Unintended consequences of policy actions have pushed up the share of currency notes in GDP, which hovers around 15.5 percent, as has been detailed in this space earlier. Such high prevalence of cash creates a drag in the economy, through lower savings in formal channels, resulting in reduced amount available for investment in the formal economy, and ultimately a smaller size of the pie for tax collection.
An increasingly complex corporatization process has also kept small and medium-sized businesses from moving towards a more corporate and regulated structure. A proxy for this can be the ratio of deposits of private sector businesses, and deposits of self-employed. In January 2005, the ratio was at 1.95x, which implies that deposits of private sector businesses were almost double of self-employed individuals. This suggests there was more liquidity in the formal system that could be attributed to formal corporatized businesses.
It has been downhill since then, with the trend further accelerating from 2015. The ratio is currently at 1.02x in September 2020, after reaching a low of 0.92x in January 2020. The ratio has essentially halved in fifteen years suggesting that an increasing number of businesses prefer to remain unregistered, categorizing themselves as ‘self-employed’, rather than corporatize. A self-congratulatory pat on the back is often in order when the number of registered companies increases but not much is done about such a secular decline in activities that can be attributed to corporatized businesses.
As cash stays out of the formal financial system, it cannot be used for further investment through the formal network; through lending by financial institutions, or investments. It either stays stashed under mattresses, saved through informal avenues such as ROSCAs (rotating savings and credit association), invested in gold, converted into foreign currencies, or invested in real estate through a largely cash transaction. Such transactions expand the size of the informal, or grey economy, while the formal economy stays starved for capital.
As cliched as it may seem, but cash remains king, considering the convenience it provides. The incentive structure required to move incumbents from cash to cashless requires minimal transaction costs, seamless transfers, and minimal to no intervention by various authorities. It is through a policy of arbitrary interventions that the payments and liquidity management regime is moving opposite to rest of the world; regressing, rather than progressing. Self-congratulatory tweets and public relations cannot catapult an industry to the future – a consumer-focused and technology-driven policy regime with the right incentive structure is the dire need.
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