Digital is growing, but why is cash still the king?

Hi,

Do you know that even with the rise in digital payments, the cash held by Indians is steadily increasing? And at a rate faster than the GDP? If the digital payment success story is so grand, why is cash becoming more popular at the same time?

It’s a question that confounds me and it’s confounded economists for a long time. Until recently.?

Standard monetary models predict that cash usage and demand typically move in the same direction. Consequently, one would expect the demand for cash to decrease as alternative payment methods replace it at points of sale.?

However,?RBI’s annual report this year?revealed a little-known phenomenon called the cash paradox.?

Cash paradox happens when the demand for cash, as measured by the value of Currency in Circulation (CIC) over GDP, has either remained stagnant or even increased over the past two to three decades, despite an uptick in other methods of payment. In this case - digital payments.?

Source: RBI

Between 2022-23, the amount of money in circulation, also known as currency in circulation (CiC), increased by 7.8%. However, this growth was slower compared to the increase in Reserve Money (RM). As a result, the ratio of CiC to the country's Gross Domestic Product (GDP) decreased.

At the same time, there was a significant rise in digital payments in India after the pandemic.?

?In India, the Unified Payments Interface (UPI)-led retail digital payments grew at a compounded annual growth rate (CAGR) of 50 per cent and 27 per cent in terms of volume and value.?

Source: RBI

While the ratio of currency in circulation to the Gross Domestic Product (GDP) in India is decreasing, it is still higher compared to other major economies. This situation is often called the "currency demand paradox." It means that even though digital payments have seen significant growth and people are using less cash for transactions, the amount of physical currency in circulation in India is relatively high.?

Over the years, the ratio of currency held by the public to the Gross Domestic Product (GDP) in India has been steadily increasing.

In the 1980s,?it was 8.2%, and by the 2010s, it had reached 10.6%. Despite a significant decline in GDP and a substantial increase in digital payments, this ratio paradoxically rose to 14.5% in FY2021. Even in FY2022, with a continuous rise in electronic payments, the ratio remained high at 13%.

This persistent increase in the ratio of currency with the public?(CwP) raises questions, considering the growth of digital payments.

Source:?The Hindu Business Line

Another noteworthy trend is the increasing cash intensity in households' financial assets. From the 1990s to the 2010s, the share of currency in households' financial assets rose from 8.8% to 9.8%, and further to 12.4% in the 2010s, indicating a continuous rise over three decades.?

These findings highlight the puzzling persistence of high currency ratios despite the growth of digital payments and raise questions about why cash is still king.?

The cash paradox

The cash paradox isn’t new or unique to India. In fact, we’re only the third country to have the highest CIC to GDP ratio, behind Hong Kong and Japan.?

In Japan, for instance, I suppose?a low crime rate,?years of ultra-low interest rates?and a?nationwide network of ATMs?have made cash appealing in Japan.

In the eurozone, the cash paradox can be explained by the?interplay between two key factors: the desire for banknotes as a means of preserving wealth within the euro area (such as citizens of the euro area holding cash savings) and the demand for euro banknotes beyond the borders of the euro area.

What about India??

1. Access is not adoption?

One of the most used arguments against the narrative of being one of the fastest growing economies is access. In terms of digital payments, access means a few things?-??

Identity?-?100%?of the adult population in India has Aadhar - almost. There are many duplicates and unaccounted Aadhaar cards around and there are definitely going to be some folks who don’t yet have an Aadhaar but we’re as close to near-universal coverage as one can reasonably get.?

Bank accounts?- In 2021,?about 78% of Indians above 15 years?owned an account at a bank. This was a significant change from only 44% in 2011.?

Internet access?-?Over 50%?of Indians are active internet users

(But smartphone shipments to India and internet access are slowing down)?

Source:?Indus Valley Annual report 2023

Prima facie, access is improving. However, the adoption of?digital payments isn’t as easy as watching IPL on Jio Cinema.?

Little-known technological products face an adoption challenge. They need to be catapulted from the early market to the mainstream market to ensure survival.?

You can read why access to digital banking alone won’t fix adoption?here!?

Source:?Indus Valley Annual report 2023

1. Cash for groceries, paying domestic help, and buying property?

According to a 2022 survey conducted by Localcircles,?a market research company based in Delhi, a striking 44% of Indians revealed that they had engaged in property transactions involving cash within the past seven years -?

• 8% of consumers paid over 50% of the property value in cash, while 15% of consumers paid between 30% and 50% of the transaction amount in cash
• Approximately 20% made cash payments to domestic staff without obtaining receipts, and 10% did the same for personal services and/or home repairs
• 16% of respondents used cash for travel, personal services, home repairs, and domestic staff salaries
• 76% of households relied on cash for groceries, eating out, and food delivery transactions in the past year?(2021-2022)
• 62% of people used cash as a payment method for groceries.

1. SMEs, kacha transactions and the informal economy?

Kaccha transactions?are common among retailers and smaller MSMEs. This means goods are purchased without a bill and sold without charging GST. As a result, the retailer earns additional income without paying taxes. In contrast, pakka transactions involve proper invoicing and taxation. The kaccha economy provides a significant financial advantage to small MSMEs, allowing them to earn more income.

The informal sector accounts for nearly 40% of the Indian economy and provides employment to approximately 75% of the workforce. It has witnessed substantial job growth due to its capacity to hire a large number of low-skilled workers. The competitiveness of many companies operating in this sector stems from their ability to circumvent taxes and disregard legal requirements related to minimum wages and other labour benefits, a.k.a, paying in cash. These companies, lacking in technological advancements and scale, rely on this approach as their sole means of competing with larger, organised players.?

1. Digital payments - A UI/UX reality check?

Limited research exists on the experiences of vulnerable population groups in the digital payment ecosystem. These users, who may have low literacy, limited technological adoption, and face various constraints, encounter difficulties that have not been adequately explored.?One study by D91 labs?found that digital payment interfaces can overwhelm users, leading to cognitive overload. Navigating English interfaces and understanding technical terms pose challenges. Users rely on visual cues like spatial positioning and icons, but this can lead to errors and decreased engagement. Simplified information architecture, tailored icons, guided videos, accessible customer support, and timely notifications can help overcome these barriers.

1. Digital literacy = digital trust?

The overarching reason for the cash paradox is we don’t trust technology, because we don’t know enough.?This graph is from a survey conducted by the National Institutes of Health (NIH), a part of the U.S. Department of Health and Human Services.?

One might dismiss the cash paradox by looking at the graph. However, the?NIH report?explicitly mentions that “most of the respondents were already?digitally literate, educated and economically sound?when compared to the population. This is one of the major limitations of the study”

Source:?NIH

Only 29% of women in India are digitally literate, compared to 59% of men. Similarly, only 30% of adults over the age of 50 are digitally literate, compared to 60% of adults aged 18-29.?

And,?only 27% of Indian adults – and 24% of women?– meet the minimum level of financial literacy as defined by the Reserve Bank of India.?

When digital and financial literacy levels are low, there is a lack of trust in the system and more cash in circulation.?

In 2020, despite the pandemic, nearly?90% of all e-commerce transactions?were cash-on-delivery (COD) in tier-4 cities in India.?

Experts who weighed in on why COD transactions are so popular posit that it’s possibly because digital adoption is slower in rural areas (possibly due to lower literacy rates).?

In an interview with Economic Times, Chirag Taneja, co-founder of Gokwik said?

“We live in a low-trust society. It's not that these people have not done UPI ever. We have in fact seen that there is a 50% overlap between people using UPI or credit cards and COD. It is also a generational thing and it will take another 10-15 years to move away from COD similar to other markets like Japan,"

India is a?low-trust society.

What worsens this trust deficit is a lack of financial and digital education coupled with old habits, and a hoarding mindset.?

The RBI’s report also uncovers a crucial finding: rather than being used for day-to-day transactions, hoarded cash, particularly in the form of high denomination notes, serves as a means to preserve value during uncertain times such as the Covid pandemic. The Covid-induced lockdowns and resulting economic contraction have played a significant role in driving up CIC as a percentage of GDP.?

While the current high CIC aids the Reserve Bank of India (RBI) in its liquidity-tightening efforts, it is essential to focus on the long-term goal of reducing dependence on cash and promoting digital transactions.?

An intriguing proposition arises: returning a portion of the hoarded cash to bank accounts would infuse a substantial amount of additional deposits into the banking system, thereby aligning with the broader objective of decreasing reliance on cash and fostering the adoption of digital payment methods.?

Do you think cash is still useful as a store of value? Despite the heavy costs of storing, preserving, and protecting it? I’d love to know your thoughts.?

See you next week.?

Written by Rajat Deshpande