Soc Gen: India Move to Cashless Society Hurting Economy

Tue, Dec 13, 2016 - 8:28am

On December 7, the Reserve Bank of India, going against consensus expectations, did not cut interest rates – underlying the assumption that the Indian economy, in the midst of moving to a cashless society, was doing fine, was doing just fine. This assumption is incorrect, says a December 12 Societe Generale report. Also incorrect is the assumption that “demonetization” will achieve its goal of curbing the black market in India. It’s not happening and the economy is suffering as a result, a trend that the bank says could last to the first quarter of 2017 and beyond.

Moving to cashless society benefits the banks, as non-performing loans are problematic

What is the primary goal of the demonetization of India? To listen to official sources, and here a tale of the need to reign in the black market, terrorist and criminal activity along with tax evaders and counterfeit currency. They did this by using the “element of surprise.”

On the day of the US presidential election, Indian Prime Minister Narendra Modi announced his nation was banning more than 80% of its cash currency and a series of logistical nightmares and outrage among its citizens followed. Those holding common notes are being told to exchange their cash for what they tout as a more secure system.

Read Cashless: The Coming War on Tax-Evasion and Decentralized Money

In a country where only 3% of its residents pay income tax and four out of five transactions occur in cash, the stated reasons for migrating to a digital currency where all transactions can be tracked is clear. But, as Societie General India analyst Kunal Kumar Kundu notes, there is another motivation: help the region’s banks.

“The potential windfall (from demonetization) would have helped the government to pump prime the economy while at the same time using part of the proceeds to recapitalize the state-owned banks which are reeling under the burden of NPLs (non-performing loans),” the report stated, without exploring all the methods that an entirely digital currency could help the banks.

Move away from paper currency will not achieve stated goals and will result in economic pain

The move away from paper currency has been widely touted based on its benefits, but rarely are the negatives discussed.

This is where the report, titled “Demonetisation: RBI downplays risk, but we beg to differ,” also differs from the wide-eyed positive analysis relative to moving to a cashless society.

The primary argument that Kundu makes is that, at its most basic level, demonetization is not likely to work. There are several points on which this thesis is based.

While India’s central bank has downplayed the economic impact of demonetization, Societie Generale “begs to differ.”

Read Martin Armstrong: Expect Cashless Society, Not Hyperinflation

“We feel that unleashing demonetisation on a mostly cash-based economy dominated by the informal (or unorganized) sector was always going to be fraught with danger,” the report stated. “The end result is most likely to be relatively sharp economic pain in the short term and a less meaningful gain in the long term in terms of curbing black money.”

They project the economic pain will continue until at least the first quarter of 2017 “if not longer.”

The pain is going to come with little gain. The report estimates that “0% of the currency in circulation (roughly around INR3tn) will not come back to the system because many people with unaccounted cash would prefer to forgo this money than to draw the tax authorities’ attention by depositing it in banks.”

The stated goals of weeding out the existing black money from the system are only likely to be achieved in small part, the report points out:

Eventually we think only a small amount of cash deposited with the bank will be identified as black money, given the multiple loopholes that have already been exploited. And even after these are identified as black money by the government, there is no guarantee that the tax revenue will follow, as a good part of these claims by the income tax department could eventually end up as litigation. Given that litigations tend to take a very long time in India, the actual tax revenue realized by the government during the current financial year would be quite low.

The negative impact the demonetization exercise has on the economy, however, is likely to be much more significant.

With a December 30 deadline to turn in cash – considered a soft time frame – the real issue with the move to demonetization might be measured in the economic hardship brought on by the change.

By Mark Melin

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