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DeMonetisation did not promote the uptake of digital transactions

Driving India towards a less-cash, digital payments economy was one of the aims claimed by the Prime Minister when he invalidated 86% of India's circulating currency. The reasoning was that India was a largely cash-based economy; if circulating cash was reduced, people would rapidly move towards electronic, or digital payment systems for their commercial transactions. That at any rate was the hope.

Did it happen?

Rupa Subramanya thinks it did. She claimed as much in a blog in the Hindustan Times. She accepts that the original aim of taking out black money has not been met, given that almost all of the Specified Bank Notes (SBNs) hav now been returned for exchange or deposit. But she goes on to say that her research shows that the secondary aim of pushing the country towards digital payments and away from a cash based economy has been achieved. To quote from her article:

....several key components of digital payments such as Point of Sale Debit and Credit (PoS) purchases, National Electronic Fund Transfer (NEFT), Immediate Payment Systems (IMPS) and mobile banking, are way above their pre-demonetisation trends

.....

The bottom line of the research conclusively demonstrates that there was a structural break after November 2016 with a permanent increase in digital payments and decrease in the relative importance of cash. Whatever you may think of the original goals and whether they succeeded, it’s clear digitisation is one demonstrable success story of demonetisation.

She expresses the use of digital payments not in absolute terms but as a proportion of total M3 Money. However, though she says she has published her findings,  they are not in peer reviewed journals. Rather the findings are published in research papers for the Observer Research Foundation - a think tank. I haven't seen these papers and therefore cannot comment on the methodology of the research. In any case she does not cite a source, nor does her article present the full results of her analysis. Her data source, though is the same that I have used earlier in a series of tweets and in a twitter Moment. This is the Reserve Bank of India's Database on Indian Economy.

I believe her conclusions are premature, they may even be misleading or wrong, based as they are not on absolute value of payments but on payment volumes as a ratio of M3.

I present here my own much simpler and more intuitive analysis of the RBI data set and draw very different conclusions.

Data and Methods: The RBI dataset consists of monthly transaction amounts for each of several different modes of digital transactions. The data goes back to 2004 and the latest available data is for August 2017, 10 months after DeMonetisation. Rather than look at just at the figures a few months either side of D-Day (DeMonetisation-Day if you are a fan or Disaster-day if you are a critic), I suggest it is best to look at the entire period. Since these are time series data (defined as data collected consistently with a defined periodicity - in this case monthly) the most obvious and simple technique would be to chart the data against time, draw a vertical line at D-day and look for a change in the trend . If D-Day did indeed result in qualitative sustained change in aggregate behaviour the change in trend would be obvious. I used the statistical programming language, R and the charting package ggplot2 to draw and annotate the charts. These statistical programmes are widely used in academia and business.

Results: The results of my analysis are best presented as a series of charts. They speak for themselves.

The key point to get is that by looking at the entire time series for each of the main digital payment modalities, two conclusions leap out immediately.

One, that in the first few months after D-Day there was a spurt the volume of payments made by digital means.

Two, for some payment modalities, they have subsequently fallen back to levels that were seen well before D-day. In particular retail electronic clearing, and plastic card volumes are effectively back on the same trend growth they always were since long before D-Day. Mobile banking transactions in particular were going up steeply in the months before D-Day was even a glint in anyone's eye; they went up even more steeply after D-day - and here's the crucial point, they have more latterly dropped right back. If we superimpose what we know about the re-introduction of new currency notes this looks like a perfect fit. As cash was re-introduced into the system, people began giving up on mobile banking transactions.

Another set of charts looks at the volumes (i.e number) of transactions.

Here there appears to be a small shift upward that, despite some month on month fluctuation appears to be settling down at a level clearly higher than anything seen pre D-Day. In the case of mobile transactions it is small-ish numbers and starting from a very low base; in the case of digital transactions its a step change from about 1.4 billion transactions a month to about 2 billion. But the volumes transacted appear not to have shifted much at all - it is in keeping with long-running trend and it is certainly not a step change.

Undoubtedly, there has been a steep growth in the number of Point of Sale outlets, as shown here:

Starting from a very low base, this is only to be expected given the huge Government push including cash incentives and subsidies for the take up of POS machines. The extend to which these have penetrated much beyond the largest urban centres and the plushest retail outlets is the big question. The last chart above is based on data published by NITIAayog

Conclusions. My analysis leads me to conclude that any effect of DeMonetisation on the use of digital payment systems has been transient, small and short-lived. Some change has occurred (POS terminals for example) but the fact that both retail electronic clearing and card usage is back on what I call 'trend growth' (i.e. on the same trend as obtained before D-day) would suggest that there has not been a structural change that can be confidently ascribed to DeMonetisation.

Post-script discussion. In all the commentary on Digital Payments insufficient attention has been paid to a most fascinating report that was published on Oct 5 by Visa India. Amitabh Kant, CEO of NITIaayog, wrote the foreword to this report. Nobody who read the detailed figures or had taken in the measured  recommendations in this report would have supported a sudden, cataclysmic and disruptive withdrawal of 86% of the currency, certainly not with the intention of promoting a digital payments economy. Among the key findings of the report are:

  • Cash usage costs the economy 1.7% of GDP (Note: borne largely by the State)
  • According to a 2014 World Bank survey, only 0.38 percent of women above 15 years old used the internet to make payments compared with 2.04 percent
    of men; 3.25 percent women had used a debit card versus 5.25 percent of men.
  • The cost of a point-of-sale (POS) terminal in India ranges from INR 8,000 to INR 12,000. The annual operating cost is INR 3,000
    per terminal. Low transaction volumes especially outside of Tier 1 cities, make it unviable for banks to expand their footprint into such segments.
  • RBI and the Govt of India already had a plan to transition to a less-cash economy.
  • If India  invested a total of INR 58,000 crores (USD 8.6 billion) over the next five years through tax
    rebates, it could not only expedite the pace of payment digitisation but also save about INR 70,000 crores (USD 10.4
    billion) in that period through a reduction in the cost of cash with a potential to save 4.7 lakh crores (USD 70 billion)
  • If we invested 60,000 crores and undertook a series of reforms and regulatory changes cash use could come down in 2025 from 1.7% of GDP to 1.3%.
  • In particlar see exhibit 7 of the rport which details the benefits from a sustained programe of policy changes as well as investments to improve the infrastructure for digital transactions. Effectively, a 5 year programme of sustained policy implementation and investment would potentially result in a growth of digital payments for Personal Consumption Expenditure from 4% to a whopping 36%, a drop in cash need from 11% of GDP to 10%.

 

A year on the Prime Minister's Great Idea may have turned out to be a dud

Mao ZeDong’s Great Leap Forward [1]  has to be the most outstanding example of the devastating harm from the unintended consequences of a state policy that aimed to modernize and develop an entire country.  It resulted in the deaths of 45 million Chinese in 4 years [2].

That was possible only because China was a Communist dictatorship and Mao held absolute power over both Party and the people of China. He decided it was a good idea and the Great Leap Forward happened.

In contrast, Mr Modi’s sudden, dramatic and hugely disruptive announcement of a year ago on Nov 8 2016 [3] was a tame affair; only a few score people died[4]. Like the Great Leap Forward, it too was one man’s Great Idea [5]; the aims were similarly laudable even if the goalposts kept changing; unlike Mao ZeDong though, Mr Modi was an elected leader of a Party that had won a decisive mandate.

Black Money was a major problem, declared the Prime Minister, and it called for a dramatic, decisive and bold step. Effective midnight 8th Nov 2016 the 500 and 1000 Rupee notes would be raddi ('worthless pieces of paper' to use the PM's words). New notes would be issued, including inexplicably a 2000R-Rupee note; and people left holding the old notes would be able to exchange them at banks or deposit them for credit to their accounts.

Almost everyone in India was affected and quite a few overseas Indians. Those with real black money (held as cash, you were safe if all your illegal wealth was held as gold or real estate)  found ingenious ways to convert their illegal stash of old notes into bank deposits.

The others, especially the poor, suffered the most. Day-to-day commercial transactions seized up. Shopping for groceries, taxi rides, buying a train ticket, paying the utility bill - all the routine stuff of everyday life became hard. Given that the notes that were declared illegal made up fully 86% of the currency-in-circulation, and that for all but the richest urban citizens India was still predominantly a cash economy, this was hardly surprising. Daily wage labourers lost livelihoods; victims of domestic violence lost the money they were hiding from violent partners; small businesses saw customers turn away; smaller businesses and street traders could not afford to take up the offer of Point of Sale equipment.  The rural sector was worst hit;  agricultural markets collapsed in a state-ordained market failure. [6]

But there was also widespread support for a ‘decisive strike against the rich and the corrupt’; in the days of chaos that followed, support for the Prime Minister hardly wavered. The cause was a noble one and people were prepared to make personal sacrifices for the national good. In time the economy would pick up, more of the informal cash-driven sector would be persuaded, cajoled or dragged into the formal, digital-transaction banked sector, the tax take would rise and India would become a modern rich economy. Trillions of rupees would not be returned to the banks by rich crooks and the ensuing windfall would be put to good use in building up national infrastructure. That, at any rate, was the hope.

It remained a forlorn hope. None of the claimed benefits materialised.

By June 2017, even the Govt's staunchest media supporter, SwarajyaMag.com acknowledged that the move had not lived up to the expectations. [7] press Very little Black money has been unearthed. After much delay a discredited central bank finally came out with the figures that almost all of the notes in circulation have been handed in [8]. There were no major prosecutions for tax evasion or illegal money laundering.

The process of re-monetisation with the new notes gradually picked up and by the 1st anniversary the total currency in circulation was back to 85% of what it used to be. Cashless transaction rose in the early days after Nov 2016 as people were forced to use alternative means of payment but have since fallen back to previous levels as currency became available.[9]

The wider economic damage too has been widely acknowledged. GDP growth fell back to levels last seen in the worst years of the previous  regime.[10] Jobs growth just did not materialise.

The Great Idea of 2016 will continue to be assessed, studied, debated and analysed for a long time, [11] But some questions may never be unanswered for many years to come.

  • What advice and analysis went into the formulation of the policy? Were experts consulted at all?
  • What was the role of economic and finance policy institutions like the Reserve Bank of India and NITI-Aayog? Did they play a role in the formulation of the policy and its implementation or were they relegated to serving as mere apologists for the ill-effects of a decision taken by an autocratic Prime Minister?
  • Why did Cabinet not protest at being ensconed in a room without access to mobile phones as the decision was announced?
  • Was it not the role of Parliament to hold the Government to account?
  • Will there ever be an independent cost-benefit analysis of the decision?

 

References:

  1. See this wikipedia account of the Great Leap Forward.
  2. See: this review of a book on the subject. I acknowledge that I have not read the book in the original.
  3. See this article in the Scroll.In for a review of how the news was covered in the newspapers on Nov 9th 2016.
  4. Deaths attributable directly and solely to the scrapping of notes was always going to be difficult. That a number of deaths occurred in queues is undeniable. Were they caused by the need to stand in queues? That's more difficult. Arguably the distress, the economic harm, the job losses and the lost wages/livelihoods and savings took its toll on ordinary people. The exact number of deaths became a political ding-dong  that diverted attention from the bigger question of the wisdom of the policy.
  5. We'll never know for certain that the final decision to go ahead and DeMonetise the currency was entirely Mr Modi's. There has never been a proper enquiry. All the indirect evidence points to it being either solely or largely his decision and his alone. Much later on it emerged that the RBI Board met on the morning of the 8th Nov and agreed to a Govt proposal but the delay in publishing this resolution leads to the suspicion that it was a hastily put together fig leaf. See: this and this . There's also speculation that a war on cash was one of the suggestions put forward to Mr Modi by an engineer and keen campaigner for tax reform Mr Anil Bokil of the Pune based ArthaKranti Foundation . Its worth noting that these ideas have no traction among mainstream economists.
  6. See the writings of P Sainath on the effects of the noteban on rural economy of India.  https://ruralindiaonline.org/articles/demonetisation
  7. SwarajyaMag.com is an online journal that is openly and avowedly right wing and a keen supporter of the PM's party. In an unexpected op-ed piece on June 14 2017, R Jagannathan the editor declared Demonetisation to be a failure but argued that the critics were right for the wrong reasons. Their criticisms, he argued was led more by animosity towards Mr Modi than by any special economic insight. But even I, as an amateur student of economics, argued in my blog of 16 Nov 2016, a week after the decision to demonetise, that it was a flawed policy that would do nothing to root out black money. I argued that DeMonetisation would cause tremendous hardship and loss to large numbers of people, that it would not deliver its claimed benefits, that there were other better targeted means of combating black money.  It was, I argued neither necessary nor sufficient to make a serious dent in black money. At that time, it is important to note, the stated aim was to eliminate black money. The push to a digital cashless payments system came later on.
  8. The earlier, almost gleeful, expectation was that as much as 3.5 to 5 trillion rupees worth of high denomination notes would not be handed back in and would be a free windfall for the Reserve Bank of India which would see a dramatic drop in its liabilities. This would be a huge bonanza in the form of a one off dividend from RBI to the Govt. This euphoria evaporated when someone pointed out that a decline in liabilities affected the balance sheet but would not lead to a profit and the RBI act  required it to pay a dividend only out of annual profits from banking activities. In the event the actual dividend that RBI paid out to the Govt in 2017 actually fell by almost half compared to the previous year. The losses arose out of scrapping the old notes, printing new ones, and the extra logistics costs of shipping the new notes out to where it was needed.
  9. I published a twitter thread and a moment with analysis of month-by-month time series data right up to August 2017 of the amount of money that flowed through non-cash digital payments systems. These include bank-to bank systems, like real time gross settlements used by businesses, paper-based payments systems (bank drafts and cheques), retail electronic payments, credit and debit card payments, and mobile banking payments. These charts show that any effect of DeMonetisation has been at best short-lived. There has been a growth in the number of point of sale terminals but from a very low base, and a growth in the number of subscribers to mobile phone based payments systems.
  10. The GDP growth slowdown has been widely commented upon. The standard Govt response has wavered between arguing that DeMonetisation was necessary medicine for a a backward economy built on cash-fuelled corruption, and a counterattack that the slowdown is not due to Demonetisation but was in the making long before Nov 2016. As arguments go both are own-goals and ill-serve the Govt's credibility.  
  11. The Harvard Business review paper argues that the 4 lessons to learn are
    • Choose your experts carefully. Mr Modi may have been influenced by a few cranks posing as economic experts with not so much out-of-the-box ideas as off the wall thoughts.
    • Dont ignore basic data. All the evidence was that only 6% of black or illegal wealth was held in cash. Not attacking the sources of corruption - politicians, real estate, and big businessmen meant tha instead of a targeted approach we had an assault on everyone - honest and weak included, in which the rich and corrupt got clean away.
    • Consider human behaviour. People found a way out of the cash crunch both to manage their poor honest lives and to squirrel away whatever illegal cash they held. Digital transaction was already growing as fast as it could given the infrastructure available, so as soon as new cash came into the system any spurt faded away.
    • Beware of digital silver bullets. India came 41st out of 42 countries just ahead of arch-rival Pakistan in the infrastructure needed to support a digital payments eco-system. However 'bold' and 'decisive' an executive ordz er cannot replace patient attention to detail.

3

Was the demonetisation a success or failure? Various government claims and the subsequent lacklustre results leave no doubt that the demonetisation has resulted in no significant utility to the nation and caused considerable damage.

 

Demonetization
success or failure?

8th November 2016 - 86% of Indian currency was wiped overnight

The Claims

Minor inconvenience

Black money would be destroyed

Initial news of massive raids. Political opponents targeted. News of currency seized from various people. Widespread understanding among critics and supporters alike that the objective was to strangle cash flows (legal or otherwise) of political opponents during the upcoming election campaign in Uttar Pradesh.

ISI fake currency thwarted

Fake currency notes would lose value when the notes it copied were illegitimate

Widely criticized through various versions of "amputating a leg to lose weight" or "bombing a city to kill criminals in it", this was an irrational goal to begin with, to go through an exercise of this magnitude, expense and cost to economy to flush out a relatively minor number of notes that would at best lose value they didn't have to begin with.

Prevent counterfeiting

The new notes would have special security features to prevent counterfeiting

Initial reports in media suggested that the new notes would have special features that prevented counterfeiting them. At the very least, having to imitiate a new design would slow the counterfeiters down and reduce the amount of fake currency in circulation.

Various reports in a pliant news media even took claims of special GPS chips embedded in notes and discussed them seriously, creating a perception among the masses that the new notes would be extraordinarily resistant to misuse or imitation.

Tax Collection would increase

Almost 25% increase in tax collection has been unquestioningly gushed over by a pliant media. This increase in tax collection has been attributed to demonetisation.

The Reality

Massive disruption

Unclear how much black money was recovered

Having cash in itself is not illegal, unless it is established that the cash would not be accounted for while paying taxes. Seizing it without evidence of wrongdoing probably is, but the government legally created impunity for tax officials, who are no longer required to explain their actions to anyone..

Fake currency made legitimate!!!

The reckless demonetisation did not allow for examining notes

The relentless crowds and high stress environment at banks did not allow for adequate examination of notes deposited and the overall understanding is that a large number of fake notes got deposited and converted into real money in accounts or converted to new currency - in effect robbing the country far worse than them being in circulation.

Easier counterfeiting

The new notes had no special features that prevented counterfeiting

The new notes are of poor quality and apparently easier to counterfeit. Various leaders and affiliates of the ruling party have been caught with counterfeited notes and the equipment to make more. The trust in the notes is very low and "even the real notes look fake". Hurried printing has resulted in real notes not having all features they should have.

Among early news of counterfeiting included school children who had photocopied a Rs.2000 note and used it to dupe a sweets shop owner when they purchased treats using it.

There has been no change

Tax collection has been increasing year on year for a long time now, and if you look at the trend over the years, this year's increase in collection fits the curve.


The country would profit

Unreturned money would be money taken away from criminals

82% of the money demonetised was rapidly returned to the banks about a fortnight before the last date to deposit demonetised notes, and the crowds continued unabated way after the RBI stopped updating figures on money returned. It has been over 7 months now and they still have not given out the final figures related with demonetisation, .

RBI would transfer profits to the government

RBI transferred Rs 30,659 crore as surplus to govt. This is lower than the Rs 65,876 crore last year - less than even half the amount. The budget has assumed Rs 75,000 crore would come from RBI and PSBs.

Not just is the windfall absent, the government has not even been able to reach half the amount of the previous year.

The windfall from demonetisation would fund welfare

In addition to the losses made by the government, the citizens have made losses - from disruption and decimation of livelihoods to time taken off daily wage work and expenses.

There will be no benefit/compensation to them. Likely, a reduction of existing benefits will happen due to the lack of funds this "minor inconvenience" will cause.

Yep, demonetisation has been every bit of the clusterfuck it had been predicted to be, and we are not even close to recovering from the damage done.

End of January marks the grape harvest season around Nashik. After falling prices after demonetisation led farmers to slash down standing tomato crops last month to make way for emergency sowing of wheat to eat, hope had rested on the grape crop coming up. However for all the reports in media about farmers adopting cashless methods and grape exports and what not, the ground reality remains grim. Here is a report from the Maharashtra Times.

Maharashtra Times report on the impact of demonetisation on grape trade in Niphad, Nashik

Rough translation

Grape season in crisis

Cash crunch in banks continues; traders and farmers frustrated

Cash crunch in the city (Niphad) continues two and a half months after demonetisation with farmers, traders and citizens furious about not being able to access their own money. This taluka, famous for its grapes is completely strangled by the note ban this time around. Grape trade has slowed due to lack of enough cash with grape farmers.

In many banks in Niphad, there is tension between bank management and employees. The announcement from two days ago of being able to withdraw a lakh rupees from current accounts has dissipated in the face of banks not having enough currency notes to give out and the fury of customers is reaching boiling point. Bank officials are being forced to deal with furious customers due to lack of cash.

RBI's directive of giving 40% cash to rural banks has proved hollow. Rural banks still don't have cash. Forget 40%, not even 4% cash has reached rural banks as seen from the condition of State Bank and regional and nationalized banks in Niphad.

At the moment, the grape season has started in the Niphad region. Even traders coming from other regions are not able to obtain money. Unless the cash crunch in banks is resolved urgently, the grape season will be muted. Grape growers are demanding that the rural banks get provided with cash as per procedure.

Received a mere 12 lakh

Employees of the Niphad branch of the State Bank of India had gone to the Reserve Bank branch in Mumbai to get cash for distributing. They had gone for a day with a vehicle and police escort for the cash they would bring. Instead of a day, they had to stay there for two days and got only 12 lakh on the third. They returned with this meagre amount, having spent for three days stay in Mumbai to obtain a mere 12 lakh.

State Bank provided us cash for 50 days during the note ban. Since the last 5-6 days, they themselves don't have cash. As a result, we are not able to give farmers their own money. We are managing the finances of the bank with great difficulty.

~ Mohan Surana, Manager, Niphad Urban Bank

 

I have come here to buy grapes for trade. For that, to pay labour, minor expenses, I went to withdraw a lakh rupees at the bank. However, they returned my cheque saying that there is no cash.

~ Amitkumar Gupta, grape trader, Ugaav