Demonetisation: Will Going Cashless and Digital Come Cheap & Easy?

Going cashless also has its costs and sometimes, they can be more significant than a business can afford.

The government’s think tank NITI Aayog announced last week that it has constituted a committee of officials, chief ministers and financial experts to draw up a plan to wean India away from cash. The move comes after the government decided to withdraw Rs 500 and Rs 1000 notes from the system, reducing the availability of cash.

The committee, however, isn’t looking for stopgap solutions. At present, more than 90 percent of all transactions in India take place in cash. They want to reduce that proportion significantly over a period of time.

To do that, sellers and buyers will have to be convinced that non-cash transactions are not only more convenient, but also cheaper.

The Cost of Cash

India has one of the highest ratios of currency in broad money measure (M1). The ratio of money held in bills and coins as compared to the amount held in deposit and and savings account is 51 percent in India, higher than economies like Egypt, South Africa, and Mexico.

While most businesses ascribe no particular cost to accepting payments in cash, working with currency doesn’t come cheap, showed a study conducted for Mastercard by the Tufts University found in 2014. The study, summarized in the chart below, estimated that the total burden of currency costs run into Rs 21,000 crore annually and 86 percent of it is borne by the banking system.

“Banks earn limited fees from cash operations but end up incurring expenses for cash handling and processing costs, insurance cost, payments for cash in transit companies, and losses on interest for standing amounts in branch and ATM,” the study said.

These costs are just a fraction of the costs that the economy faces as a whole. Consumers face high costs in procuring cash from automatic teller machines (ATMs) and bank branches while employers using cash also pay high costs to access it and stock up extra currency for exigencies, the study said.

Also Read: Why Going Cashless Is Going to Be Tough in India

Through surveys conducted in Delhi and Hyderabad, the study concluded that residents of Delhi together spend 6 million hours and Rs. 9.1 crore to obtain cash. Hyderabad, which is smaller, spends 1.7 million hours and Rs 3.2 crore to do the same. The costs for the country as whole, thus, run into hundreds of crore rupees – if not more.

An RBI paper published in 2013 on disincentivising usage of cheques as a payment instrument found high costs attached with converting digital money into cash.

“Considering the high cost of cash handling, including cash management at ATMs, banks should be active partners in discouraging the use of cash,” the paper said while adding that there’s a total cost of Rs.1.95 per Rs.1000/- which excluded the cost of insurance and dispensing cash at ATMs.

The cost of dispensing cash through ATMs alone is approximately Rs.17 per transaction; the opportunity loss for holding idle cash would be approximately 9 percent; the cost per transaction at ATMs ranges from Rs 6.60 to Rs 15.88 in case of fully outsourced operations depending upon the service provider and area of operation.

Discussion Paper On Disincentivising Issuance And Usage Of Cheques, RBI (2013)

Also Read: Your Paytm Wallet Money Is Not Safe

Meanwhile, businesses also pay for using cash. The costs associated with using cash for a business include lost interest income from bank, requirement of special front office staff to process cash payments while there are multiple other handling, insurance, and safety costs attached too.

Cost of Going Non-Cash

The reason why people still prefer cash, though, is that it’s the fastest way to transact, assures exact payments and doesn’t require dependence on internet or other related infrastructure.

“Going away from cash also has its costs and sometimes, they can be more significant than a business can afford,” said Suyash Rai, senior consultant at the National Institute of Public Finance and Policy (NIPFP). Rai added that there’s some evidence of rational behaviour from retailers who are not moving to digital payments just yet because the costs attached might not be fully sustainable.

We assume digital to be cheaper but there are implicit costs with all modes of payment. Even a cheque is an expensive medium to transact for a small value payment, for digital wallets you need to invest in a smartphone and internet connection, issuance of plastic cards costs Rs 100-150 for banks and maintaining point-of-sale infrastructure is even more costly.

Suyash Rai, Consultant, National Institute Of Public Finance And Policy

If the connectivity is poor, the retailers in the hinterland will automatically opt for cash, Rai said. A retailer moving to digital payments has to invest in a PoS terminal which costs anywhere between Rs 10,000 – Rs 25,000.

From thereon, there are fixed costs of about Rs 150 per month in addition to low transaction charges which could be another Rs 1000 if the sales during the month are below a certain threshold, according to a Bank of America estimate.

The bank estimated that there’s an additional merchant discount rate (MDR) to be paid on going digital with both payment wallets and PoS terminals. This ranges from 0.75 percent to 1.8 percent depending on the mode and size of the transaction. MDR has also been cited as a hindrance in adoption of the Unified Payments Interface, as BloombergQuint reported earlier.

Will People Switch?

Bhaskar Chakravorti, Senior Associate Dean - The Fletcher School at the Tufts University and one of the authors of the Mastercard study said, in an e-mail, that it is not easy to clearly demarcate a mode of payment as expensive or cheap.

Chakravorti added that half of the cash cost to businesses goes in ensuring its safety during transit to banks and the next highest contributor is the cost of labour need to maintain cashier operations.

These costs, however, have no chance of reducing in the near-term, the study said, since cash remains the most readily available and preferred medium of payment in India.

“Even Indians with access to formal banking tend to carry a lot of cash with them — typically in high denomination bills. While the value of non-cash payments in India has been increasing steadily since 2007, cash transactions still dwarf the alternatives,” the study said adding that most Indians lack the means to use cashless alternatives, irrespective of their desire to do so.

Chakravorti said that even if one imagines a completely cashless world, consumers and businesses would still want to hold on to cash because of its advantages.

There are three major reasons for which consumers currently have a strong adherence to cash: self-control, speed and guarantee of exact payment. Besides, the transition to digital will happen in increments - so you will never be sure that a digital payment will be acceptable everywhere. It is just pragmatic for a consumer to keep cash on hand.

Bhaskar Chakravorti, Senior Associate Dean, Fletcher School, Tufts University 

However, there are those who believe that going digital also offers incentives like access to a new set of customers and vendors. Kalpesh Mehta, Partner, Deloitte, said that while developed cities can adopt digital payments, it is going to be a challenge in interior towns and villages.

“There’s a question mark about digital adoption in the hinterland where cost and security are major issues,” Mehta said. “There could be increased cyber crimes there which has to be factored in but moving digital offers certain advantages over cash that individuals will eventually realise as the ecosystem-wide push continues.”

Meanwhile, Suyash Rai from NIPFP said that the move to digital payments will be linked to the cost of non-cash transactions coming down but it can’t be forced.

There’s insufficient infrastructure to conduct transactions digitally. The penetration of smartphones and internet is low and there’s bad connectivity. There’s good reason behind people’s preference for cash and one has to evaluate its uses both as a store of value and medium of purchase before dismissing it.

Suyash Rai, Consultant, National Institute Of Public Finance And Policy 

(This article was first published in BloombergQuint.)