Between December 2018 and January 2019, the Reserve Bank of India (RBI) surveyed half a dozen major cities to gauge the prevalence of digital payments two years after the country demonetised about 86 per cent of its currency overnight. The survey sought to gauge people’s level of awareness about digital payments and the challenges they faced while using payment cards, mobile banking, net banking, and Unified Payments Interface (UPI). It threw up a list of pain points of which the main ones were a lack of point-of-sale (PoS) machines, trust issues, complicated digital processes, and transaction charges.
That pretty much sums up the reasons for a stubbornly high level of cash in the system despite the surge in digital transactions since demonetisation and the spur from the Covid-19 pandemic.
India’s currency in circulation (CIC) touched 14.6 per cent of its gross domestic product (GDP) in 2020/21, much higher than the 12 per cent before demonetisation in November 2016.
The RBI’s studies have concluded that the CIC ideally should grow slower than nominal growth in order to reduce cash flowing through the system. The CIC—a universal indicator of measuring the cash in the system—is around 8 per cent in the US and about 9 per cent in China, which does the highest number of digital transactions globally.
For the past two years, the cash in circulation in India has been growing faster than the nominal GDP. Before demonetisation, the currency was growing at around 10-11 per cent, below the nominal GDP growth of over 11-12 per cent. In the last two years, the CIC’s growth has sped up to 14-16 per cent, outpacing the nominal GDP growth rate. The RBI-appointed committee to deepen digital payments in India has said cash should grow slower than nominal GDP, with the CIC ideally tending towards the global average of 7 per cent. Currently, India’s cash in the system is double of that number. As much as more cash is the problem, so too is the slowdown in GDP growth, which started much before Covid hit the economy.
The second way of measuring cash levels is the value of ATM withdrawals against nominal GDP. Cash withdrawals have been consistently growing at 16-17 per cent of nominal GDP for the last six years. ATM operators have observed that there have been fewer withdrawals in absolute numbers post Covid, but a higher average ticket size per withdrawal maintained the elevated cash levels. The RBI’s own analysis has found that despite the increase in digital payments, cash levels stayed high, which is contrary to what is happening elsewhere. For instance, digital payments surged in Mexico, Brazil, and Saudi Arabia between 2007 and 2016, but there was hardly any change in cash levels. This means there are other structural factors hindering India’s efforts to limit the use of cash.
Big Cash Drivers
The extraordinary increase in cash levels—from 12 per cent of GDP to over 14 per cent—during the first year of the pandemic was probably since people hoarded a lot of cash for emergency and healthcare needs, says Saugata Bhattacharya, Chief Economist, Axis Bank. Another reason for the surge is because people accumulated cash in anticipation of more stringent lockdown measures post the second wave, says Anand Kumar Bajaj, Founder, MD & CEO, PayNearby, which partners with kirana stores in tier I, tier II and rural towns.
Rural ATMs were flooded with people withdrawing cash during the pandemic. That was down to the government increasing the spend on schemes such as MGNREGA to generate rural employment, PM Kisan Yojana for farmers, and LPG subsidies. “The government spending in rural schemes has also seen a higher outgo,” says Bhattacharya. In 2020/21, the government made a huge direct benefit transfer (DBT) of Rs 2.96 lakh crore, which people promptly withdrew as cash and stored it for consumption. “The lower the income level and education, the lower is the awareness of digital payments,” says Sunil Rongala, Vice president of strategy, innovation, and analytics at payments solution provider Worldline India.
Smaller towns and cities are the weak link in the pan-India digital payments chain. There is a lot of catching up to do. “If one looks at the number of small merchants in India, there is a huge opportunity in the payments space,” says Bhasker Chatterjee, Head of Products Ezetap, a digital payments company.
Two years ago, the RBI committee estimated that about 100 million, or 10 crore, Indians made digital payments. “It’s a small number in a country of 130 crore,” says a banker. Even if one eliminates the very old and very young, there are 80-90 crore people making at least one cash payment. But, there is no data on these cash payments currently, given the tough ask of tracking money as it exchanges hands multiple times a day.
The higher cash requirement is also because of the large informal sector in India where people earn and spend in cash. “Around 80 per cent of working Indians continued to be employed by informal MSMEs. This sector produces close to 50 per cent of the GDP. So 80 per cent of Indians continue to be paid in cash,” explains Abhinav Sinha, Co-founder at Eko India, which works in unbanked and underserved areas.
Then there is also black money to blame for higher cash levels. The entire demonetisation exercise, aimed at curtailing black money, also forced the RBI to quickly push new currency by issuing high-value Rs 2,000 notes worth Rs 6.72 lakh crore. These high-value notes are now barely visible in the market anymore. While one reason is that the RBI is no longer printing Rs 2,000 notes, there is also a strong possibility they are hoarded as black money. “We don’t see them in the bank. We don’t see them in ATMs. Where the hell are these high-value notes?” asks a banker. “The estimates for black money stashed in cash before the demonetisation was Rs 4 lakh crore to Rs 5 lakh crore. There seems to be a return of the same amount back in the black market with the new high-value Rs 2,000 notes,” says a market player.
There are only 24,510-lakh Rs 2,000 notes, worth Rs 4.90 lakh crore, in circulation now, according to the RBI’s 2020/21 annual report. That means 9,120 lakh notes, worth Rs 1.82 lakh crore, have vanished in less than five years. “The RBI may be withdrawing the high denomination notes from the market,” says a market player. The RBI report has observed that the demand for the high-value currency in the past few years has outpaced low-value currency, which shows that cash may be used as a store of value and less for making payments.
Sketchy Payments Infrastructure
There is a need for a robust payments infrastructure across the country that will instill confidence in people that they will have access to their money whenever and wherever they need it. But, the number of ATMs have been stagnant for the last five years. There were 2.13 lakh ATMs in March 2021, against 2.08 lakh in March 2017. That puts India in the company of Cambodia, Egypt, Uzbekistan when it comes to the number of ATMs per 1 lakh adults. China, South Korea, and the US are the global leaders on this measure. “If you increase the cash-out points, the people will be comfortable that their money is available 24x7 when they need it for any emergency,” says a market expert. But the high transaction charges for using an ATM machine also acts as a deterrent.
People in semi-urban and rural areas tend to withdraw more cash at one go to avoid frequent visits to ATMs, while also keeping in mind that the vending machine might be out of money at times. “As the rural economy continues to grow, the need for cash also grows. Therefore, the need for infrastructure continues to grow,” says K. Srinivas, CEO of ATM provider BTI Payments. BTI hasn’t seen any drop in cash withdrawals from its ATM networks.
There are some positive developments, though, on the infrastructure front. For the first time in a decade, the RBI has increased the ATM interchange fee by Rs 2 to Rs 17 this June. This fee is paid by the card-issuing bank to the bank whose ATM is used by the customer to withdraw cash. “This will help us not only serve customers better, but also deploy additional ATMs, which are particularly needed in semi-urban and rural locations to provide financial access and enable financial inclusion. It will also give much-needed relief to the ATM industry,” Rustom Irani, MD and CEO, Hitachi Payment Services, said after the announcement.
Similarly, the POS machine infrastructure for debit and credit card swipes is also inadequate. “There is no incentive for players to deploy the PoS terminals,” says Bajaj of PayNearby. However, some fintech companies are mining this payments data to offer financial services, such as lending. “There are other opportunities like value-added services, loyalty, invoicing, and payment integration systems to increase the share of the wallet,” says Chatterjee of Ezetap.
This January, the RBI announced the Payment Infrastructure Development Fund to subsidise the deployment of the requisite infrastructure in smaller cities and towns. But you need people with cards to use the infrastructure. The debit card is supposed to be for spending, but is mostly used for cash withdrawals. This March, for instance, debit cards were used to withdraw Rs 2.47 lakh crore from ATMs, dwarfing its usage of Rs 37,036 crore at PoS machines.
But there are some encouraging trends across the board that could give heft to digital transactions. “There is a shift happening from GPRS-based old terminals to Android PoS terminals in smaller towns and cities. The Android-based PoS provides faster connectivity options via Wi-fi and 4G,” says Chatterjee of Ezetap. Rongala of Worldline India states that out of the total UPI volume in March 2021, 55 per cent transactions were person-to-person, while 45 per cent were person-to-merchant. Srinivas of BTI Payments says while the younger generation is leading the digital payments charge, “We also need to educate the masses.”
The National Payments Corporation of India (NPCI) is the umbrella organisation to oversee the many modes of digital payments and settlement systems in India. There is the Immediate Payment Service (IMPS), an instant payment inter-bank electronic funds transfer system, and the National Electronic Funds Transfer (NEFT) facility. Then there is the Bharat Bill Payment System for recurrent payments. And, of course, UPI, which Srinivas of BTI Payments calls “a path-breaking innovation.” The last five years have seen a very high growth in the payment volumes using these facilities.
Currently though, there are also systemic risks in allowing a few large players to dominate the market. This could create a big disruption if two large payment players face outages or technology issues. The NPCI is constrained because of the dominance of a few large players in the retail payments space. It has already capped the market share of third-party online payment platforms at 30 per cent from January this year. That has forced companies, like Google Pay and Phonepe with a market share of 40 per cent, to slow down customer acquisitions.
Second, the RBI has set the ball rolling for a new umbrella entity (NUE) for retail payments to rival the NPCI, which has become too big to fail. “NUE is being set up with the express purpose of reducing concentration risk in the market which is required for a country like India where digital payments are increasing at a fast pace,” says Rongala. The entry of new players would also increase competition and encourage innovation, says a top RBI official.
But just as India rolls out new digital initiatives, flaws in its older ones stymie its efforts. For instance, the new EMV chip guidelines have reduced the number of debit cards in the system, which will impact digital transactions. In November 2019 alone, banks removed 150 million debit cards from circulation as they didn’t comply with the new EMV chip guidelines.
There are also tax hindrances coming in the way of digital payments in rural and semi-urban areas. For instance, a person or banking correspondent is liable to pay tax deducted at source (TDS) of 2 per cent if they withdraw cash exceeding Rs 20 lakh in a financial year from their bank account and have not filed their tax returns for the last three fiscals. The TDS more than doubles to 5 per cent if the cash withdrawals exceed Rs 1 crore in a financial year. The problem is that most banking correspondents are small-time shopkeepers who typically file tax returns rarely, if at all. If they withdraw Rs 50,000 in a day, they will cross the Rs 20-lakh limit in 40 days.
Moreover, while banking correspondents as agents of the bank are exempted from TDS, banks, especially public sector banks at the ground level, do not follow these rules. “These banks are charging TDS. As a result, many banking correspondents are not doing business beyond Rs 20 lakh,” says a banking correspondent. This forces people in unbanked areas to store more cash to avoid going to far way branches and ATMs.
Sunil Kulkarni, who heads the Federation of Business Correspondents in India, has written a detailed note to the RBI highlighting these two key taxation issues that are hindering the sustainability and attractiveness of the banking correspondents model.
Lessons from Global Markets
Globally, the cash and digital modes have coexisted for decades despite a robust card payment system. Even the US and China, the world’s two largest economies, have a cash to GDP ratio of over 8 per cent. There are, however, global lessons from Sweden, Norway, New Zealand, and Denmark where the cash is fast vanishing. Sweden, for instance, has cash equivalent to less than 1 per cent of its GDP in circulation. Besides widespread and stable broadband connectivity, what also worked in its favour is high acceptance rates, with even small store owners always insisting on digital payments.
The Bank of England has conducted a study that showed that while the currency in circulation increased since Covid-19 struck, the transactional use of cash has reduced because of national or regional lockdowns. There was less cash that was returned to the banking system. In fact, people actually took longer to make deposits as they didn’t visit bank branches due to the lockdowns or the fear of getting infected. “The higher cash in the system post-pandemic has been a global phenomenon across UK, Japan, the US, and other developed countries. We could see a reversal in the trend once things stabilise,” says Bhattacharya. Even in India, the cash in circulation actually dropped after the first year of demonetisation, but bounced back later. And while India is striving to expand and bolster its digital payments infrastructure, only time will tell if there is a real change in the digital payments behaviour of people.
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