Shock therapy for cash

I expect that most of you will by now have read a fair bit about the (to my mind) fabulous living monetary experiment that is India. Obviously, I feel sorry for people who have been (to put it mildly) inconvenienced by the chaos caused by the removal of 85% of the currency “in circulation” in the country but as a student of monetary history and the interaction between technology and economics, it is absolutely fascinating to look at what is happening. I’m sure it will be a case study for years to come, and who knows what the long term impact will be, but I couldn’t wait and I couldn’t resist blogging. So let’s start at the beginning…

Indian Prime Minister Narendra Modi has announced that the existing 500 and 1,000 rupee banknotes will be withdrawn from the financial system overnight. The surprise move is part of a crackdown on corruption and illegal cash holdings, he said in a nationwide address on television.

From India scraps 500 and 1,000 rupee bank notes overnight – BBC News

I saw some television reports of aggrieved and panicked Indians who were unable to get any cash and since much of the economy is cash-based, worrying about a slowdown in economic activity. It’s a bit of shock to go to the bank and discover it is closed. When the banks re-opened, it was with new money. Or at least it would have been with new money, had replacement been produced and distributed beforehand.

On November 8 evening, Reserve Bank of India governor Urijit Patel and senior government officials unveiled the new currency note of Rs 2000 and redesigned Rs 500 note.

From New Rs 2000 note to be introduced in India after banning old Rs 500 & 1000 notes: Pictures of 8 best looking currency notes across the globe –

The result was pandemonium. People went to ATMs to try to obtain new bills only find that there were none to be had. Rich people started paying poor people to stand in line for them to get money. I even saw a photo of people praying to a garlanded ATM! India is a big country and the ATM vendors had no more warning of the change than anyone else, so as you can imagine the planning and logistics were complex. The ATM operators were as non-plussed as the general public by the sudden change.

“Re-configurations takes time so it has to be done one by one. Things should be normal in ten days. You have to understand there are 2 lakh ATMs in the country but there are only three to four vendors.”

From Just 35,000 personnel to replenish ₹16 lakh crore in ATMs | business-news | Hindustan Times

The net result of all of this was that the country ran out of money. Literally. There was no money available for commercial transactions. So to Indians, it really was a big deal and a major disruption.  So why was this done? There were two explicit reasons given for the de-monetisation. One was that it was an attack on terrorist funding and the second was that it was an attack on the black economy. I don’t know enough about terrorist financing in India to comment on the efficacy of the  move, but it seemed to target counterfeiting operations in Pakistan.

It disrupts the production of FICN in Pakistan, and makes redundant existing stocks of fake currency with a vast network of terror funders-the hawala traders and money launderers. “The phaseout of these notes is a double whammy for Pakistan,” says Colonel Vivek Chadha of the Institute of Defence Studies and Analyses, Delhi.

From Taking out Pakistan’s terror mints : The Big Story – India Today 21112016

As for the black economy, there is no doubt that the move has had, and will have, an impact. There was an awful lot of money sloshing around outside of the banking system and as far as I understand there was rampant tax evasion amongst the more well-off amongst the population. Having spoken to a couple of people recently returned from India, I got the impression that members of the public were comfortable that the distruption, bad though it was, was a price worth paying. And there is no doubt that the move shifted many transactions on the record immediately.

“A majority of our transactions have suddenly become white because of card payments and people are also not tipping as much now,” a waiter at the restaurant said.

From demonetisation of currency: Card payments surge, trip & steady after restricted flow of money – Times of India

The government’s plan was that people would bring their cash to the bank, declare it, pay tax on it and then either get new cash in return or actually start using bank accounts (a great many of which are dormant). And, indeed, this is what seems to have happened, with the cash being returned in amounts greatly exceeding the government’s calculations. By the end of the year, almost all of the notes had been deposited. 

Banks have received 14.97 trillion rupees ($220 billion) as of Dec. 30, the deadline for handing in the old bank notes, the people said, asking not to be identified citing rules for speaking with the media. The government had initially estimated about 5 trillion rupees of the 15.4 trillion rupees rendered worthless by the sudden move on Nov. 9 to remain undeclared

From India Said to Get 97% Banned Notes in Setback to Graft Crackdown – Bloomberg

This was taken to mean that Modi had been ill-informed and that there was no corruption and that certainly may be the case. But an alternative explanation is that people who may have been uncomfortable with depositing their money for one reason or another laundered the money before it got to the banking systems. They went out to start buying gold and jewellery for cash instead. 

The gold and jewellery route has been followed by persons with black money to convert their Rs 500 and Rs 1,000 notes at a haircut of 20-40%. 

From Govt likely to put curbs on jewellers | Business Standard News

That seems a reasonable deal. Pay tax to the government and potentially have to give up the rest o the cash because of anti-corruption investigations or pay tax to the jeweller and mum’s the word. Since India has a long tradition of using gold jewellery as a store of value, this seems unsurprising in retrospect. It led to another crackdown on those who decided to convert their black money into black but still quite liquid gold.

This move will halt such sales of gold at a huge premium against old currency notes, which jewellers were doing till the Income Tax (I-T) department raided them across the country on Friday and sent around 600 notices to jewellers asking the details of daily sales from November 7 to 10. The I-T department, in its notices, also asked for CCTV footages, especially of cameras near cash counters, to seek date-wise information and to check if PAN numbers or ID proofs were collected from customers.

From Govt likely to put curbs on jewellers | Business Standard News

CCTV footage! Incredible. Anyway, the upshot of all of this was that cash vanished from circulation without a viable alternative in place. What kind of alternative might there have been? Well, the answer is obvious. India really should have a widespread, vibrant and effective mobile payment infrastructure but it has been slow to develop. I wrote about this a few years ago, noting that it was the regulatory environment that was holding back the evolution of the sector (the Reserve Bank of India’s “calibrated approach” to mobile payments). As the figures from Kenya that I posted last week show, it is possible to use mobile phones as an alternative to cash.

Look at Kenya, where there are now more than 33 million mobile money users and 174,000 mobile agent locations. The most recent figures from the Central Bank of Kenya (CBA) show an astonishing trend. From February 2013 until September 2016, the number of monthly M-PESA transactions almost tripled, going from 53 million to 131 million, while the number of card transactions fell from 34 million down to 18 million.

From Fish without cash | Consult Hyperion

So Kenya (and, for that matter, China) show just how effective mobile solutions can be. Hence my thinking that it may have been better for India to have waited until the more flexible regulatory regime had begun bear fruit before taking the quite drastic step of removing those banknotes. I’m sure I will blog again and in more detail about the Indian experiment as more data comes in, but I think we can already see a shift in government rhetoric from corruption and terrorism to cashlessness and efficiency, with officials urging banks, merchants and mobile players to accelerate the deployment of alternatives. Meanwhile, I just want to pull in a couple of other observations on the great experiment underway in India right now. First, the potential for alternatives:

‘Bitcoin adoption in India sees surge’

From ‘Bitcoin adoption in India sees surge’ – The Hindu

In fact Bitcoin volume on India exchanges doubled in the couple of weeks following the announcement but then fell back again at the end of the year. I think it highly unlikely that Bitcoin will step in to fill the gap left by the removal of the highest value banknotes. It looks to me that a more widely-used alternative to cash will be… nothing. In the cities the merchants are getting payment terminals or mobile phone alternatives but outside the cities, people could easily get by for some time without a circulating means of exchange. This is not wild prediction. I have previously posted about the famous case study of the Irish bank strikes that demonetised the Emerald Isle in the 1960s and 1970s. Subsequent economic analysis showed that the absence of money had surprisingly little impact on the economy! People just began to write cheques or IOUs and these debt instruments began to circulate.

Murphy points out that one of the key reasons why a “personalised credit system” could substitute for cash was the local nature of the circulation — which… was centred on pubs — so that the credit risk was minimised.

From Payments without banks | Consult Hyperion

In summary Ireland was a more rural economy in those days so life continued in a reputation-based transaction economy. Well, guess what: the same thing is happening in India.

However being a very close knit society, local people count on each other so they are able to buy the essential commodities from the shops in good faith, the payment of which they would make later on after having money. So this way, they are not feeling panicky like rest of the country

From Here, banks are giving only 10 rupee coins – Times of India

OK so the demonetisation of Ireland and the demonetisation of India are wholly different in origin, scale, purpose and destination. Still. Mr. Modi’s actions must have set a few more national leaders thinking about taking radical action to move toward a less-cash economy more quickly than otherwise might have been the case especially since we know that high-value banknotes in many countries (e.g., the UK) are primarily used for criminal purposes. 

Fish without cash

 We all still processing the data coming in from India’s radical experiment with money, and I still think that is way too soon to pass any judgement at all on whether the experiment has been worthwhile or successful, but it is interesting to see some of the immediate effects of the government’s policy of de-monetisation. For example, fish.

Modi’s surprise announcement wiped out 86% of the nation’s currency overnight, leaving the vendors at Panjim’s fish market to suffer heavy losses. “Nobody has cash, so they’re not buying fish.”

From ‘Who buys fish with a credit card here?’ Traders scoff at Goa’s bid to ditch cash | World news | The Guardian

 The headline, of course, sets up a slightly false dichotomy because the choice facing the Goan fish market traders is not cash or credit card but cash or an electronic substitute for cash. And it gives me an excuse to post a picture of me in Goa, because I just read an article that said that blog posts with pictures have more of an impact than text-only.


A completely irrelevant picture of me in Goa.

Now, as it happens, the local government in Goa have already decided that the future lies beyond cash and very shortly those fish traders (as well as absolutely everybody else) will have a substitute.

From January, Goa’s government has announced that the city will go “cashless”, meaning every street vendor, rickshaw driver and shopkeeper must offer their customers the option to pay using a debit card or mobile phone.

From ‘Who buys fish with a credit card here?’ Traders scoff at Goa’s bid to ditch cash | World news | The Guardian

Is it possible to imagine Goans buying fish without cash? Well, yes. Look at Kenya, where there are now more than 33 million mobile money users and 174,000 mobile agent locations. The most recent figures from the Central Bank of Kenya (CBA) show an astonishing trend. From February 2013 until September 2016, the number of monthly M-PESA transactions almost tripled, going from 53 million to 131 million, while the number of card transactions fell from 34 million down to 18 million. Yes, you heard that correctly. While mobile money using was tripling, card use was halving. I am told by reliable sources that one of the key reasons for this, apart from M-PESA being accepted  at some 150,000 retail outlets now in a country with only around 10,000 cards terminals, is that when it came time to re-issue EMV cards for Kenyan bank customers, the customers had to go their local branch, with identification, and stand in line to get their new card. Many of them just didn’t bother, especially since they had already started to use mobile money instead of cards.

Central Bank of Kenya statistics show a decline in the use of credit and debit cards, despite the number of Kenyans holding them rising.

From Which payment system is best for when you are drunk? M-PESA! | Consult Hyperion

Anyway, the point is that an astonishing 96% of Kenya household now have at least one M-PESA user. That means, to all intents and purposes, that mobile money is an alternative to cash. That’s not to say that the cards guys are taking it laying down. They can read the papers just as well as I can, and so they have begun to look at alternatives to the dip, tap or swipe at point of sale and are investigating more mobile-centric alternatives.

Visa, has entered into partnership with Ecobank,  to roll out “mVisa,” an innovative mobile payment service in 33 African markets by year-end. Mvisa enables consumers to pay for goods and services for their everyday expenses from  groceries to  taxi services by simply scanning a QR code on a smart phone or entering a merchant identification number into their feature phones

From Mobile Money Africa

The Kenyan banks are also preparing to launch an instant payments switch so that Kenyans with bank accounts can send money to one another instantly using their mobile phones so at some point in 2017 there will be bank-account, payment-account and card-account competition in the marketplace, which should be great for users.

The Kenya Bankers Association (KBA) yesterday unveiled Integrated Payments Service Limited (IPSL) — the company that will facilitate direct transfer of money between banks without going through M-Pesa.

From Banks launch firm to take on M-Pesa’s mobile cash dominance – Money Markets

The M-PESA figures are fascinating and they show just how effective a mobile solution can be. So how come India didn’t have this kind of mobile infrastructure in place before the government decided to de-monetise. It’s not because Indians don’t have phones, don’t have entrepreneurs, don’t have programmers and don’t have users who would prefer mobile solutions. They have all of these. What they didn’t have, until recently, was a regulatory platform to build on. This began to change last year when the RBI licensed 11 “payment banks” to provide competition and the National Payment Corporation of India launched their Universal Payment Interface (UPI). I said at the time that I thought these moves would grow the sector.

I am sure that the competition and innovation that these non-banks will bring to the Indian market will lead to a pretty rapid increase in the use of mobile financial services there

From An Indian summer for mobile payments | Consult Hyperion

Mobile is the future of fish purchases as far as I can see. The most commonly used mobile wallet in India, Paytm, saw its volumes pretty much double (to around 7m transactions per day) following the withdrawal of the bank notes and I’m sure new services from the payment banks will help such mobile plays to continue to grow. However, the first of those payment banks only went in to operation about a week before the de-monetisation so they didn’t really have much of chance to make an impact. Hence my thinking that it may have been better for India to have waiting until the more flexible regulatory regime had begun bear fruit before. I’m going to blog in more detail about the Indian experiment as more data comes in, but I just wanted to put down a marker here to make the point that given the appropriate regulatory infrastructure I think that the evidence is clear that mobile phones do indeed provide a viable alternative to cash.

An Indian summer for mobile payments

I’ve written before about the Indian environment and what the Reserve Bank of India (RBI) called its “calibrated” approach to mobile payments, beginning with strict regulation back in 2009, and how it failed to unleash the latent demand from Indian consumers or the inherent enterprise and creativity of Indian businesses. We are familiar with the stories of mobile payment use in, say, Kenya or China. But India has been lagging, and I have always thought that it was the regulatory environment that was to blame.

In India, where 22 percent of the world’s unbanked reside and over 900 million mobile phone connections exist, 0.3 percent of adults use mobile money.

[From Digital Financial Services | CGAP]

That is not to say that nothing is happening in India! That’s not true at all (and in fact a Consult Hyperion team was in Mumbai last week working with a client in the payments field). But I think it is fair to say that India has not yet fulfilled its potential in mobile payments. In fact, a couple of years ago it was clear to many people that the India was missing out because of this and that something would have to be done to allow the multiple benefits of mobile payments to spread in the country. Mobile payments have a key role to play in financial inclusion and this is vitally important to India, so the lack of progress was becoming a social and political issue. Back in 2013, there was an article in the New York Times titled “Mobile Payment Startups Face Reluctant Indian Consumers” that I suggested at the time should really have been titled “Mobile Payment Startups Face Reluctant Indian Regulators”! I never thought the sticking point in India was the lack of consumer demand.

In their book “Financial Inclusion at the Bottom of the Pyramid”, Carole Realini and Karl Metha look at the issue of financial inclusion in India in some detail. They note that the previous approach towards national financial inclusion there was to use “business correspondents” (i.e. banks were to use third-party non-bank “BC” agents to deliver services) and have an interesting case study on Eko, one such BC. I couldn’t help but notice that the most widely-used EKo services is domestic remittance, which is a payment application in my eyes and not really a banking application at all. So while, as Carole and Karl note, India may have relatively few bank accounts but a lot of mobile phones, it is not in my view the natural corollary to imagine that getting people to open bank accounts and then access those bank accounts using those mobile phones is a way forward. This isn’t just my opinion: the figures show that it is not the optimum route to inclusion. More than half of the 160m bank accounts created in the Indian government’s most recent account opening drive have never been used and at cost of $3-$4 to open and maintain, that’s a lot of wasted money.  Most consumers, most of the time, need payments not banking.

Unbanked, as we say, is not the problem and banked is not the solution. Therefore I was very happy to see the steady relaxation of the Indian mobile payment regulations. This culminated last year in the decision to create a new category of finanicial institution (similar to the approach adopted in Europe) and issues licenses to these new “payment banks”. I am sure that the competition and innovation that these non-banks will bring to the Indian market will lead to a pretty rapid increase in the use of mobile financial services there. Payment banks can:

  • Accept deposits from individual customers with a maximum limit of Rs. 1 lakh (around 1,300 euros).
  • Issue debit and ATM cards for transactions but not credit cards.
  • Allow transactions through Internet and leverage technology to offer low cost banking solutions.

Importantly, a key to overall systemic risk evaluation is that a payments bank cannot undertake any lending activity. This makes it possible to expand the systemically less risky payments business while keeping the systemically risky core banking credit activities under control. Anyway, news has now arrived to the effect that the RBI has now granted the first 11 licenses in this category to a variety of fintech, tech and telecoms companies and consortia.

Among the successful bidders are telcos Vodafone M-Pesa and Bharti Airtel, tech firms Fino PayTech and Tech Mahindra, the Department of Posts, and Vijay Shekhar Sharma, the founder of m-commerce outfit Paytm.

[From Finextra: Finextra news: Telcos and tech firms get Indian payment bank licences]

I think this is unreservedly good news. The Indian market will now grow and Indian entrepreneurs will create services to deliver across the social spectrum, the Indian mobile payments industry will expand and a new non-bank financial services industry will grow up innovating around products and services.

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