Cost of Cash: India

The payments business in India is on the cusp of a revolution. With rapid growth and modernization of the economy, there is no doubt that a majority of India’s 1.2 billion plus citizens will demand and get modern financial services far superior to what their parents’ generation enjoyed. It is simply a matter of when the supply side catches up.

This report is the product of a research effort that analyzed the most pertinent policy documents, reports, scholarship, expert interviews, and payments data. It is the second in a series of country reports on The Cost of Cash by the Institute for Business in the Global Context (IBGC). The series seeks to ascertain the private costs and risks of cash management facing diverse stakeholders in society: consumers, business, government, and financial systems. It does not forecast the likelihood that cash will fall into disuse, or drop below any threshold in payment market share. It is different from much of the academic work in payment economics, which focuses explicitly on social costs with a view toward informing debates around payment clearing and settlement. Instead, we analyze the private costs to households and businesses that arise from their use of cash, beginning when cash is received and ending when it is spent again. We base our estimates on original IBGC surveys, coauthors’ surveys and interviews, and a broad mix of academic studies and official statistics.

The motivating question is why Indians transact primarily in cash, and whether there is reason to expect any drastic change in their payment behavior in the short to medium term. Our conclusions are as follows:

India is cash intensive, even for a developing country.

India uses a lot of cash by any measure. It has a very high ratio of currency in broad money (M1) and a low velocity of cash — that is, a low ratio of GDP to narrow money. For example, the velocity of M1 in India is 1.5, compared to more than 6.6 in the United States in Q3 of 2013 — at which time the American easy money policy had driven velocity down from a five-year peak of nearly 11.

The ratio of money held in bills and coins (M0) to the amount held in demand deposit and savings accounts (M2) in India is 51%, which is higher than Egypt (29.3%), South Africa (8.9%), and Mexico (8.7%). For example, the velocity of M1 in India is 1.5 versus more than America’s 6.6 in 2013 Q3 — at which time the USA’s easy money policy had driven velocity down from a five year peak of nearly 11.Moreover, considering just currency, the ratio of currency to GDP in India (12.2%) is higher than countries such as Russia (11.9%), Brazil (4.1%), and Mexico (5.7%).

Most Indians currently lack the means to use non-cash payments, even if they want to.

India’s infrastructure of payments is growing, but from very modest beginnings. Fewer than 35% of Indians above the age of 15 have used a bank account. Less than 10% have ever used any kind of non-cash pay-ment instrument. The proportion of payments made in cash is thought to be dropping, but from 2009-2011, growth of bank branches slowed. Check transactions have decreased by more than 20% from a 2008 peak, balanced by an increase in Automated Clearing House (ACH) outlays and payment card transactions. Mobile banking remains a banking product and not a robust retail payments system, with less than 3% of the value transacted by cards in the year ended March 2014.

The growth in value of ATM transactions has far outpaced the growth in the value of card payment transactions.

ATM transactions in India are worth more than point-of-sale payment transactions, the opposite of what we find in rich countries. The total value of ATM transactions increased more than five times between 2007 and 2012, from about 3 trillion to about 18 trillion rupees, while the value of card transactions barely doubled in the same period from 1 to 2 trillion rupees.

Despite its prowess in the telecommunications field, India has been left behind by its peers in mobile payments.

Though India has a fiercely competitive telecommunications market, possesses a well-developed financial system, and is a widely acknowledged technology exporter, fewer than 2% of Indians have used a mobile phone to receive a payment, compared to over 60% of Kenyans and 11% of Nigerians.

The RBI has consciously chosen a bank-led model over a telecoms-led one to achieve its financial inclusion goals.

Telecoms firms have only recently been allowed to enter the payments space in India, but are limited only to partnerships with banks. The RBI sees the expansion of the banking system through the appointment of business correspondents as crucial to increasing access to a wide range of financial services, not just remittances, which it sees as a limitation of the M-PESA service in Kenya.

Aadhaar, India’s Unique Identity project, will significantly reduce costs of serving India’s unbanked population.

With 350 million unique IDs already issued and 600 million expected to be completed by 2014, the Aadhaar project aims to give every Indian a portable identity that will enable them to access a range of financial services independent of their physical location. For banks and their partner banking correspondents, this will mean a significant reduction in the costs of complying with “know your customer” (KYC) norms during account opening and assessing credit risk histories of low-income borrowers.

Households pay differently for access to cash according to their place in society, determined by income, employment, age, and place of residence. They also hold widely differing views on the risks of cash and strategies for risk management.

Although conventional wisdom assumes that cash is free, the residents of Delhi together spend 6 million hours and Rs. 9.1 crores (US $1.5 million) to obtain cash. Hyderabad, which is smaller, spends 1.7 million hours and Rs 3.2 crores (US $0.5 million) to do the same, which corresponds to fees and transport costs about twice as high as Delhi on a per capita basis. These fees, along with cash balances and wealth overall, rise in a linear fashion along with age in Delhi. Gender gaps are inseparable from women’s place in the economy; they tend to remain outside of the labor force and in the home. Employers handle the most cash, spend the most for access to cash, appreciate the risks of large cash stocks the most, and most regularly breach their preferred cash ceilings.

In Delhi, residents accept that cash is unsafe to hold, even if they rarely or never hold more cash than would be prudent. Cash also seems more risky to the rich, to men, to the aged, and to those with bank ac-counts. Conversely, the amounts of money deemed high enough to be risky and low enough to be a feasible minimum balance both scale in a linear way with wealth. The wealthy are accustomed to holding and spending more, so both their preferred maxima and minima are higher; the same is true of employers and those paid electronically. Most crucially, those that receive bank deposits are keen to keep money in their accounts. They are much more likely than the rest to retain balances in the bank if the value is first paid into an account.

Consumers choose cash because they are keenly aware of its benefits and limitations.

ICE360° research shows that most consumers see three main benefits of cash. Cash confers power on the buyer, since she can offer fixed bids for a bundle of goods and services. More than 90% of respondents in every category agree this is the case. Self-control is very important to rural respondents, with more than 80% agreed that cash prevents people from spending too much. Cash transactions are perceived to be fastest, particularly among debit users and Delhi residents. Still, large majorities — about two-thirds of respondents — agree that cash ensures exact payment.
In terms of spending location, online shopping was the only category in which a majority of respondents preferred not to use cash. Wealth effects dominate cash balances. Consumer confidence, wealth, financial access, and the levels of cash ceilings and cash floors all correlate in a linear way. Moreover, cash-only consumers know far less about the features of credit card spending.

India’s reserve bank and commercial banks face a grand total of Rs. 21,000 crores (US $3.5 billion) in currency operations costs annually.

The vast majority (86%) of that burden falls on commercial banks. The components are summarized be-low. In addition, the Reserve Bank of India (RBI) enjoys interest on the reserve assets that offset currency liabilities on the central bank balance sheet, or seigniorage.

A raft of circulars since 2008 illustrate the Reserve Bank’s priorities: availability, integrity, cleanliness, ef-ficiency, reporting. Vigilance against counterfeit has ramped up recently, including the designation of a nodal officer to liaise with police in order to report suspected counterfeiting promptly. Cash in transit (CIT) is just a couple of decades old in India and remains a small industry. In a country of 1.25 billion and a GDP of Rs. 109 lakhs crores, just Rs. 1,500 crores (US $250 million) is spent on cash in transit, employing only 40,000 individuals and 6,000 vehicles.

Commercial banks are rapidly deploying new technology to optimize costs and enhance value delivery in cash operations. The most common areas of enhancement are deposit-taking ATMs, monitoring of cash deposit ratios, facilitating currency note exchange, improved currency chests, and doorstep banking services.

Black money remains a well-documented failure of governance in India with profound consequences for tax revenue, corruption, and law enforcement in general.

Statistics show that the informal economy, nearly 90% of India’s labor market and firms, account collectively for some 40% of GDP. Economist Surjit Bhalla suggests that personal income tax compliance in India may be just 29%, or less than one-third the revenue that is India’s due. Bringing in the informal economy out of the shadows would thus have enormous impacts on India’s fiscal position.

Payments are central to India’s future success in financial inclusion.

Much of India’s recent approach has focused on the supply side of financial inclusion. The priorities of the Reserve Bank are to promote safe, efficient, accessible, inclusive, interoperable, and robust payment systems. India has addressed these priorities both through the creation of national champions, such as the National Payments Corporation of India (NPCI) and its subsidiaries, and through direct investment in universal identification. India has built the capacity to clear and settle payments. Access to that in-frastructure on a sustainable and profitable basis is a key reason behind India’s investment in universal identification and Aadhaar-enabled payments services (AEPS). According to a recent McKinsey report, the benefits of a government-led payments strategy will include lower costs of payments and less leak-age from public expenditures.