Going cashless: Can demonetization help?

Smart politicians have a way of framing crisis to their advantage. And the Indian Prime Minister Narendra Modi has that sense of cunning. His governments bold November 8 move that took out Rs500 and Rs1000-deniominated money bills (an estimated Rs15 trillion at the time, or 86.4% of entire currency in circulation), was rationalized with a hard crackdown on the estimated $2 trillion black-economy, one of Modis campaign pledges.

Jury is still out on whether some good will result from the massive purge. But in the short-term, the demonetization has caused angst, with the burden reportedly falling disproportionately hard on small farmers, merchants, low-income consumers, and daily-wagers. With the hoped-for consequences still long on the horizon, the Modi regime has been trying to avoid the political backlash some 100 Indians have reportedly died on account of cash crunch, with millions of lives in disarray by framing the move as an opportunity to take India towards a less-cash, and eventually, a cash-less society.

On Twitter and over radio, Modi has been urging his young friends and small merchant brothers and sisters that this is the chance for you to enter the digital world. In late December, his government announced incentives on digital transactions, and launched a mobile app, BHIM, which has had more than 5 million downloads to date. Two leading mobile wallets have witnessed spectacular user growth in the wake of the liquidity crisis.

While one can see through Modis bait and switch argument here, the evolving scenario in India does raise a question: can a governments top-down push result in significant uptake of cashless/digital transaction mechanisms? And in doing so, do the perceived benefits outweigh the real social pain?

Bhaskar Chakravorti, Senior Associate Dean of International Business & Finance at the Fletcher School at Tufts University recently pointed out in a Harvard Business Review article that Modis move was tantamount to an enforced digital disruption. He argued that the government-handed directive didnt take into account the fact that India was not ready for such mass migration to digital.

We find a similar argument from payment experts in Pakistan. To be digitally-ready, a country first needs a sizable portion of its population to be comfortably using internet-enabled smartphones. But capability is not enough it must find an avenue for action. There, a country needs a digital payment infrastructure, built on channels such as m-wallets, m-POS, online banking, etc.). As trust grows in the system, folks are readily willing, and not just able, to transact virtually.

Ecosystems grow where demand-side is comfortable with the supply-sides ability to make good on its promise most of the times. Chakravorti makes it clear that on both counts, India is not ready. Based on his 2014 study, he noted that only 30 percent of Indians had smartphones; only one-third of folks were using the Internet; adult banking penetration was about 35 percent; one in ten had ever used a non-cash payment mechanism; plastic cards generated less than 3 percent of total payment value; and less than 2 percent of Indians had ever used a mobile phone to receive payment.

The academic cast Modis cashless call as putting the cart before the horse, with horse being the digital infrastructure and trust in the system. The horse must be healthy before folks can board the cart. Chakravorti didnt discount the possibility that the objective of going cashless might receive a boost in the wake of the demonetization exercise. He has instead suggested a thought-out strategy to meet the goal such that it doesnt penalize the society hard.

Judging from Indias experience, there may be better ways to nudge Pakistans cash-rich society to go digital. But first, some questions need to be answered. What is it that Pakistan needs to tackle? Is it the documentation of the economy, and by extension a crackdown on black money? Is it just digital migration of the countrys largely paper-based formal and informal economies?

One suspects it is both. But then the question arises: how do we sequence the two goals? Documentation should ideally come first; because if you started mandating digitization without prior documentation, it runs the risk of further fueling the undocumented economy as currency in circulation can grow without any penal consequences. On a practical level, digitization sans documentation can only work when cost of handling physical cash is significantly greater than perceived benefits of what folks have to hide.

Pakistans current digital numbers dont look good. On a per capita basis, it fares poorly compared to countries like India, Iran and Turkey on penetration of cellular, Internet, plastic cards, and POS connectivity. In any case, as with documentation, digital readiness, on both the usage and infrastructure (banks/telcos) side will remain an ongoing, incremental process. To accelerate that, it will be better to incentivize digital transactions, instead of simply declaring war on physical cash and their withdrawals.