One Year After India Killed Off Cash, Here\u2019s What Other Countries Should Learn from It<\/h1>\n\n\n- Bhaskar Chakravorti<\/a><\/li>\n<\/ul>\n<\/div>\nNOVEMBER 02, 2017<\/div>\n<\/div>\n<\/div>\n
\n\n\n\n\n\n- <\/i>\u00a0SUMMARY<\/span><\/a><\/li>\n
- <\/i>\u00a0SAVE<\/a><\/li>\n
- <\/i>\u00a0SHARE<\/a><\/li>\n
- <\/i>COMMENT<\/span><\/a><\/li>\n
- <\/i>\u00a0TEXT SIZE<\/span><\/a><\/li>\n
- <\/i>\u00a0PRINT<\/a><\/li>\n<\/ul>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/section>\n<\/div>\n\n\n
<\/a><\/p>\n<\/div>\n\n\n![\"nov17-02-476556668-Mint\"](\"https:\/\/hbr.org\/resources\/images\/article_assets\/2017\/11\/nov17-02-476556668-Mint.jpg\")
Mint\/Getty Images<\/figcaption><\/figure>\n<\/div>\nAlmost a year ago, the Indian government rolled out an unprecedented policy move. Arguably, it was a time when the country was poised for economic success.\u00a0With\u00a0$9.49 trillion in purchasing power parity<\/a>, it was the third-largest (in PPP terms) and the fastest-growing large economy in the world. On November 8, with no advance warning, India\u2019s two highest-denomination banknotes, the 500-rupee and 1,000-rupee bills, were demonetized, rendering 86% of the country\u2019s currency invalid overnight. The ostensible objective was a popular one: to root out corruption and illegitimate activity involving untraceable cash transactions. As the implications unfolded, I wrote two pieces (\u201cIndia\u2019s Botched War on Cash\u201d<\/a>\u00a0and\u00a0\u201cEarly Lessons from India\u2019s Demonetization Experiment\u201d<\/a>) evaluating the policy and its impact. My assessment of the action was that the policy was poorly thought\u00a0out and executed and that its net impact would be negative and particularly bad for the poor.<\/p>\nIndeed, India subsequently suffered a dramatic drop in its GDP growth rate, which fell to\u00a06.1% annualized during January\u2013March 2017<\/a>\u00a0after three quarters with the annualized growth rate\u00a0staying in the range of 7.9% to 7%. It most recent GDP growth figure has fallen to 5.7%, and part of that, too, can be attributed to the policy move from last November.<\/p>\nAs we are closing in on the one-year anniversary, it is natural to reflect on the lessons of this policy move. The Indian experience holds powerful lessons for policy makers planning economic interventions around the world.<\/p>\n
Lesson One: Choose Your Experts Carefully<\/h3>\n
All policies have consequences. Tracing the paths of those consequences is seldom straightforward, particularly when the impact is felt across a complex economy. In light of this, every economic policy ought to be preceded by some essential process elements: a sound theory; a rationale\u00a0for why the underlying assumptions are valid, and the evidence for those assumptions; and cost-benefit analyses, including accounting for the systemic effects, unintended consequences, and learnings from similar actions elsewhere. Such processes are not easy to do and ought to be guided by experts in economics, business, and technology paired with experts in policy execution.<\/p>\n
When considering action as drastic as shutting down highly-used currency in a large and complex economy, as was the case in India,\u00a0such professionals ought to have been part of the process. To\u00a0quote<\/a>the person who may have been the most qualified to advise on such action, Raghuram Rajan, the widely respected former governor of India\u2019s central bank: \u201cAs a country, you would want to ask what were the inputs that went into that decision.\u201d Rajan, in a new\u00a0book<\/a>, reveals he was against the idea of demonetization. The other natural professional, the Indian government\u2019s chief economic adviser, has been quiet on the matter. He is known to have been a critic of\u00a0\u201cbig bang\u201d<\/a>\u00a0policy. One might speculate that he too would have advised against one of the biggest of bangs, such as a surprise demonetization.<\/p>\nIt\u2019s unclear if any other experts have been consulted on the India policy.\u00a0NPR\u2019s Planet Money<\/a>\u00a0did report\u00a0on one \u201cexpert\u201d who might have been the inspiration: a hitherto unknown mechanical engineer-turned-turned-social-activist named Anil Bokil, with a five-point plan for \u201cprincipled, prosperous, and peaceful living\u201d and a 94-page PowerPoint\u00a0manifesto<\/a>\u00a0that he pitched to Prime Minister Narendra Modi.<\/p>\nBefore launching a policy action with such far-reaching consequences, there should have been a clear process for receiving professional expertise, data, and analyses and a mechanism for debate and discussion of the assumptions and the impact. It is important to have a record of such a process, even if it has to be conducted in secret. Governments need to be able to demonstrate that they have done\u00a0their homework regardless of the ultimate outcomes of the action. Any democratically elected government owes this to its citizens \u2014\u00a0and to its country\u2019s future.<\/p>\n
Lesson Two: Don\u2019t Ignore Basic Data<\/h3>\n
All policies have a stated objective of providing a public good. But every policy decision also involves trade-offs; invariably, creation of a public good places a burden on some segments of society. A fact-based cost-benefit analysis is essential. Any policy ought to be able to pass a simple test: If the basic data on the economy in a pro forma assessment suggests that the policy runs a high risk of failure or has a major negative impact, stop and ask more questions before proceeding.<\/p>\n
The primary public good cited for India\u2019s demonetization move was to take on the problem of corruption and illegal activity. Many commentators have commended the Indian prime minister for his\u00a0\u201ccourage\u201d<\/a>\u00a0in taking on such fundamental problems with bold action. This decisiveness was also popular and was rewarded politically by the strong performance of the Modi administration in crucial\u00a0midterm regional elections.<\/a><\/p>\nThere are, however, several factors that ought to have been considered in the context of invalidating cash in India from the outset. For one, invalidating\u00a086%<\/a>\u00a0of the value of cash in circulation should be an automatic red flag, because it\u00a0could bring the economy to the brink of chaos. Second,\u00a090%<\/a>\u00a0of India\u2019s workers are in the informal sector, where the predominant form of payment is cash. It is hard to imagine a scenario in which such \u201cdouble\u201d invalidation would not constitute a body blow to the workforce and the economy. Third, in a recent\u00a0analysis of income tax probes<\/a>, the cash component of undeclared wealth in India was estimated to be only about 6%. In other words, the policy instrument was aimed at the wrong target: most undisclosed wealth is held in noncash assets. All of this data was readily available and should have given the policy makers pause.<\/p>\nLesson Three: Consider Human Behavior<\/h3>\n
As observed earlier, policies ought to be accompanied by a theory about how the policy intervention is expected to translate into impact. This translation mechanism itself relies on the assumptions about how real people behave in response to a change in their environment. The effectiveness of policies ultimately depends on how well one anticipates such behaviors, which, in turn, involves taking a holistic view of the incentives and contexts of citizens\u00a0\u2014 what people want, what they believe, and what they know about their environments. Policy makers must factor in how they have an effect on these fundamental drivers in order to change behaviors.<\/p>\n
In the case of India\u2019s demonetization, it is safe to assume that people have a strong incentive to not lose money, so it is natural that they found ways to deposit their invalidated cash in the banks. In Indian society, not unlike in societies around the world, there is access to money-laundering networks and creative schemes for getting around rules and regulations. For an example of one such scheme, people with large holdings of the old banknotes sold them at a discount to brokers who then distributed them across a network of other people to deposit smaller amounts at banks so that they would not trigger an audit. India\u2019s central bank, the\u00a0RBI, recently reported<\/a>\u00a0that of the estimated 15.28 trillion rupees ($239 billion) in currency taken out of circulation by demonetization, almost 99% had been returned to the banking system. The original argument for demonetization unraveled because of the strategy of leaving the holders of illegal cash stranded with useless banknotes appears to have mostly failed.<\/p>\n<\/div>\nLesson Four: Beware of Digital Silver Bullets<\/h3>\n
With the growing embrace of mobile communications and digital technology worldwide, along with\u00a0major technology players<\/a>\u00a0committing to using their products and technologies as forces for social good, there is a growing belief that these technologies can bring about rapid change. Of course, it also helps that the term \u201cdisruptive\u201d is frequently attached to such technologies. With this context in mind, it is tempting for policy makers to champion something that promotes digital uptake with the argument that it will be transformational. In such situations, it should be verified that the conditions for such uptake do indeed exist in the economy.<\/p>\nIn India\u2019s case, when it was becoming clear that the initial objective of leaving illegal cash hoardings stranded was failing, the administration changed its narrative to a backup rationale: The demonetization was good for weaning the country off its dependence on cash and moving transactions to digital platforms, thereby leading to greater efficiencies, transparency, and growth of online commerce, thereby catapulting India more forcefully into the digital age.<\/p>\n
Unfortunately, here, too, the policy\u2019s impact has fallen short. According to\u00a0additional data from the RBI, while digital transactions did spike post-demonetization (when consumers had few alternatives), they have now\u00a0dropped below the peak levels<\/a>\u00a0in both volume and value. Growth in digital transactions has been slowing each month since demonetization.<\/p>\nWith the exception of the Unified Payments Interface, a payments system that facilitates instant fund transfers between bank accounts on mobile platforms, all other digital payments transactions have declined. All things considered, this modest change in digital uptake could deliver over the longer term, but it is not clear why invalidating 86% of the country\u2019s cash was necessary to promote a single payment platform.<\/p>\n
The Indian experience also helps us explore the reasons why the adoption of digital payments did not accelerate as one might have expected after demonetization. The explanation relies on an understanding of factors that drive digital adoption. The quality of the digital experience is one such factor. If nothing else changes in their environment and incentives, and users\u2019 digital experiences are poor, they will go back to the predigital status quo.<\/p>\n
- \n
- Bhaskar Chakravorti<\/a><\/li>\n<\/ul>\n<\/div>\nNOVEMBER 02, 2017<\/div>\n<\/div>\n<\/div>\n
\n \n\n\n\n- \n
- <\/i>\u00a0SUMMARY<\/span><\/a><\/li>\n
- <\/i>\u00a0SAVE<\/a><\/li>\n
- <\/i>\u00a0SHARE<\/a><\/li>\n
- <\/i>COMMENT<\/span><\/a><\/li>\n
- <\/i>\u00a0TEXT SIZE<\/span><\/a><\/li>\n
- <\/i>\u00a0PRINT<\/a><\/li>\n<\/ul>\n<\/div>\n<\/div>\n<\/div>\n
<\/div>\n<\/div>\n<\/section>\n<\/div>\n\n\n<\/a><\/p>\n
<\/div>\n\n\nMint\/Getty Images<\/figcaption><\/figure>\n<\/div>\n Almost a year ago, the Indian government rolled out an unprecedented policy move. Arguably, it was a time when the country was poised for economic success.\u00a0With\u00a0$9.49 trillion in purchasing power parity<\/a>, it was the third-largest (in PPP terms) and the fastest-growing large economy in the world. On November 8, with no advance warning, India\u2019s two highest-denomination banknotes, the 500-rupee and 1,000-rupee bills, were demonetized, rendering 86% of the country\u2019s currency invalid overnight. The ostensible objective was a popular one: to root out corruption and illegitimate activity involving untraceable cash transactions. As the implications unfolded, I wrote two pieces (\u201cIndia\u2019s Botched War on Cash\u201d<\/a>\u00a0and\u00a0\u201cEarly Lessons from India\u2019s Demonetization Experiment\u201d<\/a>) evaluating the policy and its impact. My assessment of the action was that the policy was poorly thought\u00a0out and executed and that its net impact would be negative and particularly bad for the poor.<\/p>\n
Indeed, India subsequently suffered a dramatic drop in its GDP growth rate, which fell to\u00a06.1% annualized during January\u2013March 2017<\/a>\u00a0after three quarters with the annualized growth rate\u00a0staying in the range of 7.9% to 7%. It most recent GDP growth figure has fallen to 5.7%, and part of that, too, can be attributed to the policy move from last November.<\/p>\n
As we are closing in on the one-year anniversary, it is natural to reflect on the lessons of this policy move. The Indian experience holds powerful lessons for policy makers planning economic interventions around the world.<\/p>\n
Lesson One: Choose Your Experts Carefully<\/h3>\n
All policies have consequences. Tracing the paths of those consequences is seldom straightforward, particularly when the impact is felt across a complex economy. In light of this, every economic policy ought to be preceded by some essential process elements: a sound theory; a rationale\u00a0for why the underlying assumptions are valid, and the evidence for those assumptions; and cost-benefit analyses, including accounting for the systemic effects, unintended consequences, and learnings from similar actions elsewhere. Such processes are not easy to do and ought to be guided by experts in economics, business, and technology paired with experts in policy execution.<\/p>\n
When considering action as drastic as shutting down highly-used currency in a large and complex economy, as was the case in India,\u00a0such professionals ought to have been part of the process. To\u00a0quote<\/a>the person who may have been the most qualified to advise on such action, Raghuram Rajan, the widely respected former governor of India\u2019s central bank: \u201cAs a country, you would want to ask what were the inputs that went into that decision.\u201d Rajan, in a new\u00a0book<\/a>, reveals he was against the idea of demonetization. The other natural professional, the Indian government\u2019s chief economic adviser, has been quiet on the matter. He is known to have been a critic of\u00a0\u201cbig bang\u201d<\/a>\u00a0policy. One might speculate that he too would have advised against one of the biggest of bangs, such as a surprise demonetization.<\/p>\n
It\u2019s unclear if any other experts have been consulted on the India policy.\u00a0NPR\u2019s Planet Money<\/a>\u00a0did report\u00a0on one \u201cexpert\u201d who might have been the inspiration: a hitherto unknown mechanical engineer-turned-turned-social-activist named Anil Bokil, with a five-point plan for \u201cprincipled, prosperous, and peaceful living\u201d and a 94-page PowerPoint\u00a0manifesto<\/a>\u00a0that he pitched to Prime Minister Narendra Modi.<\/p>\n
Before launching a policy action with such far-reaching consequences, there should have been a clear process for receiving professional expertise, data, and analyses and a mechanism for debate and discussion of the assumptions and the impact. It is important to have a record of such a process, even if it has to be conducted in secret. Governments need to be able to demonstrate that they have done\u00a0their homework regardless of the ultimate outcomes of the action. Any democratically elected government owes this to its citizens \u2014\u00a0and to its country\u2019s future.<\/p>\n
Lesson Two: Don\u2019t Ignore Basic Data<\/h3>\n
All policies have a stated objective of providing a public good. But every policy decision also involves trade-offs; invariably, creation of a public good places a burden on some segments of society. A fact-based cost-benefit analysis is essential. Any policy ought to be able to pass a simple test: If the basic data on the economy in a pro forma assessment suggests that the policy runs a high risk of failure or has a major negative impact, stop and ask more questions before proceeding.<\/p>\n
The primary public good cited for India\u2019s demonetization move was to take on the problem of corruption and illegal activity. Many commentators have commended the Indian prime minister for his\u00a0\u201ccourage\u201d<\/a>\u00a0in taking on such fundamental problems with bold action. This decisiveness was also popular and was rewarded politically by the strong performance of the Modi administration in crucial\u00a0midterm regional elections.<\/a><\/p>\n
There are, however, several factors that ought to have been considered in the context of invalidating cash in India from the outset. For one, invalidating\u00a086%<\/a>\u00a0of the value of cash in circulation should be an automatic red flag, because it\u00a0could bring the economy to the brink of chaos. Second,\u00a090%<\/a>\u00a0of India\u2019s workers are in the informal sector, where the predominant form of payment is cash. It is hard to imagine a scenario in which such \u201cdouble\u201d invalidation would not constitute a body blow to the workforce and the economy. Third, in a recent\u00a0analysis of income tax probes<\/a>, the cash component of undeclared wealth in India was estimated to be only about 6%. In other words, the policy instrument was aimed at the wrong target: most undisclosed wealth is held in noncash assets. All of this data was readily available and should have given the policy makers pause.<\/p>\n
Lesson Three: Consider Human Behavior<\/h3>\n
As observed earlier, policies ought to be accompanied by a theory about how the policy intervention is expected to translate into impact. This translation mechanism itself relies on the assumptions about how real people behave in response to a change in their environment. The effectiveness of policies ultimately depends on how well one anticipates such behaviors, which, in turn, involves taking a holistic view of the incentives and contexts of citizens\u00a0\u2014 what people want, what they believe, and what they know about their environments. Policy makers must factor in how they have an effect on these fundamental drivers in order to change behaviors.<\/p>\n
In the case of India\u2019s demonetization, it is safe to assume that people have a strong incentive to not lose money, so it is natural that they found ways to deposit their invalidated cash in the banks. In Indian society, not unlike in societies around the world, there is access to money-laundering networks and creative schemes for getting around rules and regulations. For an example of one such scheme, people with large holdings of the old banknotes sold them at a discount to brokers who then distributed them across a network of other people to deposit smaller amounts at banks so that they would not trigger an audit. India\u2019s central bank, the\u00a0RBI, recently reported<\/a>\u00a0that of the estimated 15.28 trillion rupees ($239 billion) in currency taken out of circulation by demonetization, almost 99% had been returned to the banking system. The original argument for demonetization unraveled because of the strategy of leaving the holders of illegal cash stranded with useless banknotes appears to have mostly failed.<\/p>\n
<\/div>\nLesson Four: Beware of Digital Silver Bullets<\/h3>\n
With the growing embrace of mobile communications and digital technology worldwide, along with\u00a0major technology players<\/a>\u00a0committing to using their products and technologies as forces for social good, there is a growing belief that these technologies can bring about rapid change. Of course, it also helps that the term \u201cdisruptive\u201d is frequently attached to such technologies. With this context in mind, it is tempting for policy makers to champion something that promotes digital uptake with the argument that it will be transformational. In such situations, it should be verified that the conditions for such uptake do indeed exist in the economy.<\/p>\n
In India\u2019s case, when it was becoming clear that the initial objective of leaving illegal cash hoardings stranded was failing, the administration changed its narrative to a backup rationale: The demonetization was good for weaning the country off its dependence on cash and moving transactions to digital platforms, thereby leading to greater efficiencies, transparency, and growth of online commerce, thereby catapulting India more forcefully into the digital age.<\/p>\n
Unfortunately, here, too, the policy\u2019s impact has fallen short. According to\u00a0additional data from the RBI, while digital transactions did spike post-demonetization (when consumers had few alternatives), they have now\u00a0dropped below the peak levels<\/a>\u00a0in both volume and value. Growth in digital transactions has been slowing each month since demonetization.<\/p>\n
With the exception of the Unified Payments Interface, a payments system that facilitates instant fund transfers between bank accounts on mobile platforms, all other digital payments transactions have declined. All things considered, this modest change in digital uptake could deliver over the longer term, but it is not clear why invalidating 86% of the country\u2019s cash was necessary to promote a single payment platform.<\/p>\n
The Indian experience also helps us explore the reasons why the adoption of digital payments did not accelerate as one might have expected after demonetization. The explanation relies on an understanding of factors that drive digital adoption. The quality of the digital experience is one such factor. If nothing else changes in their environment and incentives, and users\u2019 digital experiences are poor, they will go back to the predigital status quo.<\/p>\n
- <\/i>\u00a0SAVE<\/a><\/li>\n
- <\/i>\u00a0SUMMARY<\/span><\/a><\/li>\n