Cash isn’t king

India’s latest move to withdraw banknotes from circulation revived memories of its chaotic 2016 demonetisation strategy, but changes in the financial system meant the ripples were barely felt this time.

In November 2016, the government announced that the Rs500 and Rs1,000 notes would be withdrawn from circulation overnight. These accounted for 86% of currency in circulation, or US$235bn – a whopping 10% of GDP.

Newspapers reported tales of patients unable to pay for hospital treatment, cancelled weddings and struggles to complete the most basic purchases.

The most notable impact from this month’s decision to withdraw the Rs2,000 note from circulation has been a slight tightening of government bond yields and an easing of tight liquidity conditions as Indians put their cash into bank deposits.

The different outcomes are due to two things: Rs2,000 banknotes account for only around 10% of notes in circulation, and India has wholeheartedly adopted non-cash transactions.

Back in 2016, 78% of India’s consumer payments were in cash. That has since dropped below 50%, and it’s easy to do day-to-day business without ever touching a banknote.

Digital payments currently stand at around 14% of all transactions, but that is forecast to increase to around 32% by 2030, payment provider Paytm wrote in its most recent annual report.

Demonetisation’s main goal is to force participants in the shadow economy out into the light, where they will start paying tax (though undoubtedly a secondary motivation is to make it harder for unscrupulous politicians to bribe voters during election season).

The demonetisation drive in 2016, plus other enforcement efforts, helped add more than 21 million new taxpayers in the two financial years immediately afterwards. That has helped strengthen India’s finances, as well as introducing more liquidity to the banking system and, broadly speaking, bringing down borrowing costs.

The execution of these exercises hasn’t been perfect, but by and large they have strengthened the nation’s coffers and the advance of fintech companies has made finance more accessible to the masses.

Other countries might do well to ask themselves if paper money is holding back the development of their own financial systems.