Policymakers must encourage it to check black money and plug leakages
Recently, the government of India presented a White Paper in Parliament regarding black money. FICCI has also raised the issue of repatriation of black money to immediately mitigate the BoP situation. In this piece, we will present some clear evidence of a cashless revolution in India that we believe should be actively encouraged to fight the menace of black money. Additionally, such a trend could also be used for facilitating financial inclusion and plugging leakages in the financial system.
One logical corollary of the elevated prices (in fact, recent numbers do suggest that CPI has been in double digits) has been a significant increase in currency holdings with the public (increased by more than 10% in 2011-12). In Keynesian parlance, such an increase in currency holdings with the public may be attributed to a transaction motive, the desire for individuals to hold cash in order to bridge the gap between the receipt of income and its expenditure. Alternatively, the increase in currency holdings may also be attributed to the erosion of purchasing power of the consumers. (In a scenario of rising prices, purchasing the same basket of commodities will require a larger amount of cash and hence increased currency holdings.)
Although an increase in prices causes increased currency holdings with the public, it may also be possible that such causation is bi-directional: a prolonged period of increased currency holdings with the public may result in inflation, if such cash is used for purchase of commodities. But we believe that the causation from currency to inflation may not be valid in a situation of rising prices. To establish the causation between the two, we used the Granger Causality test. In econometric parlance, such causality is basically a statistical hypothesis test used to show whether one time series is useful in forecasting another.
For the statistically minded, the results when considering a one period lag (from April 2008 till February 2012) did actually show that inflation causes an increase in currency holding with the public (F value = 487.99) and has a significantly stronger impact than the impact of currency with the public causing inflation (F value = 447.86). Interestingly, if we work with a longer lag data (the public holding onto currency for a longer period), then it has an impact on inflation. Such an impact is statistically significant but only in a situation when prices are not rising.
We believe that an increase in currency with the public results in a substitution impact, whereby cheque transactions are substituted over a period of time. For example, as Exposition 1 reveals, the ticket size of cheque transactions (amount of cheque/no of cheque, May 2008 onwards) has declined significantly. More importantly, the average size of cheque transactions, that was R90,000 in the pre-Lehman period, has declined significantly in post-Lehman period to around R70,000. Clearly, the continued increase in inflation, coupled with the economic slowdown, has impacted the cheque transactions. And this, as we will shortly see, may have adversely impacted the real sector variables (a suitable proxy is IIP growth). Interestingly, as Exposition 2 shows, such a substitution is reflected in the ratio cheque times currency that declined from a high of 3 times in April 2005 to 0.7 times in March 2012.
One possible reason for declining cheque transactions, apart from inflation, is the significant jump in ECS transactions by the public in recent times. However, one point of caution here. As Exposition 2 shows, the ratio of ECS times cheque jumped from a low of 0.03 in the pre-Lehman period (September 2008) to 0.26 in March 2012. We believe, a large part of this jump in ECS transactions may be attributed to the desire to conduct transactions in electronic form post the crisis on the part of merchants etc, as this is a low-risk transaction, compared to a cheque transaction that may be more risky. Alternatively, the shift to ECS transactions is not purely because of public convenience, but also because of the desire to conduct risk-free transactions.
What are the implications of such a change in transaction behaviour in the financial system? We constructed a simple model to test the null hypothesis that a decline in the value of cheque transactions adversely impacts industrial growth. The index of industrial production (IIP) data for the general category was considered as an indicator of industrial growth. The independent variables that were considered for our model were (a) cheque amount (total amount of transactions through cheque in a month), (b) substation impact between currency and cheque, and (c) cheque and ECS. It was also hypothesised that while (a) cheque transactions and (b) ECS to cheque substitution were likely to have a positive impact on IIP, the substitution between (c) cheque and currency was likely to have an adverse impact on IIP.
The results obtained from our statistical model show that all the coefficients were statistically significant and correctly signed. In particular, the positive association between ECS to currency substitution clearly reflects that ECS transactions are now not merely retail transactions but encompass a larger gamut of financial transactions having a positive impact on economic activity.
We believe the shift to paperless transactions is likely to continue in the near future also, given the convenience, security and relatively risk-free nature of such transactions. RBI in its turn may look at the ECS data more minutely at a more granular level and make a distinction between retail transactions that are for convenience and non-retail transactions that may have a larger connotation and linkages with real sector variables. This could have important policy ramifications. For example, the Aadhaar-based payment system that will cover payment disbursals under old age pension, MGNREGA, and credit of subsidy amount for purchases of liquefied petroleum gas, kerosene and items distributed under PDS may revolutionise paperless transactions in India and plug the leakages from the financial system.
The world is currently going through a difficult phase. The eurozone is on the verge of collapse (historical experience suggests that most currency unions have broken up, including the recent ones like Soviet Union, Yugoslavia and Czechoslovakia). Additionally, as all of us know, part of the fallout from the recession is that the scythe is being taken to public spending and being driven by the markets, who are forcing governments to reduce their deficits and clean up their finances. At this juncture, Indian policymakers may well do with some out-of-box thinking for driving growth, whereby inclusiveness, adaptability and sustainability must be incorporated as essential prerequisites for a sustained double-digit, high growth rate, at least over the next 10 years.
The author is director, economics & research, FICCI. Views are personal