Vijay Kumar Gaba: Demonetization

One of the economic positives of Covid-19 pandemic is material rise in digital payments and e-commerce. The steep rise in adoption of digital payments by household consumers and merchants in past one year should have arguably led to lower currency in circulation. However, the recent data released by RBI indicates that the cash in circulation is highest in 6 decades relative to GDP. In absolute terms also, the cash is materially higher than the pre demonetization levels.

It may be argued that holding more cash during the times of distress (e.g., Pandemic) is natural instinct; and this trend has been seen globally. Nonetheless, in the Indian context, the issue needs deeper examination by the policy makers.

Digital payments rising exponentially

The initial public offer (IPO) by One 97 Communication Limited, the owner of India’s largest payment brand PayTM, celebrates the exponential growth in digital payment in past few years. As per NASSCOM, digital payments in India have grown ~10x in five years, from Rs352cr in FY15 to Rs3435 in FY20. The apex body of IT Services Industry in India, expects, the digital payment volumes to grow another ~16x to Rs54,800 crores by FY25. The fastest growth during FY20-FY25 is expected to be in UPI payments, which are expected to grow 26x, from rs1251cr in FY20 to Rs32,500cr in FY25. Payments using Aadhar enabled payment system (AePS) are also expected to grow 23x to Rs3800cr over this period.

The NASSCOM’s 2020 Country Adoption Report for digital payments, highlighted that all economic segments (Individuals, Merchants and Enterprises) have high adoption maturity, insofar as the preference for digital payments is concerned. But the adoption maturity is limited for digital payments for business transactions, government transactions and higher value transactions. In 2020, about 75% of digital payments were Rs5000 or below; and only 1% transactions were over Rs1,00,000.

…triggered by Covid-19 pandemic

The lockdown forced by the Covid-19 pandemic has definitely given a strong push to the digital payments in India. As per the available data, the digital payments have increased to 25% of the private consumption expenditure in 1QFY22 from mere 4% in FY15.

As per a recent report by brokerage firm Sanford C. Bernstein, “The pandemic has changed user behavior – more people are buying things online. This has given a boost to online payments. Further, buyers are shifting towards digital payments for in-store purchases as well. Mobile payments, driven by UPI, has been a big factor in the rising adoption of digital payments in India during the pandemic.

Digital merchant payments stood at ~25% of PCE for Q1FY22 in India. The number stood at ~22% for Q4FY21, and at ~18% for FY20. The first boost to penetration came from demonetization when higher denomination currency notes were discontinued for three months. The rise of UPI has supported the increased adoption over FY18-20. The pandemic has provided another step-jump in the adoption of digital payments by merchants and consumers. The rapid adoption growth comes from the rising share of mobile payments, mainly from UPI. UPI has grown from 3% of PCE in FY20, to 9% of PCE in Q1FY22.”

Informal economy is shrinking

As per a recent note released by SBI Research, share of informal economy in India may have shrunk to 20% from 52% in 2018. The note “estimates that currently informal economy is possibly is at max 15%-20% of formal GDP. There is wide variation across sectors, though, with formal sectors like finance and insurance expanding post pandemic.”

Though many experts have challenged the data and method used by SBI Research to assess the formalization level in the economy, it cannot be denied that the level of formalization of economy has increased in past one decade or so.

“For India, post 2016 plethora of measures which accelerated digitisation of the economy, emergence of gig economy have facilitated higher formalisation of the Indian economy - at rates possibly much faster than most other nations”, the note reads.

The note highlights that “E-Shram is a big step towards the formalisation of employment as our calculation indicates that till date the rate of formalisation of unorganised labour due to E-Shram is around 17% / Rs 6.8 lakh crore / 3% of GDP in just 2 months. Even in Agriculture, the usage of KCC cards has increased significantly and we estimate Rs 4.6 lakh crore formalisation only through KCC route, with more marginalized farmers coming under the banking sector ambit through such usage. The total number of insurance and pension accounts that have been opened across several schemes for the unorganised as well as organised is as much as 68.9 crore.”

Paradoxically currency in circulation is highest in six decades

The currency in circulation (cash in pocket) grew to six decade high of 14.7% of GDP by the end of FY21. The currency in circulation grew at staggering 17.2% in FY21 to Rs28.6trillion. The amount was Rs16.63trillion five years, before the demonetization of higher denomination notes in 2016.

Moreover, the proportion of high denomination currency (Rs2000 and Rs500) has also increased to 85.7% in March 2021, against 83% share of Rs1000 and Rs500 currency notes in November 2016.

I guess there could be a variety of reasons for the people preferring to hold more cash in pockets. Moderating pace of financial inclusion efforts; lower denominator (nominal GDP); increased cash payout to poor for Covid-19 relief; rise in corruption; rise in election spending; etc.

Financial inclusion progressing at modest speed

Financial inclusion has been one of the primary thrust areas for successive governments in past two decades. Indubitably, the access to basic banking services has improved materially in past one decade. Nonetheless, in absolute terms, the access to basic banking services is much below optimal levels and growing at very modest speed. The rate of improvement in accessibility to banking services has actually declined in past five years as compared to the previous block of five years.

During 2010-2015, the number of savings account in India had grown at the rate of 16% CAGR. The rate of growth slowed down to just 9% CAGR during 2015-2020. The regional dispersion in access to banking facility has improved over past five year, with the states with lowest penetration, especially Bihar and Jharkhand, witnessing sharpest growth. However, in absolute terms, the regional disparities continue to be very high. Most populous states of Bihar and UP have about 100 savings account per 1000 population, while the southern states and Delhi have 160-180 accounts per 1000.

Denominator (Nominal GDP) growing at much slower rate

One reason for higher cash to GDP ratio could be the sharp decline in growth rate of nominal GDP in India. The decline started much before the pandemic shock.

Rise in election spending

In past five years, the amount spent on national and local elections has seen sharp rise. The reported spending by various parties in 2019 general elections was about 37% higher as compared to the previous (2014) general elections. Similar trends are visible in the state and local elections. A significant part of this expenditure is incurred in cash.

Corruption might be rising again

After declining sharply post 2014 general election, India’s positioning on the Corruption Perception Index, published by Transparency International, has begun to worsen again. Though the methodology used for this Index is questionable, it does give some sense of the situation on the ground.

The sharp rise in corruption perception in past couple of years, could be one of the explanations for rise in the cash in circulation.

As expected, the GDP growth data for 2QFY20 came out to be poor. In the quarter ended September 2019, India's real GDP grew 4.5% and GVA grew 4.3%, the lowest rate of growth in 6years. The latest economic growth rate of India is now lower than China, Indonesia, Myanmar, Vietnam, Philippines, and similar to Malaysia.

The supply side data explains that the slowdown is pervasive and all sectors of the economy are struggling. Industrial sector was stagnant with manufacturing recording its first quarterly contraction in a long time. Services grew less than 7%, the lowest pace in 2years. Despite above normal monsoon, the agriculture growth at 2.1% was also lowest for the second quarter of a fiscal in many years.

On the demand side, private consumption grew 5.1%, slightly better than 3.1% in 1QFY20, but dismal in comparison to historical trends. Investments grew barely at 1%. Both exports and imports contracted for the first time since 2016. Import contraction of 6.9% despite weaker rupee further highlights the poor demand conditions.

This poor GDP growth data was supported to a great extent by the government expenditure which grew at 11.6%, highest rate in 6 quarters. Given that the government has already surpassed its fiscal deficit target for FY20, the tax collections continue to be sluggish and the nominal GDP is slipping at a faster rate than real GDP, it would reasonable to assume that the slowdown may persist for few more quarters at the least.

Regardless of what the government spokespersons and some enthusiastic market analysts may say, it is highly likely that we may end up FY20 with sub 5% growth. Given the fiscal challenges and intensifying global slowdown and deflationary pressures, we may struggle to grow more than 6% in FY21 as well, despite lower rates, taxes, and base effect and improving credit availability.

Based on an informal survey of traders, SME and professional, I am inclined to conclude that this sub 5% growth trend may persist for at least next 3 to 4 quarters. The key feedback from the survey could be listed as follows:

(a) The growth rate shall slip further as the government continues to be in denial mode insofar as the most important cause of slow down is concerned.

(b) Most respondents highlighted that lingering effects of demonetization and serious faults in GST processes are reasons for the slowdown.

(c) Demonetization has hit the small businesses very hard. It has destroyed the traditional sources of short term financing for traders and small businesses, increased the working capital cycle, constricted the inventory holding and business expansion capacity and increased the cost of doing business. Many of these SME businesses were critical part of the supply chain of the larger businesses. It has therefore affected the larger businesses also indirectly. Poor business conditions for large number of small businesses have obviously impacted the employment and consumption demand conditions. There is nothing to suggest that these conditions shall correct on their own in near future.

(d) The implementation of GST has been hasty and seriously flawed. More than 75% of GST assesses must be facing problems of reconciliation, wrongful disallowance of credit, defaults, harassment, corruption, and/or delayed (or no) refunds. A careful examination indicates that the system is even more problematic and cumbersome than the erstwhile Excise, VAT and Sales Tax regime. Unless the GST system and processes are streamlined for seamless flow of credits and payments, any meaningful acceleration in growth rate looks highly improbable.

Vijay Kumar Gaba

Saturday, November 13, 2021

Pocket bulging with cash

Tuesday, December 3, 2019

Demonetization, GST major culprits for growth slowdown