The DEMONetary Reform?

In this issue:

» Is India ready to go digital?

» RBI's credibility being questioned

» Round up on markets

» ...and more!

We've spilt a lot of ink covering the most disruptive economic event of 2016 and the various possible outcomes of the whole demonetisation drive...

But two central questions keep recurring:

1. Does cash really support the existence of a parallel economy?
2. How much cash is really needed in an economy?

Let's address the first question first. Take the example of Japan - where more than 80% of all transactions are in cash, yet there is almost no parallel economy. This perhaps is because of their tax system, which taxes most working individuals at pretty low rates! (Note that rates are high, but post the deductions, in comparison with similar wages in India, they are effectively low.)

Clearly, cash does not necessarily cause a parallel economy. Cash is merely a means by which a parallel economy may come into existence, but blaming cash-based transactions for the existence of a parallel economy is wrongheaded.

This leads to our second question: How much cash really is necessary for an economy?

The cash to GDP ratio in the US is around 8%. In India, it's around 12%. Now, you might be tempted to argue that the US has an infrastructure that better supports a digital economy. But note that around 40% of transactions in the US are in cash. Furthermore, the US dollar is the world's base currency, meaning it is more widespread in terms of both location and users.

Perhaps this indicates that cash levels in the Indian economy had exceeded the right balance, and thus cash was serving purposes other than legitimate buy and sell transactions. Even so, is this enough to justify the unleashing of the demon of demonetisation?

We don't quite know.

What we do know is the demonetisation drive has given impetus to a digital economy. And the government is leaving no stone unturned to promote cashless transactions.

But let us remind you, a large part of the Indian population is still outside the banking system. SBI chief Arundhati Bhattacharya too raised various concerns on this front recently. The disparity in the country is wide, and the gap between the accessibility to services and delivery of them won't be easily filled.

Taking all these aspects into account, would it not make more sense for the government to align its vision of curtailing black money with a better tax structure and further reforms, rather than a cashless society?

03:20 Chart of the Day

SBI has one of the largest share of point of sale transactions in the country. It has the widest reach. And if there is any bank in the country that can make a real difference towards the cashless drive in hinterlands, it is SBI. So, Ms Bhattacharya's comment that there is a long way before Indian economy goes cashless is not unfounded. Data from the SBI EcoWrap has all the proof.

According to SBI, the size of digital transactions (both PoS and mobile) in the country need to go up multi-fold before India can even think of becoming cashless. Most banks are moving in that direction. The urban banks will be able to achieve their targets faster. But for a bank like SBI, which is a true reflection of India's financial inclusion, this will take time.

Move towards Cashless - A Long Way To Go

Before 8^th of November 2016, when was the last time you worried if the ATM will shell out cash? When was the last time you worried if your bank was safe enough for fixed deposits? And did the thought of any Indian bank going the Lehman way ever cross your mind?

The governance of India's financial stability has been rock solid. For years! Never after the 1991 balance of payment crisis did we come across such a dire scenario. And generations of Indians after that have taken the economy's resilienece to shocks for granted.

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This is why going cashless is not the solution to India's Parallel economy...

All thanks to the Reserve Bank of India (RBI).

It was the only financial regulator globally heaped with praises post 2008 subprime crisis. Jim Rogers famously wished that RBI should have been the US' central bank. Many economists recommended that past RBI governors, including Rajan, deserve nothing less than a Nobel prize.

It would have been fair on our part to give the new RBI governor some benefit of doubt. After all he has had really large shoes to fill. But after a disappointing start, Governor Patel did not add any feather to his cap being a mute spectator to demonetization. More importantly, it is not just his but even the RBI's credibility that is now being questioned.

Ex-RBI governors, Dr Y.V Reddy and Dr Bimal Jalan are stalwarts in their own right. They have led the country's financial system through some of the most trying times. Most importantly they laid the foundation for RBI becoming an institution that is revered globally. The fact that they are now questioning and defending the sanctity of RBI's institutional image is itself sad.

The performance of Indian banks, especially PSUs, is currently near historical lows. Trust in banks has taken a hit with recent instances of corruption. That the RBI is doing little to redeem itself of the shadow of incompetency at such times is doing more damage to the institution than ever before.

In the meanwhile, after opening the day on a flat note with a positive bias, the Indian share markets have continued to trade above the dotted line. Sectoral indices are trading on a mixed note with stocks in the FMCG sector and the pharma sector witnessing selling pressure. Power stocks are trading in the green. At the time of writing the BSE Sensex is trading up 101 points (up 0.4%) and the NSE Nifty is trading 28 points (up 0.3%). Meanwhile, the BSE Mid Cap index is trading up by 0.1%, while the BSE Small Cap index is trading flat.

04:50 Investing mantra

" Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it." - Peter Lynch

This edition of The 5 Minute WrapUp is authored by Bhavita Nagrani (Research Analyst) and Tanushree Banerjee (Research Analyst).