From Demonetization to Digitalization

From Demonetization to Digitalization

Ravi Kumar Pillai

“A tale of two D’s” is how the current phase India’s financial governance can be summed up. The two D’s are Demonetization and Digitalization. Together they have disrupted the processes, pace and compliance of finance and taxation.

Demonetization was one of the most controversial and much pilloried decisions of Narendra Modi midway through his first term as the Prime Minister. A broad spectrum of critics from committed leftists to academicians, business leaders and economists mounted a high decibel attack on this unexpected move. While acknowledging the naivety and political risks involved in this move, let us look at the flipside of the matter.

From a transformational perspective, this single step has a number of long-term consequences for the economy, structural discipline and governance. True, the hurried implementation did put an enormous strain on the socio-political fabric in the short term. Those at the margins of sustenance, who relied on the informal cash-based economy for their livelihood, suffered the most.

The original intention of demonetization, as we understood from Government’s posturing and commentaries in the press, was to unearth black money. Significant amount of unaccounted wealth was slashed away by unscrupulous businessmen, avaricious politicians and the public which took parallel economy as the Indian ‘normal’. However, the ill-gotten wealth has been seldom held in cash, but mostly deployed in other avenues like gold, real estate and money lending. Also, a significant share of illegal earnings found way to financial safe havens including the Swiss banks and other offshore banking channels. The informal foreign currency rackets, in the form of havala trade, have been funding drug trafficking, gangsterism and subversive activities over the years.

However noble the intentions were, declaring 1000 and 500 denomination notes no longer legal tender failed to dent black money markets to the extent Government expected. According to RBI, almost the entire estimated currency in circulation prior to demonetization came back to the banking system post-the exercise. Possibly a significant amount of black money would have been regularized with the connivance of willing bank officials utilizing the opportunity to exchange old notes for new. Further, by November 2018, the cash in circulation bounced back and surpassed the levels existing before November 2016 when demonetization was announced.

The other three intended outcomes were choking the avenues of terror funding, delivering a body blow to counterfeiting and giving a jolt to corruption. While terror funding would have been squeezed to an extent, counterfeiting reared its head within a short span with fake 2000 denomination notes surfacing within six months. As for corruption, over seventy years of “soft gloves” policy had reinforced the comfort level of corrupt officials; apart from being a temporary “alarm bell”, demonetization did not send any strong retributory message.

Therefore, the overall assessment is that demonetization failed to achieve most of its high impact objectives. But in this milieu, there are a few silver linings that auger well for the future of financial systems in the country. Most notably, demonetization created a favorable environment to fast track the move to the other D, digitalization.

Digital transactions have gone up post-demonetization. National Payment Corporation of India (NCPI) data shows that digital transactions volume in its immediate payment system doubled in the span of just one year since demonetization to reach nearly Rs. 3,25,000 crores by Q1 of 2018.

The tax net has been widened and direct tax collections have gone up significantly. The number of taxpayers increased by 15% over the two-year period 2014-2016 prior to demonetization; but post November 2016, taxpayer base went up by a whopping 58% in the next two years.

Direct tax buoyancy nearly doubled in the two years since demonetization. This means that for every percentage point increase in GDP, the overall tax collection has gone up to 1.8%, as against nearly 1% in the pre-demonetization period. Clearly demonetization increased tax net and compliance.

There was significant increase in usage of card, wallet and immediate payment systems like NEFT and RTGS following demonetization. The success of new fin-tech startups like Paytm and Phone Pe and increased traffic to the mobile wallets by Telcos were catalyzed by the demonetization nudge. Google Pay and Amazon Pay are now gaining ground giving tough competition to the local alternatives.

Demonetization served as a wake-up call to speed up the transformation to digital transactions. A digital economy has a high proportion of non-cash transactions through formal banking channels, mobile wallets and credit/debit cards.

After two years, when we look back on the aftermath of demonetization, the following aspects of the sudden jolt and its aftermath were noteworthy:

  1. The exercise highlighted the importance of risk taking as a strategic competence of political leadership. Transformational leaders do not back away from taking risks. If only the political leadership in this country had dared to take more studied and calculated strategic risks in the past, without shying away on populist considerations, the stability and strength of our economy would have been greater.
  2. Resilience of the Indian socio-political structure revealed an unexpectedly high pain threshold. The pent-up anger and frustration of the public against the businessmen – politician - bureaucrat nexus of corruption might have motivated ordinary people to put up with threats to livelihood in the short run. A weaker polity would have recoiled under the stress of demonetization, as happened in many countries which attempted similar exercises.

Any discussion on digitalization of Indian economy needs to acknowledge the early landmarks that served as the harbinger of changes piloted by Dr. Manmohan Singh, such as the setting up of National Stock Exchange (NSE) in 1992 and the initiation of Direct Bank Transfer (DBT) of subsidies in 2013. Both were landmark events in the evolution to a digital economy.

We have come a long way in our journey of digitalization and the initiative has gathered speed in the past five years. The digitalization of the economy is well and truly on a fast track. The learning curve is maturing after having gone through two painful processes - demonetization and roll out of GST. GST Net seems to have overcome the teething problems. GST has served in formalizing and expanding the indirect tax coverage and collections.

Nearly 30 Crores Jan Dhan Accounts (zero-balance accounts) have been opened bringing banking within the reach of the aam admi. Aadhar (Unified National Identity) card system has almost reached universal coverage. The penetration of smart Mobile phones is on the rise with addition of over 25 million smart phones every quarter. Over 40% of the mobile phones in use are smart phones. These three developments provide the basis for digitalization of financial transactions on a massive scale. This digital eco system for democratization and financial inclusion is popularly referred to as JAM, taking the first letters of the initiatives.

The greatest impact of digitalization is that it enables targeted and transparent system of direct transfer of subsidies to the deserving sections of society. Apart from preventing leakages and reducing corrupt practices, it insulates the utilities and government institutions from the overhang of poverty alleviation schemes in their balance sheets. How direct transfer of LPG Subsidy has helped clean up the financial health of Oil PSUs is an example worth carrying to the next level. Hopefully all subsidies will be converted to targeted direct transfer in the near future. This is what is made possible by the multi-layered India Stack system built on the backbone of Aadhar. The contribution of Nandan Nilekani and his band of dedicated youngsters to drive the India Stack Project has been remarkable. The scalability, security and resilience of the system enables seamless transformation to a cash-less (or more appropriately less-cash) society.

India Stack has at the bottom of the layers, the Aadhar database and the unique identification number of citizens. Aadhar data has fingerprint identification and can be fortified by biometric identification. Above that sits the e-KYC layer which serves as the verification and consent of the individual to use the data for the intended purpose. Then there is the linkage to the bank account and the cashless transaction layer with Application Program Interface (API). An API is a set of routines, protocols, and tools for building software applications. UPI (Unified Payment Interface), forming part of the India Stack bundle is one of the popular APIs enabling instant money transfer with security and accuracy. BHIM App operated by the National Payments Corporation of India brings financial access and mobility to the masses on the back of UPI.

There have been concerns and litigation about the privacy and security implications of Aadhar platform. The Supreme Court held that Aadhaar scheme is constitutionally valid, but it struck down Section 57 of the Aadhaar Act that permitted private entities like telecom companies and banks to use Aadhaar data. In the interest of social security net for the vulnerable sections of the society and smooth subsidy disbursal, we need to fortify and empower the Aadhar-enabled, presence-less, paper-less and secure delivery protocol to cover all citizen payments from Government exchequer.

Digitalization of financial disbursement is definitely the way forward for enhancing inclusiveness in public finance and governance. Hopefully, over the next couple of years digital delivery of all payments from Government to the targeted beneficiaries would be formalized and implemented to usher in simplicity, transparency and ease of living for people at large. The next decade should see the transformation of India to a substantially digitalized society where access to secure and fast services is assured to all citizens.

*Ravi Kumar Pillai is CEO and Principal Consultant at Cherrypick India, Trivandrum and can be reached at