India's War on Cash: Who, and Why
Cross-posted from Real Economics.
On 8 November 2016, the government of India announced its intent to demonetise large denomination currency. It is one of the most baffling economic actions taken by a government in recent memory, but a few weeks ago, the Indian news website Scroll carried an excellent three part series explaining what was going on and why. It seems some economic ideologues have joined forces with large financial institutions to force demonetisation on the citizens of India. What could go wrong?
Note the role of Harvard economics high priest Kenneth Rogoff, the deficit scold whose April 2013 book warning that disaster inevitably resulted when a nation surpassed a specific ratio of debt to GDP, was found to contain computation errors.
Understanding demonetisation: The problem with the war on cash
Force marching unprepared citizens towards a cashless utopia that has little space for the informal sector is callous and indefensible.
Another Indian news source described the "bewildering pain and desperate hope" the real economy has been plunged into after two months of demonetization. The article includes timetable of demonetization in India.
Fast-moving consumer goods (FMCG) firms have reported lower sales, especially in rural areas. Some 90% of the FMCG market
in India comprises small mom-and-pop stores, heavily reliant on cash sales. And 60% of small traders have already seen a drop in sales post-demonetisation, according to market research firm Nielsen.
In rural areas, where internet penetration is limited, cash is often the only mode of payment. People in the hinterlands have struggled to access cash—there are 7.8 bank branches per 100,000 persons in rural India—and this, in turn, has affected wage and loan disbursal in these areas.
The largest maker of motorcycles, scooters and auto rickshaws in India is Hero MotoCorp, which saw its sales of scooters fall from 663,153 in October, to 479,856 in November. (Sales in November 2015 were 550,731 units.) A month later, The Economic Times reported the Hero's sales fell another 34% in December 2016, to 330,202 (compared to 499,665 units in December 2015). More recently, Hero MotoCorp sales were down 14% in January 2017.
Bajaj Auto suffered a sales drop of 12% in November last year, 237,757 (compared to 270,886 a year earlier). December sales were even worse, with a reported 225,529 being a 22 percent collapse from 289,003 vehicles in 2015. According to the India Times, January sales were 211,824 units in January 201, down 16 percent from 252,988 units in January 2016.
Meanwhile, India's homegrown automaker, Tata Motors, has reported that its profits have plummeted 96% after the cash ban.
So what could possibly be the reason for inflicting such immense pain on one's own country? The answers are laid out in the Scroll 3-part series, excerpts of which follow:
The war on cash is being waged by four major groups. One, existing financial services providers such as banks and credit card companies. Two, technology companies, including start-ups, with financial services ambitions (known as Fintechs in current terminology). Three, governments. And four, Central banks. It is difficult to imagine a more powerful combination of forces.
It is not that they have the same objectives. In fact, they have different objectives that sometimes conflict. But their interests are complementary when it comes
to driving cash out of existence.
....for banks, it costs money to count, manage, store and move cash. But the moment currency turns into digital bits, two opportunities present themselves – one, to charge tiny little fees on every single transaction and two, to create a data trail of income and expenditure of customers that would come in handy to sustain new services and business models.
Cash today forms only 22% to 68% of transactions by volume in advanced economies. Norway, Australia and Denmark lead the digital pack while Japan, Germany and South Korea are among those who still prefer cash to cashless, with the United States falling somewhere in between, with a figure of 49%. But the theoretical scaffolding and reasoning for
eliminating cash altogether began being put together only after the financial crisis of 2008.
[As central banks responded to the financial crash of 2007-2008 and the ensuing economic crisis, they] "began to cut interest rates down to zero to stimulate investment and
spending. But they found to their horror that zero or near-zero interest rates were not enough to get their economies humming again."
Interest rates are the single most powerful tool that Central banks have, to control inflation or stagnation. If the economy is heating up and inflation is going beyond the targeted rate, central banks raise interest rates thus cooling down investment and consumer spending. People save more and spend less, bringing down inflation and along with it, growth. But if the economy is stagnant and inflation is lower than targeted, with not enough investment or consumer demand, central banks reduce interest rates to stimulate demand. Economic theory suggests that pushing interest rates significantly below zero might have been necessary to pull many advanced economies out of the funk they have been in since 2008.
A negative interest rate means that if you keep Rs 100 with your bank for a year, instead of getting back, say Rs 105 including a 5% interest, you may get back only Rs 99.90 – the rest being taken as, say, 0.1% negative interest rate. The expectation is that negative interest rates will force banks, businesses and individuals to lend, invest or spend their money rather than keep it idle, because there’s a cost to keeping it idle.
Now this is great in theory, but there is a practical problem. Central banks can take interest rate as high as they want without limit, but they cannot take it into seriously negative territory for a simple reason: if it goes there, everyone would just take their cash out of the banks and keep it in safe deposit boxes. No spending happens, and the
central bank objectives are not met. In other words, economists argue that there is an asymmetry in the way central banks can use interest rates. They have immense power to cool down an overheating economy, but only limited power to stimulate a stagnant economy by bringing down interest rates sufficiently.
The technical term economists use to describe this situation is Effective Lower Bound, or ELB – the negative interest rate below which people will just withdraw their money from
banks. Since there is a convenience to keeping money in the bank, the ELB is usually not exactly zero, but a little below zero – say, - 0.5% or -1%. People don’t mind keeping their money in the bank if the negative interest rate is a minor annoyance, because there is a
convenience to operating with a bank account and say, a debit card.
After the Great Recession, this is the situation that central banks found themselves in: operating close to ELB. And it is in this situation that some economists started pushing a new idea that sounded horrendous to many: eliminating cash altogether. If there is no cash, people cannot take their money out of banks, and central banks can take interest rates as much below zero as needed. In other words, eliminating cash will improve the ability of central banks to fight stagnation and improve growth.
There are two well-known economists who pushed forward the idea of eliminating cash initially: Willem Buiter, now Chief Economist at financial services behemoth Citigroup and Professor Kenneth Rogoff of Harvard University. (Buiter was a thesis advisor to current Reserve Bank of India Governor Urjit Patel, and they have authored many papers together.) Willem’s 2009 piece titled “Negative Nominal Interest Rates: Three Ways to Overcome the Zero Lower Bound”
Rogoff presented his paper, “Costs and benefits to phasing out paper currency in 2014” at the National Bureau of Economic Research’s Macroeconomics Conference at Cambridge, Massachusetts,
Since these two men made their case, others have added their own powerful voices to the chorus, including former US Treasury Secretary Larry Summers (who was considered for appointment as the Federal Reserve Chairman) and Nobel Laureate Paul Krugman. Both Krugman and Summers argue that in the situation that advanced economies are faced with, there are only two choices: either have negative interest rates (along with its inescapable corollary, currency elimination), or tolerate much higher levels of inflation,
These ideas are gaining momentum. Denmark, for example, is predicting that it will eliminate cash by 2030. In Italy and France, it is illegal to make purchases exceeding 1,000 Euros in cash. In Spain the limit is 2,500 Euros. Last year, European Central Bank decided to stop printing and issuance of the 500 Euro note,
At a conference that was held in London on May 18, 2015 titled “Removing the Zero Lower Bound on Interest Rates”, Buiter and Rogoff were the keynote speakers, and other speakers
represented the central banks of Switzerland, Europe, US, Denmark and Sweden, Soros Fund Management, insurance company Generali, Asset Management Company Brevan Howard and so on. So by 2015, the war had already been joined by many financial service behemoths who had begun to see the gains to be had from pushing currency out of the system. And by October 2015, the International Monetary Fund itself had released a paper titled “Breaking Through the Zero Lower Bound.”
There is also a belief that emerging markets are where new digital financial technologies will evolve, by leapfrogging the stages that the advanced economies had to go through.
....the Better than Cash Alliance in 2012, hosted at the United Nations in New York and funded by the United States Agency for International Development (commonly known as USAID), Bill and Melinda Gates Foundation, Citi Foundation, Ford Foundation, Mastercard, Omidyar Network and Visa Inc. The United Nation’s Capital Development Fund serves as the secretariat. In June 2015, the finance ministry put up a draft proposal on its website, recommending tax concessions to reduce the cost of credit, debit and online payments. In July 2015, 11 new payment bank licences were given out, including one for PayTM. In November 2015, a Memorandum of Understanding was signed between the Ministry of Finance and USAID – the same agency behind the Alliance – to start working on interoperable digital payment models to drive transactions that involve small businesses and low-income consumers.
On October 14, 2016, USAID, one of the founding partners of the Better Than Cash Alliance, announced the launch of a new initiative called Catalyst to drive cashless payments in India.
....a report on the great opportunity that digital finance presents in emerging economies, prepared by McKinsey and released just four months ago, in September. The report is prominently linked on the website of the Better Than Cash Alliance.
As more people obtain access to accounts and shift their savings from informal mechanisms, as much as $4.2 trillion in new deposits could flow into the financial system
Scroll next gives us an amazing excerpt from the above mentioned international "business consulting" firm McKinsey, which comes right out and admits the goal is to destroy small, independent "informal" producers and retailers, in order to give more "market share" to "formal" "high productivity, modern firms," i.e., multinational conglomerates run by the new world corporatist oligarchy:
....the kind of growth that will result from a forced move towards cashless is likely to be particularly weak on employment growth for a simple reason: The stated intention of the cashless push is to make it impossible for the informal sector to survive as it does today – even though it employs more than 70% of India’s labour.
“From an economic perspective, the informal economy imposes a high cost and significantly
hinders growth. Many developing countries have a two-speed economy: a modern sector of healthy companies with high productivity (or output per unit of input), and an informal sector of subscale firms that drags down overall productivity and growth. Informal firms face perverse incentives and may avoid investments or growth that could increase their visibility to regulators and tax authorities. In Turkey, for instance, MGI has found that the productivity of formal companies is 2.5 times that of informal firms. The gap in productivity levels between formal and informal firms is similar in Brazil, India, Mexico, Russia, and elsewhere.
“The presence of informal firms also harms the economy by limiting the ability of high productivity, modern firms to gain market share, given the significant cost advantage informal firms enjoy by not paying taxes. MGI research has found that the cost advantage from tax avoidance ranges from 5 percent of the cost of goods sold in Mexico food retail to 25 percent in India’s apparel sector and to more than 100 percent in the case of Russian software. Formal companies also face additional costs and complexity in managing informal firms with outmoded technology in their supply chain. This dampens the healthy process of
“creative destruction” in the economy in which the most productive companies take market share from less productive ones.”
Shashi Tharoor, a former UN under-secretary-general and former Indian Minister of State for Human Resource Development and Minister of State for External Affairs, is currently an MP for the Indian National Congress and Chairman of the Parliamentary Standing Committee on
External Affairs, writes in Project Syndicate:
....the impact is not being felt equally by all. India’s wealthy, who are less reliant on cash and are more likely to hold credit cards, are relatively unaffected. The poor and the lower middle classes, however, rely on cash for their daily activities, and thus are the main victims of this supposedly “pro-poor” policy.Small producers, lacking capital to stay afloat, are already shutting down. India’s huge
number of daily wage workers can’t find employers with the cash to pay them. Local industries have suspended work for lack of money. The informal financial sector – which conducts 40% of India’s total lending, largely in rural areas – has all but collapsed.
India’s fishing industry, which depends on cash sales of freshly caught fish, is wrecked. Traders are losing perishable stocks. Farmers have been unloading produce below cost, because no one has the money to purchase it, and the winter crop could not be sown in time, because no one had cash for seeds.
Perhaps the worst part is that these sacrifices are not likely to achieve the government’s
stated goal. Not all black money is in cash, and not all cash is black money. Those who held large quantities of black money seem to have found creative ways to launder it, rather than destroying it to avoid attracting the taxman’s attention, as the government expected. As a result, most of the black money believed to have been in circulation has
now flooded into banks, depriving the government of its expected dividend.
On top of all of this, the government’s plan does nothing to control the source of black
money. It will not be long before old habits – under-invoicing, fake purchase orders and bills, reporting of non-existent transactions, and blatant bribery – generates a new store of black money.
Modi has been discussing going even further, moving India to an entirely “cashless society.” Does he not know that more than 90% of financial transactions in India are conducted in cash, or that over 90% of retail outlets lack so much as a card reader? Is he unaware that over 85% of workers are paid in cash, and that more than half of the population is unbanked?
Again, here are the links for the 3-part series in Scroll:
Understanding demonetisation: The problem with the war on cash
Force marching unprepared citizens towards a cashless utopia that has
little space for the informal sector is callous and indefensible.