What Does India’s Demonetization Mean for Financial Inclusion?

Last week was a rather challenging one for the Indian economy. On November 8, India’s Prime Minister Narendra Modi announced a dramatic demonetization exercise that rendered all Rs. 500 and Rs. 1000 notes void starting November 9, with the objective of curbing black money, corruption, counterfeit notes, and the financing of terrorism – all of which has leveraged these larger currency notes (with values equivalent to about US$7.50 and $15.00).

The next morning saw newspapers flooded with advertisements by e-wallet companies thanking the Indian Government for its visionary move and congratulating the Prime Minister on “taking the boldest decision in the financial history of Independent India.” They even claimed Indians to be the biggest beneficiaries in this exercise, indicating this was a positive step towards solving the problem of financial inclusion and encouraging more and more people to transition to the digital world. Several banks printed front page advertisements praising this move as progress towards a cashless India. A full-fledged commercial bank endorsed the move with the tag line –Who says you need cash to get by in life?

All I could think while reading these advertisements and endorsements is that we couldn’t be any more oblivious, as we are forgetting the plight of those who remain excluded from the formal economy.

When talking about financial inclusion in India, we talk about two categories of people: those who have a bank account and those who don’t.  With the many financial inclusion reforms that India has seen over the last 5 years, the proportion of the adult population with a bank account has increased to 65 percent. But, a substantial 23 percent of those accounts remain dormant, indicating that it will take a lot more than just opening formal bank accounts for the financially excluded to be truly included.

However, given the rise of digital financial services in the last couple of years, and the facilitation of financial access through numerous electronic platforms, financial inclusion is being seen through a new lens: those who are digitally financially included versus those who are not. This category includes the population who transact digitally using debit/credit cards, point of sale (POS) machines, online banking, and mobile financial services. As per the latest Financial Inclusion Insights survey, 49% of Indian adults are digitally included. However, usage of these digital accounts remains debatable and very little data exists around this.

India’s current episode of demonetization has revealed the stark digital financial divide of the nation. Millions of people are crowding the banks and queuing outside ATM centers to deposit their cash before the deadline, revealing that India has a long way to go before it fully transitions into a digital financial economy. In spite of expanded digital access to bank accounts, a very small percentage of the population has been able to operate without withdrawing cash or visiting the bank regularly. This is in part due to lower levels of digital financial literacy.

India’s massive informal economic sector (comprising of domestic help, contract laborers, daily wage workers, farmers, fishermen, microentrepreneurs, etc.) that runs almost entirely on cash could very well come to a halt if the cash crunch situation is not tackled in the next few days. These groups of people typically do not have a formal bank account or adequate identification documents. Cash is their only means of receiving income and making payments. This overnight mandate creates a huge disruption for their work and daily lives, potentially preventing them from performing any transaction for days on end, and might have severe adverse impacts on their livelihoods and well-being.

Women in particular are less likely than men to have a formal bank account. Although we can’t generalize and say this is the case for all women in India, they often save in the form of cash stored in their homes in secret cabins and shelves, away from the eyes of the men of the household. As compared to those living in middle to higher income households and those living in urban areas, this is true more often for women from low income households residing in rural areas. The Government’s sudden announcement to make the high denomination notes void may put this segment of women in an extremely vulnerable position.

The effects of demonetization have been even more worrying in the rural parts of the country which are even more dominated by cash and which have limited physical accessibility to banks and other financial institutions. Visiting physical bank branches in rural areas still remains a time consuming and costly exercise for many. Other digital financial services like ATMs and POS machines at shops are limited in number and crippled with infrastructural issues. Ordinary rural residents are placed  in great stress with nowhere to go.

What does this demonetization mean for India’s financial inclusion landscape? Contrary to the views of some fintech  providers, the large-scale demonetization exercise will not bring the uninitiated to digital financial platforms overnight. Yes, currently the majority of people both in rural and urban areas of India do need cash to get by in life! It is true that e-wallet companies have seen a rapid surge in the number of transactions and traffic on their web and app-based platforms over the past week, but these are mostly driven by urban and metropolitan parts of the country. The state of affairs since the demonetization announcement might very well have taken people further away from holistic financial inclusion, upending their financial and overall well-being, and compromising their trust in financial institutions and the government.

In spite of this drastic step, the case for digital money and digital financial services has never been stronger. Imagine what it would be like to get by in our daily lives without using a single rupee of physical cash from our wallet! Imagine what it would be like if the electronic privileges enjoyed today by the few were enjoyed by the rest of the nation. The burden of travelling to ATM counters and banks could be avoided, access to financial services would be available at affordable costs with greater convenience, and an announcement such as the one heard last week would hardly affect anyone. It might not be needed in the first place. Needless to say, many levers in the system need to function simultaneously for us to achieve this scenario.

However, until we reach such a utopian state, we need the liquidity to keep our economy going. Declaring void roughly 85% of a country’s currency in circulation without prior notice, and without adequate planning and coordinated execution could cause severe harms in the longer term. While the effectiveness of the demonetization experiment remains debatable, it seems more and more evident that the Indian Government might have made the wrong move for the right reasons.

Note: The views set out in this article are solely those of the author and do not necessarily reflect the opinion of IFMR LEAD.

This blog post was originally published on the Center for Financial Inclusion blog.

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