The Hindu Business Line : Pay by cash please!

If India wants to march ahead towards becoming a developed nation, it will have to get out of the `cash please' mentality sooner than later. And it is time generous incentives were given to encourage the use of cards instead of cash.

Payment by cash, rather than by cheque or credit card, is still much more welcome in India, which has ambitions to become a developed country sooner than later.

And it is not only in a village fair where cash payments are insisted on; there are urban retailers of different hues who take the same route too.

Jewellery shops prefer cash. If a shop is comfortable with credit cards, it must be a relatively large jewellery store in a city such as Bangalore. In less-endowed cities, one must pay a small percentage for the `inconvenience' the credit card bestows on the seller.

Travel agents in Hyderabad or Bangalore have no problem getting paid by credit cards, though this, too, has no universal applicability. One agent in a large metropolis had to get used to the credit card, since most of his customers paid cash.

Some months ago, as I was collecting my ticket for a flight on a private carrier from its city office, I noticed a young man collecting a number of tickets and paying with bundles of currency notes.

I asked the sales executive if it is in order to collect so much cash and he said that there was absolutely no problem.

Upper limit for cash payment

A traditional health centre in a fairly large town advertises in the front office that only cash is accepted. It never occurred to me that there is no official limit on how much cash one could use for different purposes.

In what seemed like an official brochure on the schedule of payments, a property vendor of considerable repute states how much of the price is payable in cash — running into several lakhs of rupees.

A friend commented favourably about the volume of black money payment involved, by stating that it was just under 14 per cent, against the horrors of the not too distant past, when some had to pay as much as half of the property cost in cash.

For many erstwhile NRIs, spending many years abroad has resulted in a lack of appreciation of the vital `life skills' needed for survival at home. It appears as though there is no limit what so ever on the amount of cash that could change hands legally.

In elementary macroeconomics, one of the first topics discussed is the `circular flow mechanism', which refers to production leading to incomes (wages, rents, interest payments and profits) and that, in turn, generating demand for the products of economic activity via consumption and capital expenditures. In the aggregate, the values of the three flows — production (or more precisely, output), income and expenditure — are identical.

The formal system of national income accounting has evolved over the years to capture the quarterly/annual magnitudes of product, income and expenditure, which help in ascertaining the health of the economy. When the aggregates are available periodically, one obtains a picture of how the economy has been performing over time.

An important aspect of the practice of macroeconomics and national income accounting is that only legally accepted, approved and recognised activities enter the calculus. But it is the illegal activities that propel what has come to be known as "the parallel economy, black economy, underground economy", etc, the terms being not quite the same in terms of what they denote, but all referring to a part of the economy that is not legally recognised and, hence, does not enter the official national income accounts.

The parallel economy has all the features of the legally recognised macro-economy — pricing, production, income generation, etc., — with the convenience of not having to worry about policy induced or legally binding hassles, or taxation. The parallel economy comprises both segments of legally accepted activities as well as purely illegal and even socially unacceptable activities. Examples of the former are charging a higher than announced price for a commodity and collecting the premium in cash (also known as `in black') and the performance of legitimate duties, such as rendering medical services, for cash in full or in part. In such instances, full or partial tax evasion is the main benefit.

Socially unacceptable and illegal `economic' activities include such harmful ones as drug-pushing and illicit arms trade. How large is the parallel economy?

Estimates are hard to come by but some think it is at least 15-20 per cent of the legal economy, while estimates as high as 70 per cent are heard too.

Countering Parallel Economy

For a long time, one used to blame the erstwhile government control and licensing systems for all the black money. At a time when the setting up of a new economic activity required a few dozen permits, when the highest marginal tax rate on income was over 90 per cent, when Customs duties were sky-rocketing, when the so-called luxury imports were totally banned and when access to foreign exchange was severely restricted, it was relatively easy to explain the evolution and growth of corruption, tax evasion, smuggling and black market for foreign currency, all of which formed the parallel economy.

Today, that should not be the case, but the black economy continues to flourish. This is because some approval or the other is needed and to either get it or to expedite it one must pay a bribe and often the payer would like to use his/her ill-gotten cash to pay bribes.

Efforts have often been made from time to time to check the fortunes of the players in the parallel economy, including raids by tax officials leading to unearthing of black money and then `the law taking its course'. At times, the carrot of voluntary disclosures, with benign tax payments, was dangled, with some success.

Tax on Cash Withdrawals

One of the recent initiatives, though since abandoned, was the so-called cash withdrawal tax, introduced in the 2005 Budget. The proposal was to collect a tax of 0.1 per cent on cash withdrawals of Rs 10,000 or more from the banks. In the Budget speech that year, the Finance Minister, Mr P. Chidambaram, had referred to "large cash transactions, especially withdrawals of cash, which leave no trail and presumably become part of the black economy... "

Surely the policy-makers are fully aware of how black money is created. Every check-post and every control/regulatory mechanism has the potential to create black money and hence the fewer, the better. It is not as if the parallel economy and the rest of the economy are totally unrelated and exist in water-tight compartments. As long as cash expenses are allowed without limit, the cash economy, both legal and illegal, will flourish. That fuels the real economy in such varied segments as construction, travel and tourism and health-care.

What is the solution, then, if one is serious about arresting the parallel economy, with its horrific consequences for government revenue and the perceptions among foreign investors? As much as possible, one must get out of the cash economy.

More than the liberal Government and tax systems, the new economic policies and ICT growth have allowed the banks to promote the use of credit cards and electronic transfers. If airlines, railways, luxury hotels, and real estate developers are mandated to give a fairly robust five per cent discount for payment by credit card and a hefty 10 per cent discount for payment through debit cards, at the very least, it would be sending the right signal that cash is not welcome.

(The author, formerly with the National University of Singapore and the World Bank, is Professor Emeritus, GITAM Institute of Foreign Trade, Visakhapatnam and Visiting Faculty, Sri Sathya Sai Institute of Higher Learning, Prasanthi Nilayam. He can be reached at bhanoji@gmail.com)

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