Six Months out from Demonetization: Is Digital Finance in India’s Future?

Today, June 30, marks six months from the day Indians had to change their old 500 and 1000 rupee notes following the “demonetization shock” announced by the government. The turmoil in the economy has since calmed to a large extent. In the past six months, the government also launched a concerted effort to wean Indians away from cash as the preferred method of payment for transactions. And within a short period of time, “digital” and “cashless” had become common parlance. It seemed as if India was poised for a complete restructuring of its economy leaping into the digital future. But did that happen?

Our analysis of recently released data from the Reserve Bank of India shows that the initial euphoria has died down, but digital payments are here to stay. Digital financial inclusion was only expressed as a goal of the demonetization policy well after it was originally announced—yet the Indian government adroitly exploited this opportunity to develop a more robust digital ecosystem. The data, however, says something very interesting: Indians are moving to digital transactions, but at a pace of their own choosing. Cash is still the king—or so it seems.

Figure 1. ATM transactions in India by value and volume, Aug. 2016 - Apr. 2017

ATM transactions are a strong indicator for reliance on cash. With restrictions to cash in the economy in November and December, the volume and value of ATM transactions dramatically fell. However, once cash was restored in the economy, ATM transactions achieved close to pre-demonetization levels.

As expected, transactions using mobile banking and point-of-sale (POS) that experienced sharp increases during the demonetization phase also did not sustain after December. While the volume and value of mobile banking and POS transactions have not fallen to pre-demonetization levels, given that they were on a steady growth trajectory pre-demonetization, India may have simply regressed to the previous trend. (The volume of transactions for March and April can be misleading because at the time of financial year closure, a higher volume of transactions generally take place.)

Figure 2. Mobile banking and POS transactions in India by value and volume, Aug. 2016 - Apr. 2017

The quick reversion to business-as-usual signals that consumers are not ready to give up cash just yet. There are several reasons for this: 1) digital transactions have explicit overhead costs; 2) a neighborhood grocery store in India would most likely charge extra for the same product if it is paid by any non-cash instrument; 3) India also still has a dominant informal sector; and 4) reliance on cash is inevitable for economic activities to remain outside the tax net.

However, cash is also implicitly expensive—lost tax revenue due to under-reported income, risk of counterfeit and theft, and access to cash is far more time-consuming. But such costs are often not internalized when comparing cash to digital transactions. Thus, a behavioral shift to digital finance cannot be coerced, but requires gradual improvements in financial literacy and formalization of the economy.

The Indian government, however, has taken an atypical approach to transition into a digital financial economy. Most developed economies transitioned to a cash-lite economy due to market-driven consequences. The Indian government, on the other hand, has taken an active part in incentivizing citizens to shift towards digital finance. While demonetization may not have been successful in this vein, the Modi government capitalized it to launch several novel digital payment instruments, such as the BHIM application that utilizes the Unified Payments Interface for instant bank transfers, and AadhaarPay that connects the Aadhaar-enabled biometric identification as an authentication process for mobile banking.

With several digital financial instruments in the market, the consumer now has more choice than ever. Demonetization forced consumers to hastily adapt to non-cash instruments, proving the digital financial ecosystem of India is in good health. With careful attention to crafting the right incentives, the Indian government could play a successful role in furthering India’s journey towards true digital financial inclusion.


CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.