Digital payments zoom, but cash in still king

People continue to hold cash given the growing uncertainty in economic and financial conditions. Cash, like gold, gives people the comfort of holding onto an asset which is highly liquid and used readily

It is not very often that a research paper by economists at the Reserve Bank of India (RBI) attracts media attention. A paper by Sakshi Awasthy, Rekha Misra and Sarat Dhal titled ‘Cash versus Digital Payment Transactions in India: Decoding the Currency Demand Paradox’ is one such paper.

The paper discusses the evolution of cash and digital payments in India. One would imagine that as there is an increase in the volume and value of digital payments, there would be a decline in cash payments. However, the paper points to a paradox that both digital and cash payments have been rising in India. What explains this paradox?

For this, we need to understand some basics of money. For anything to be classified as money it needs to serve three functions: medium of exchange, store of value, and unit of account. Medium of exchange means that money should be acceptable to people for buying and selling goods and services. ‘Store of value’ means that money should have some value as that will only enable you to buy/sell goods and services. ‘Unit of account’ means that goods and services should have a common base to enable transactions.

The paper argues that though cash is losing its share to digital payments as a medium of exchange, cash has become important for ‘precautionary’ and ‘store-of-value motives’. The decline of cash in transactions is explained by muted growth in small denomination currency (Rs 100 and below) which is used for transactions and the decline in cash withdrawals.

The graph below shows that the volume of low-denomination currency notes has remained flat for the last 10 years. Parallelly, the decline of cash payments for small transactions is being replaced by the rise in digital payments.

The rise of cash as a ‘store of value’ is explained by the rise in the share of large denomination currency (Rs 200 and above) used for ‘store of value’. We can see that share of large-value notes has increased significantly over the years barring 2016 when the government demonetised the Rs 500 and Rs 1000 currency notes. The Covid-19 pandemic created uncertainty over income and employment leading people to hold and store cash for future emergencies. The decline in interest rates and cash transfers also played a role in people holding cash.

What is interesting is that India is not the only country facing this paradox. The Bank for International Settlements (BIS) in its research noted that both digital and cash payments rose during the pandemic. While digital payments grew as people switched to contactless payments whereas demand for cash increased for ‘store of value’ purposes.

The RBI paper mentions studies with similar findings for Euro-area and Canada. Sweden is the only country that is bucking this trend and is seeing a freefall in cash payments and a surge in digital payments. So much so, that Sweden’s central bank is asking the government to frame laws urgently so that cash remains a payment option for citizens.

The RBI paper puts the spotlight on the continued importance of cash among people despite a government push towards digital payments. The research by RBI economists notes that ‘cash serves as the de facto foundation for all types of payments’. Digital payments are concentrated in regions with high economic development. Cash enables transactions between formal and informal sectors, and serves people who are financially excluded and lack digital awareness. In fact, going by the number of mushrooming scams in the digital payments space with elderly and less educated people becoming victims, cash makes a stronger case to remain an important part of the payments system.

Despite the findings, the RBI paper believes that this recent demand for cash may not translate into a permanent shift. India is witnessing a large scale development of digital infrastructure and over time more people are going to become digitally aware. The digitalisation of the economy has broader benefits such as the development of financial markets, financial inclusion, and effective governance.

The summary of the paper is rather surprising. The argument should rather have been that despite the importance of digitisation, cash continues to play an important role, and should remain in the payment system. People continue to hold cash given the growing uncertainty in economic and financial conditions. Even after the pandemic, the Indian and other national economies have constantly faced negative shocks. Cash, like gold, gives people the comfort of holding onto an asset that is highly liquid and used readily. While holding gold and cash may seem illogical to policymakers and economists, people think it is rational to hold both assets given the uncertainty.

We should be careful pushing this all-digital strategy and undermining cash. The discussion should not be about cash vs digital payments but rather the co-existence of cash and digital payments.

Amol Agrawal is an economist teaching at Ahmedabad University.

(Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH).