraction at best in midst of a noble demonetization exercise. The fin tech startups and banks  need to compete with cash and win over the public , otherwise sooner of later we will find the govt indirectly favouring individual players in this segment to save face.  The equity aspects of the switch to cashless are real, the regulatory, inter operability, security aspects are real too. Legally the new regime that places arbitrary curbs could push up against Banking Regulation Act and other statutes.   All of this is unnecessary.  Promotion of a cashless economy is a completely discretionary and separate exercise can be undertaken at any time. Start with digitizing all govt and PSU payments,  reduce excise & import duty on cashless tech, tax holidays for Fin Tech (like you did for IT with the STPI and SEZ schemes), etc etc.

On the political aspect, I have no comments to offer. The main difference I see with fellow “RW” critics  is that I dont view demonetization  as a great agenda. The real battles are in what I call “Core Right” , by betting your house on the Cashless horse, you are running a risk which I view is too great. You could be out before you even take a single swing at Core. Think about that.