When cash turns to ash: a look at India’s demonetization drive

Some 50 days into India's efforts to funnel out black money, something seems not to have gone to plan, writes Nilanjana Bhomwick.


Queues outside a bank to exchange ₹500 and ₹1,000 banknotes in Salt Lake City, Kolkata. © Biswarup Ganguly

On 8 November, India banned two of its highest currency notes to fight graft. In an apparently impromptu address to the nation late evening – as the collective imagination of Indians were focused on the US presidential elections – Indian Prime Minister Narendra Modi had announced that the ₹500 (about $7) and ₹1000 (about $15) notes would cease to be legal tender from midnight onwards. Indians had till 30 Dec to exchange their old notes for new ones. The sudden announcement, the government said, was to catch unawares tax cheats and unaccounted cash (or black money) hoarders, and kill off the counterfeit currency industry.

Two months later, it seems Modi's plan actually aimed to usher in a digital payments revolution in the country.

After 50 days of hardship, Indians have validated 97 per cent of the unaccounted cash. A Bloomberg report quotes unnamed sources saying banks had cashed in ₹14.97 trillion (about $220 billion) as of 30 December. The government had estimated that of the ₹15.3 trillion ($225.5 billion), about ₹5 trillion ($73.7 billion) black money would stay undeclared. The validation is a major setback to the PM’s claim that the abrupt demonetization would help funnel out black money.

Globally, experts too have questioned the abrupt and secretive nature of India’s demonetization. Demonetization, they say, should be gradual to minimize inconveniences to the people. Abrupt demonetization exercises are justifiable only in the face of hyperinflation, which is monetary inflation at a very high rate – such as monthly 50 per cent price rises – something like what Venezuela undertook recently by taking out of circulation 100 Bolivar notes.

That was obviously not the case with India, where consumer prices grew 3.63 per cent year-on-year in November, the lowest inflation rates since November 2014. Food inflation too had eased for the fourth straight month to 2.56 per cent.

The much-touted utopia of digital payment revolution might already be receding.

The only other factor that can explain the abruptness of the drive is Project Catalyst, which India’s finance ministry was implementing with the help of USAID. On 14 October, a USAID press statement said the project is aimed at bringing about a quantum leap in cashless payments in India and that it 'marks the next phase of partnership between USAID and Ministry of Finance to facilitate universal financial inclusion.'

The earlier phase had included a comprehensive study on how to effectively transform India into a cashless economy, the result of which was a report that had identified three problems with India going cashless, including the fact that 97 per cent of retail transactions in India are conducted with cash or check, with as few as 11 per cent of consumers using debit cards for payments, and only 6 per cent merchants accepting digital payments. Only 29 per cent of bank accounts have been used in the last three months. According to Reserve Bank of India's (RBI) estimates, the cash floating in the system is about 11 per cent of the country's gross domestic product, making India one of the most-currency dependent countries in the world.

'While the benefits of digitizing payments are clear, what is less obvious is how we can change the everyday behavior of consumers and merchants in a cash-based economy like India,' the report says.  

The USAID report added: 'We do know that these efforts must be grounded in a strong understanding of consumer and merchant preferences, which can then be used to tailor solutions to drive digital adoption.'

'What will it take for them to make the switch?' the report asks.

The PM already had the answer, which was to exploit a deep-seated frustration among the middle classes and the poor over black money and graft. The issue has roiled India more than once in the last few years. It had led to the rise of a national movement against it in 2011, was the genesis of the Aam Aadmi Party (AAP) that is currently in power in New Delhi, and has struck down governments. Fight against graft has been one of the greatest unifying factor in India over the last few years.

It was the only factor that would have united 1.25 billion Indians to embrace the 50 days of hardship that were to ensue. And it was the easiest and perhaps the only way to force a cash-dependent nation to embrace a cashless existence almost overnight. Meanwhile, manufacturing took a hit in December, while neighbour and economic rival China recorded the fastest growth in its manufacturing sector in the last four years.

As expected, after the PM’s impassioned speech on 8 November, calling all Indians to unite against black money and graft, a digital payments revolution hit the country. Digital wallets such as Paytm and Mobikwik had 150 million and 35 million users before 8 November. A fortnight into demonetization the numbers had gone up to 158 million and 40 million respectively. The use of debit card RuPay, aimed mainly at the lower income groups, reached 2.1 million per day, recording a rise of 446 per cent since demonetization. In mid December, global financial services major Deutsche Bank said demonetization would cause non-cash retail payments to jump 10-fold by 2025. The report called demonetization 'an immediate catalyst for the digital payments revolution'.

But the much-touted utopia of digital payment revolution might already be receding.

Last month, I paid my milkman, my electrician through Paytm. Middle of the month the money was back into my wallet.

'The suppliers are not accepting Paytm payments,' electrician Devinder Singh tells me, as my Paytm wallet is growing fatter as vendors keep returning payments.

My vet, a middle-aged, always smiling-man had very enthusiastically taken to digital wallets. They have always maintained a card payment option too. A few days back, when I went with my dogs for a checkup, I had no cash on me as I haven’t had the time to queue up at an ATM. I was secure in the knowledge that he accepts card transactions as well as Paytm. But here’s the thing: he doesn’t anymore.

'There is something wrong with the card machine and the bank people have been so busy with all these [the demonetization exercise] that they have been unable to address the problem,' he told me.

'What’s the point in taking Paytm payments, I will still have to close my clinic and queue up at the bank to withdraw the money,' he sighs a bit wearily.

India’s digital payment revolution is an enforced boom – a bubble that might burst soon.