On 8th November, 2016, India woke up to 86% of the cash in the economy no longer being legal tender. What followed after the initial shock was chaos – not just at ATMs and bank counters, but also in Parliament, TV debates, and among other stakeholders. Now that the dust is settling somewhat, a crucial debate is shaping up on the longer term effects of the Demonetisation policy.
On balance, the popular sentiment seems to have endorsed the Prime Minister’s bold move, taking the inconvenience in its stride. Much of this initial goodwill has focused on the impact on black money. Indeed, once the chaos of Demonetisation is over and the cash hoardings are flushed out, the infusion of money with the banks will, in the short-to-medium run, spur economic activity and unfold the virtuous cycle of growth. However, for this process to sustain over a long term, reduction in tax rates, widening the tax base, reducing the scope of corruption through administrative reform, and transparency in electoral funding will become necessary to avoid the repetition of a parallel economy and – most importantly – to ensure an effective transition to a digital economy.
For, other than the legitimate goals of choking off sources for terror financing and ensuring monetary sovereignty, the main thrust of the Demonetisation move is to accelerate this transformation to a digital economy. This will minimize the role of cash and transit with least cost to a predominantly digital economy.
You may also like to watch this:
There are several good reasons for going digital. These range from cost considerations to security issues. Overall, the transition to a digital economy is regarded as a higher trajectory in the development of a nation and society. The issue is not why we need a predominantly digitized economy but how to reach there – swiftly, effectively and painlessly. This requires an objective assessment of the processes involved and the managerial challenges that lie ahead. The path from a cash economy to a predominantly digital one is not going to be linear. It will be multi-dimensional, with each dimension exhibiting its own quirks and thus requiring a disaggregated approach.
The biggest challenges and opportunities in this path lie within the Micro, Small and Medium Enterprises (MSME) sector, where a significant proportion of transactions are in cash. Initially, the ripple effect of squeezing cash from the economy due to Demonetisation will be felt across the sector. Businesses that rely on cash payments between buyers and suppliers will feel this most acutely. These will include large swaths of unorganized retail – kirana stores, small distributors, merchants – as well as producers and traders operating in cash-dominated segments such as transportation and agricultural commodities.
Admittedly Demonetisation, leading to a drop in cash sales and receivables, has put a strain on working capital cycles among these segments. At the same time, traditional financial institutions remain shy of providing working capital loans to these segments due to inflexible credit underwriting parameters, stringent collateral requirements, and the practice of long term loans with penalties on early pay backs. The space for short-term lending, traditionally occupied by private moneylenders at high interest rates, will now open up due to the shortage of cash in moneylender hands. Alternative credit options will need to emerge and here, digital technology has a huge role to play.
In the SME sector, some digital literacy already exists thanks to the growth of smartphone penetration, banking services and e-commerce in recent years. In the aftermath of Demonetisation, more consumers are opting to swipe their plastic cards and use e-wallets to purchase goods and services. As a consequence, merchants are going in for point-of-sale card machines in unprecedented numbers. To come out of the current dip in sales, more and more vendors will be accepting payments through cards. In the business-to-business (B2B) world, electronic channels to raise invoices and make payments are likely to arrive in full force, as the cash is squeezed out of traditional supply chains. And as a result, the digital data footprint of individual SMEs in India – previously non-existent or obscured by the parallel cash economy – will emerge to the surface in full clarity.
This scenario is facilitating the introduction of working capital financing by digital lending platforms to merchants, against their sales through card payment machines. It is enabling such platforms to create mobile apps that businesses can use to pay suppliers on credit at the click of a button. With a digital footprint, even the smallest of businesses – a kirana store – can access micro credit within minutes on their phone. As consumers start paying with plastic more than cash, new options are emerging for small merchants to offer credit at the point of sale to drive up business volumes over time.
Through a form of shock therapy, Demonetisation is accelerating a process of digitisation across the economy that – while already underway – would have otherwise taken years to reach fruition. For digital finance companies, it opens up a great opportunity across sectors and regions. It will motivate them to demonstrate greater responsiveness to demand and faster innovations to maintain lead time in the changing scenario. And as SMEs become more and more adept at electronic payment systems, they will become an integral part of the formal economy; as a result, cashlessness and the use of digital technology will gain in force.
Does this sound too good to be true? Perhaps both good and true, in due time. For the moment, let’s say the glass is half full.
(Author is co-founder & managing director of Capital Float, an online lending platform)