The limits of digital economy

The government is trying to take the country towards the digital economy and this intention is welcome. However, there are costs to digital transactions as well. The Ipsos MORI Social Research Institute commissioned by the British government to conduct research to understand how small business and consumers use different payment methods.

First finding of the study is that cash transactions are undertaken because the fees charged by card providers are high. Second reason is that e-payments portals deducted an amount for enabling the transaction.

The third reason is that people used cash for everyday purchases of less than £10 and cards for larger transactions. The fourth reason is that people found it easy to manage their budget by making cash payments. One can look into his wallet and assess how much he can spend.

It involves considerable effort to keep track of e-payments. This experience of Britain indicates that e-payments are not preferred for small everyday transactions even in a developed economy. No wonder, the UK chapter of the Global Cash Index by PUMNTS.com says that 48 per cent of payments made by British consumers and businesses in 2014 were in cash.

These studies indicate that cash is the preferred mode of transaction for small payments while e-portals are preferred for large payments. The same holds for India. I give below comparison of the costs of digital transactions. First cost is of the mobile phone. The consumer has to buy a mobile phone for, say, Rs 5,000. The mobile lasts 2 years.

Thus, she spends Rs 2,500 per year on the phone. She uses it for talking as well. Let us say 10 per cent of the use is for digital transaction. Thus she incurs a cost of Rs 250 per year for digital transactions. Second cost is of interest lost on the money deposited with the payment portal such as Paytm. Let us say she keeps Rs 1000 balance with Paytm on the average.

The interest on this amount @ 12% per year is Rs 120. Third cost is of the additional time taken to complete each digital transaction. My estimate is that a digital transaction takes about 1 minute to complete. She works 8 hours per day for 22 days every month.

Say, her salary is Rs 10,000 per month or 94 paise per minute or Rs 1 per minute approximately. She makes 10 digital transactions per month or 120 transactions per year. The cost of the 120 minutes is Rs 120 per year. The total cost borne by her comes to Rs 490 per year for spending Rs 1,20,000 by digital transactions. This works out to Rs 410 for spending Rs one lakh.

The cost of undertaking the same transaction in cash incurred by the consumer is nil. However, the Reserve Bank bears the cost of printing and replacing notes. The cost of printing each Rs 100 note is Rs 1.20.

Therefore, the cost of printing 1000 notes of Rs 100 denomination totalling the value of Rs 1 lakh is Rs 1200. Say, these notes circulate for 500 times before they are sent back to the RBI for replacement.

Therefore, the cost incurred by RBI in making one exchange of these notes to make a transaction of Rs 1 lakh is 1/500th of Rs 1200 or Rs 2.40.

Now we can compare the two modes of transactions. A transaction of Rs 1 lakh undertake digitally costs Rs 410 per lakh to the consumer even though the RBI gains Rs 2.40. The economy loses Rs 407.60 per lakh. Digital transactions, however, become cheap if the amounts involved are large.

Let us say a small businessman makes digital transactions of Rs 10 crore every year. The total cost borne by a small businessman in mobile phone and time taken for undertaking these digital transactions comes to Rs 370 per year assuming he does not keep a balance in the bank on which he loses interest.

The cost borne by him is Rs 37 for a transaction of Rs 10 crore or 37 paise per lakh. On the other hand, the RBI gains Rs 2.40 as calculated previously. The economy gains Rs 2.03. It is clear that digital transactions are harmful for the economy when used to make small transactions but beneficial when used to make large transactions.

The e-payment portals and the Reserve Bank of India will, however, gain hugely if people make large numbers of small digital payments. A number of people have parked monies with Paytm in order to make day-to-day purchases. Paytm will earn interest on this amount.

The issuing banks will gain from the increased numbers of transactions undertaken on credit and debit cards. Therefore, demonetisation imposes costs on the people while providing benefits to the e-portals and banks.

Rahul Gandhi raised the right slogan “Garib se khincho, amir ko sincho,” but he failed to communicate this to the people in view of the long history of charges of corruption against the Gandhi family. Therefore, his words did not carry conviction even though they were factually correct.

Conclusion is that the government is imposing large unnecessary costs on the ordinary citizens in pushing them to embrace digital payments. People of the country will soon realise that small payments are better made in cash and this campaign of digitisation will come to a naught.

The present drive is also not likely to hit at black money. A Report from Bank of England says that only 48 about per cent of currency issued in England is used for transactions. Rest is either held abroad or used in the ‘shadow’ economy—which is the same as black money.

A trader I know made a payment of Rs 2 lakh in cash for the purchase of building material barely 10 days after demonetisation. The savings of tax on this purchase made in back money would be about Rs 24,000. This is substantial.

The traders have already reverted to cash for making their black money transactions. The large numbers of new notes apprehended in bulk after the demonetisation drive indicates that new notes have taken place of old notes in the stocks of black money.

It is clear that the drive of the Central government towards cashless economy will fail utterly. However, it will take a few months for the people to understand this reality.

For the present, the poor people stand in support of this drive. They feel that the Central government has taken a bold action against the corrupt rich and powerful howsoever incorrect this may be.

By: Dr Bharat Jhunjhunwala
Author was formerly Professor of Economics at IIM Bengaluru