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Impact of Cashless Transactions on Money Supply – Case of India
Riti Jain
Sarla Anil Modi School of Economics, NMIMS University
Semester 6: Research Paper
Prof. Anjali Masarguppi
March 31, 2023
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Impact of Cashless Transactions on Money Supply – Case of India
Abstract
Cashless economy is a dream various nations sleep on and a phenomenon that various
individuals are reluctant their economy will ever achieve despite government’s policies. This
study explains the benefits, and challenges of a cashless economy, how cashless transactions
can help achieve a solution to the government's problem of tax evasion with special focus on
how money supply is affected due to surge in cashless transactions, how the central bank is
affected, basically giving a monetary overview. We also find out that a cashless economy can
curb corruption to a great extent. The paper then discusses the impact of cashless transactions
on consumer perception with a significant focus on rural population and change in behavior
after covid-19 outbreak, followed by businesses with a special focus on MSME’s. We
proceed to understand the relationship between cashless economy and economic growth,
where we discover that there is a positive relationship between both but only in the long run.
We then look at different viewpoints of the same where Khalaf (2018) agrees that revenues of
the central bank do decrease and there will be change in the role, whereas on the other side
economists like Fressman (2022) thinks otherwise. We then consider various economies like
Sweden, Canada and Nigeria to understand the progress these nations made on the path of
cashless economy with a special case study of the UAE who failed to adopt this policy.
Literature reviews from various backgrounds are studied to understand each subtopic in detail
and to understand the world's position in terms of achieving a cashless economy.
Furthermore, the research proposal is outlined in depth giving the reader a sense of
understanding on what is expected from this paper, i.e., establishing a relationship between
money supply and cashless transactions.
Key Words: Cashless Economy, Cashless Payment, Consumer perception, Businesses, Tax
Evasion, Corruption, Covid-19, Economic Growth, Money Supply, Monetary Policies,
Central Bank
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Impact of Cashless Transactions on Money Supply – Case of India
Executive summary
Almost all the economies are itching towards cashless transactions, payments through
e-money and merely using paper notes. ‘On the go’ is a concept taken very strongly by the
individuals as they intend to do most of the things in their commuting way. In India,
especially after demonetization - where Rs. 500 and Rs. 1000 notes were banned, cashless
payments became of high use. And now, since Covid19, according to Polasik et al. (2021) a
direct impact has been observed on individual consumer’s perception regarding the risk of
covid-19 transmission with coming in contact with physical cash. Thus it's important to have
an extensive study on this topic.
This paper provides us with an overview on the cashless economy and how it is being
used by different sectors of the economy (retail businesses especially). Along with it, it also
aims at discussing the impact of cashless payments on the monetary situation of our country.
This report contains the first two chapters of the final research paper on ‘Impact of cashless
transactions on India’s Money Supply’. The first chapter gives a brief about the research
proposal talking about the research objective, questions, how we intend to carry out the
research along, and how it will add on to the existing literature review on this domain. The
questions answered in this paper vary from whether the use of electronic money is actually
affecting the money supply and how it is really changing the functions of the central bank.
The second chapter consists of an extensive literature review which is further divided
into eight subsections to understand the emergence of the cashless economy, its benefits,
challenges how it is impacting the economic growth of the economies and monetary policies.
Most of the literature reviewed gives us theoretical evidence on various findings and restricts
us on analytical evidence. Through this paper we aim to support the theoretical evidence in
any way we could. Around twenty-five papers were reviewed for the second chapter. There
also have been opposing views on various subparts, for instance, will central banks’ role be
changed?
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Impact of Cashless Transactions on Money Supply – Case of India
The third chapter consists of Research Methodology and Analysis, which is further
divided into theoretical framework of our model, description of the sample data and then
analysing the output generated from the study. Further this chapter delves into what policies
have been implemented and what are some policy recommendations that can lead to easy
inclusion of cashless transactions.
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Impact of Cashless Transactions on Money Supply – Case of India
Table of Contents
1. Introduction .............................................................................................................................. 7
2. Research Proposal ......................................................................................................................... 9
2.2 Research Objective............................................................................................................. 9
2.3 Research Question ............................................................................................................. 9
2.4 Rationale ................................................................................................................................. 9
3. Review of Literature .................................................................................................................... 10
3.1 Benefits of Cashless Economy ................................................................................................ 10
3.2 Challenges of Cashless Economy ............................................................................................ 10
3.3 Consumer Perception on Cashless Payment ........................................................................... 11
3.3.1 Rural India .................................................................................................................... 12
3.3.2 Cashless economy and Covid 19 ............................................................................... 12
3.4 Effect on Retailers and Businesses ......................................................................................... 13
3.5 Cashless Payment and Economic Growth ............................................................................... 14
3.6 Impact of Cashless transactions on money supply .................................................................. 14
3.6.1 Money supply ................................................................................................................. 14
3.6.2 Impact on Money supply ................................................................................................. 15
3.7 Change in the role of Central Bank ......................................................................................... 16
3.8 Progress of Various Economies towards Achieving Cashless Society ....................................... 16
4. Methodology and Analysis ........................................................................................................... 18
4.1 Theoretical Framework .......................................................................................................... 18
4.2 Description of Sample Data .................................................................................................... 20
4.3 Selection of Variables............................................................................................................. 20
4.3 Methodology ......................................................................................................................... 20
4.4 Results of Empirical Research ................................................................................................. 21
4.4.1 Regression of Money Supply (M0) on Electronic Payments (E) ......................................... 21
4.4.2 Model Specification Test ................................................................................................. 23
4.4.3 Granger Causality Test .................................................................................................... 24
4.4.4 Chow Test ....................................................................................................................... 25
4.5 Analysis Conclusion ................................................................................................................ 25
5. Policy Implemented by Indian Economy ....................................................................................... 27
6. Policy Recommendations ............................................................................................................. 28
7. Research Gap............................................................................................................................... 29
7.1 Literature Review ................................................................................................................... 29
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Impact of Cashless Transactions on Money Supply – Case of India
7.2 Limitations of the Study ......................................................................................................... 29
8. Conclusion ................................................................................................................................... 30
9. References .................................................................................................................................. 31
10. Appendix ................................................................................................................................... 35
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Impact of Cashless Transactions on Money Supply – Case of India
1. Introduction
Money, a medium of exchange, is an ever-evolving technology that has been part of
human history for thousands of years, from barter to cash to checks to online banking. While
cash is expected to remain a significant payment instrument in the near future, factors such as
"contactless" pay systems, rising mobile penetration, and high cash costs (ATM fees for
individuals, cash storage for businesses, currency printing for governments, and so on) are
causing society to rethink its ubiquity. ‘On the go’ is a concept that the current society lives
and breathes on as most individuals intend to get things done while commuting, eating or
even when they are in their beds. This evolution has contributed to the revolution of mobile
phones and ICT which has managed to convert the world to a small mobile village (Suy et al.
2018).
The notion that physical money is bothersome and that a cashless society would be
more simplistic and economically efficient isn’t novel. A cashless economy is defined as an
economic setting whereby goods and services are transacted without cash (Paul and Friday,
2012), either through electronic transfer or cheque payment.
Today, if you are buying a coffee at Starbucks, you would notice that fewer and fewer
people are transacting in cash. It wasn’t very long ago that items with high prices were paid
by credit/debit cards or cheques and items with low value were usually bought with cash.
According to the World Payments Report 2016, globally non-cash payment volume has
increased where 90% transactions are cashless in most of the developed countries. Since in
the span of few decades, cashless payments have gone from being rare to a standard practice,
where economies have started adopting policies to turn their nation completely cashless, it
has raised questions on how to make these payments feasible to all, how to ensure security of
the payments, especially after the world underwent a pandemic that has changed the lifestyle
of not only the people but also brought changes in the policies implemented by the
government.
How to make a cleaner society? How to stop tax evasion? And some many more
questions have a simple answer - by going cashless. Economies can become more transparent
and simpler if all the transactions are made in a cashless method instead of physical cash. As
cash-based economies are big supporters of counterfeiting and black money circulation.
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Impact of Cashless Transactions on Money Supply – Case of India
Other than this, with growing uncertainty around the world after a contagious global
pandemic, most of the individuals already opted for cashless payment, increasing the demand
for better and secure windows for cashless transactions. With growing demand, proper
studies and research need to be done that can help policy makers and various businesses to
give a direction towards this subject. It is certain that the future of the world is cashless.
Though there might be some security issues related to going cashless, the benefits outweigh
the challenges this economy presents itself with. Implementation of this policy needs tedious
work from the government's end.
Such transformational changes in our financial institutions have raised many
questions on the development of the economy. This paper begins by chalking out the benefits
and challenges faced by a cashless economy with certain examples from India ‘s context and
highlighting tax evasion and reducing corruption along with identity thefts, and then proceeds
to discuss the consumer perception of a cashless economy, where literature review is
conducted from the perspective of rural consumers along with change in consumer perception
after the covid-19 outbreak. This section also describes different consumer perceptions on the
basis of demography. Next, we consider the effect of a cashless economy on businesses and
how beneficial cashless payment might make them, along with difficulties that might be
faced by the MSMEs. We then discuss the impact of a cashless economy on economic growth
of the country, where research on five countries is specifically done. Further we dwell into
impact of cashless payments on money supply by introducing money supply and then
studying about the impact on the role of central banks. Moreover, we investigate the progress
nations like Canada, Sweden and Nigeria made towards adopting the strategy of a cashless
economy along with the failure of UAE in adopting this strategy.
This paper gives the relationship between the money supply and cashless transactions
and if there is then what are some policy recommendations of the same. Also the paper
provides a study on if there is actually a structural break in money supply due to Covid19
Outbreak and what are the reasons for it. Concluding the paper with a literature research gap
as well as analysis research gap.
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Impact of Cashless Transactions on Money Supply – Case of India
2. Research Proposal
2.2 Research Objective
1) Study the impact of cashless economy on money supply and to check if there has been
any change in the money supply after Covid19.
2) Furthermore, commenting on the recent Indian policies on inclusion of cashless
transactions.
2.3 Research Question
1) How are people adjusting to a cashless economy?
2) Did cashless transactions have any impact on money supply in India?
3) How effective are monetary policies with the emergence of a cashless economy?
4) What changes can be seen in the role of government as well as central bank?
2.4 Rationale
Cashless transactions are the new normal in today’s time. The term includes all kinds
of electronic money from credit/debit (which was introduced way back) to applications like
Paytm, Gpay, Payla etc. Over time there have been various theoretical papers published on
cashless economy, how it has impacted different sectors of society, what is the consumer
perception etc. Through empirical data study, Agarwal and Khatri (2021) observed that in
majority of the cases males are more comfortable with cashless payment along with
individuals belonging to middle age category, part of a higher income group and who are
living in cities prefer and use cashless mode of payment more than the others, the reason for
the same is level of literacy.
With increasing demand, it is crucial to understand how the adoption of e-money will impact
the money supply of our economy and what changes will the central bank see in their roles.
Policymakers need to analyze the monetary as well as fiscal policies to implement better
policies in future due to the adoption of cashless transactions. This study is being conducted
to answer these questions as this subheading hasn’t been touched enough when talking about
cashless economy.
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Impact of Cashless Transactions on Money Supply – Case of India
3. Review of Literature
3.1 Benefits of Cashless Economy
Every economy in today’s time wants to go cashless, either through the
announcement of Cashless Policy in Nigeria or Demonetisation in India. The motive behind
this digitalisation is to build a transparent, participative and responsive system (Pal and
Mohd., 2020). Sharma (2019) in her study, “Cashless Economy in India: Benefits and
Challenges Ahead”, gives major emphasis to prompt settlement of transactions as the benefit
of cashless society.
According to Bayero (2014) cashless economy and financial inclusion go hand in
hand, if a country (according to his study - Nigeria) wishes to digitalise itself, then complete
financial inclusion is necessary. Thus, a cashless economy leads to financial inclusion, which
according to the World Bank is a key enabler for eradicating extreme poverty and boosting
prosperity in a nation. Furthermore, a cash-based economy is a key player for corruption in
the economy. Cashless payment hinders tax evasion as it builds a trail of underlying
transactions (Immordino and Russo, 2018). Immordion and Russo (2018), used empirical
evidence to support their argument that cashless transactions which include credit and debit
cards are negatively related to VAT evasion.
Besides, reduction in tax evasion would lead to higher generation of revenue through
increased tax collection (Gujrati, 2017).
3.2 Challenges of Cashless Economy
Cashless system looks very beneficial, but it also comes with its own costs and
challenges. An economy with complete absence of cash is not possible in near future as well,
as economies can attain a certain level of cash lessness after which this process ends
(Skinner, 2012). In further section of literature review we will come across statements where
the consumers are happy about going cashless, but little do, they realize the implications of a
cashless society is far more stretched than online shopping.
Rather a cashless system has the ability to expose their private information for profit
(Skaggs, 2014). According to Skaggs (2014), a cashless society can expose consumers to
identity theft. Furthermore, according to her study a new threat “electronic pickpocketing” is
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Impact of Cashless Transactions on Money Supply – Case of India
emerging, where criminals are purchasing scanners that are capable of retrieving information
stored in RFID, embedded in credit cards. Other than divulging private information through
thefts.
Gujrati (2017) in her research paper highlights various challenges India could face if
they opt for complete cashless payment. Some of which include lack of digital infrastructure
in the context of rural areas, high cash dependency of Indian citizens and digital illiteracy
observed in senior citizens and rural population.
(Hasan et al., 2020) There are several challenges in the way of a Cashless economy
like resistance to change, lack of grievance redressal body among many more addressed
in various papers. Hasan et al. (2020) in their paper suggested that governments need to
market their schemes well, in order to incentivize individuals to go cashless.
3.3 Consumer Perception on Cashless Payment
In recent scenarios, innovation of electronic payment has reduced the number of
places that still only accepts cash (Zhang et al, 2022). This is a vital sign showing that
economies are gradually moving towards cashless society, increasing the importance of
consumer perception in the matter. Subhash and C. (2019) argue that since demonetization
most of the employees have started receiving salaries online, thus making them well versed
with cashless payment. They surveyed 100 respondents through a structured questionnaire
which was followed by a personal interview. Upon using SPSS, they concluded that the
majority of the respondents supported cashless transactions as they made their payment easier
without having to carry cash around.
Though there are still some negative perceptions that have been holding individuals
back from accepting a cashless economy (Podile, 2017). When we break the individuals into
different age groups, it has been concluded by Subhash and C. (2019) that young India is
aware and accepting towards this change, whereas the senior citizen category is still finding a
hard time accepting this change. According to the research conducted by Mohd. (2020) in
Himachal district respondents are receiving higher benefits through digital payment than
physical cash transactions.
Through empirical data study, Agarwal and Khatri (2021) observed that in majority of
the cases males are more comfortable with cashless payment along with individuals
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Impact of Cashless Transactions on Money Supply – Case of India
belonging to middle age category, part of a higher income group and who are living in cities
prefer and use cashless mode of payment more than the others. Justification of the same could
be the level of literacy prevailing in India.
3.3.1 Rural India
When we take into consideration the consumer perception of a cashless
economy it is significant to incorporate rural regions as well. In India, 70% of the
economy resides in the rural region, thus, to make India a cashless economy it is
necessary to turn the rural region cashless as well. Majority of the rural population is
still operating on cash payment because of a small proportion of people having a bank
account or operating one (Thomas and Krishnamurthi, 2017). This has mainly been
characterized due to the digital illiteracy among the rural population, along with
erratic power and internet connection.
Rural population is ready to learn and are strongly in favor of going
completely cashless provided accurate support from the government (Thomas and
Krishnamurthi, 2017). Though there might be some apprehensions in the beginning as
when demonetization took place, poor people were impacted the most (Kousalya and
Gurushankar, 2018).
According to the study conducted by Thomas and Krishnamurthi (2017) they
listed various suggestions on how the rural population can be made well accustomed
with cashless transactions. Out of those suggestions, a particular way in which the
government can actually make an impact is making electronic payment mandatory for
receiving Public Distribution System (PDS) benefits.
3.3.2 Cashless economy and Covid 19
The World Health Organisation declared a novel coronavirus (Covid-19)
outbreak a global pandemic on March 11, 2020. Covid-19 has not only affected the
health of people but also profoundly changed people’s habits and behavior. During
this scenario there was a worldwide speculation of the link between Covid-19
infection and physical money (Auer et al. 2020).
According to Polasik et al. (2021) a direct impact has been observed on
individual consumer’s perception regarding the risk of covid-19 transmission with
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Impact of Cashless Transactions on Money Supply – Case of India
coming in contact of physical cash, and there’s been a change in the consumer
behavior related to shopping, human interaction has an impact on the preferred
payment of method. These impacts have played a vital role in the abandonment of
cash as a medium of exchange. The possibility of infection on cash notes and the
change in the habits of individual not only led to shift from cash to cashless payment
for short period of time, rather these impacts have imprinted themselves on the
respondents’ (under study) future transactions as well, where they can be seen
transacting in cashless manner after the Covid-19 pandemic has been contained
(Polasik et al., 2021).
The microbial persistence is far greater on paper notes as compared to the
coins (Vriesekoop et al., 2016). This led to various research to gather information on
the durability of the SARS-CoV-2 on paper surfaces. Chin et al. (2020) undertook
research on the same and put a droplet of virus on the banknote, it was observed that
the infection remained on the note for the period of 4 days. Thus, giving a strong
reason for individuals to shift to cashless payment.
3.4 Effect on Retailers and Businesses
There have been various studies and research papers on consumer perception or
consumer behavior towards cashless economy, but limited papers on cashless economy
affecting businesses. Business plays a vital role in the economic performance of a country;
thus, research is required in this area. Rofiat (2017) studies the effect of cashless payment in
SMEs in Zaria Metropolis through primary data collection and multiple regression analysis
and hypothesis in SPSS. His research provides empirical evidence of cashless payment
having a positive impact on the performance of the SMEs. Cashless transactions provide
unique opportunities and services which boosts the profitability of businesses by increased
sales and average ticket size. It has been found that cashless transactions lead to large average
ticket size, due to which customers end up spending 20% more than they would have been
paying in cash payment (Skaggs, 2014).
Furthermore, it has been observed that business opportunities created by a cashless
economy led to increased foreign investment and attracted foreign investors (Muyiwa et al.
2013). However, Igbara et al. (2015) study in Nigeria, discovered that adoption of cashless
policy in the economy led to hindrance in the growth of MSMEs. Operators of MSME’s are
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Impact of Cashless Transactions on Money Supply – Case of India
usually illiterate dealing in cash transactions and lack the knowledge of technology; leading
to unemployment which may lead to failure of MSME’s.
3.5 Cashless Payment and Economic Growth
Tee and Ong (2016) undertook a study to examine the effect of adopting cashless
payment in five European Union countries, namely Belgium, France, Germany, Austria and
Portugal for a period of ten years (2000-2012). They observed two scenarios - long run and
short run. In the short run, a casualty arrives from cheque payment to telegraphic transfer and
card payment, though a long-term effect was noticed in the adoption of cashless payment on
economic growth. Exception was card payment. One reason stated by them for the above
conclusion was that the countries that were studied are developed nations due to which any
effect of increased usage of cashless payment is observed after a certain period of time as it
takes time to diffuse in the economy.
Zandi et al. (2013) studied the effect of card payment on the GDP. He concluded that
there is a positive relation between the card payment and GDP. According to this paper 56
countries in the sample approximately added $900 billion cumulatively to the real GDP from
2008 to 2012 due to increase in card payment in these nations, which yielded to 0.3% of their
total GDP per year during this period. Thus, cashless payment is a crucial catalyst for
economic growth of a nation, leading to more support for a cashless economy (Zandi et al.,
2013).
3.6 Impact of Cashless transactions on money supply
3.6.1 Money supply
Money supply is defined as all the currency and other liquid instruments in a
country’s economy on the date it's being measured. It roughly includes both cash and
deposits which can also be used as easily as cash. According to Investopedia,
economists make use of money supply reports to develop policies to oversee the
interest rates along with the fluctuations (increasing, decreasing) of money flow in the
economy.
Besides, public and private sector analysis is enacted due to money supply’s
possible impacts on inflation, price levels etc. Qin (2017) attempted to define money
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Impact of Cashless Transactions on Money Supply – Case of India
supply after the introduction of e-money. Traditionally, according to volatility of
currency, there are various levels at which currency is classified. M0 (includes cash in
circulation), M1 (besides M0, takes into account the circulation of other money
equivalents that can be easily convertible into cash), and M2 (along with M1, includes
short term deposits in banks, 24-hour money market funds and others). M0 has the
highest liquidity followed by the other two (Qin, 2017).
3.6.2 Impact on Money supply
Introduction of the term ‘cashless’ in our economy has led to questions arising
on how it, if it does, impact the money supply of the country. There are different
views on this topic.
Boeschoten and Hebbink (1996) argued that going cashless and making use of
e-money does have an impact on the money supply, whereas Charles Fressman (2002)
thinks otherwise. Qin (2017) argued in his paper that if going cashless, that is, using
electronic money is issued through the conversion of banknotes or deposits, and hence
wouldn't impact money supply and will maintain the price stability.
However, if issued as a consequence of credit it does impact the money supply
of the country. Increased use of cashless transactions can lead to quantifiable as well
as non-quantifiable risks, and would eventually limit the ability of the central bank to
control money supply (Qin, 2017).
Further, to strengthen the theoretical aspect, Nizam (2022) in his research
study, empirically proved how mobile financial services, a component of cashless
transaction, in Bangladesh, directly affects all the three monetary variables (cash
outside bank, narrow money, broad money).
Hong (2009) in his study analyzed that the value of e-money is still very
small, thus having a small impact on M1 and GDP, thus it is quite hard for cashless
transactions to replace money. Though a caveat, this study was conducted a decade
ago and a lot changes with time.
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Impact of Cashless Transactions on Money Supply – Case of India
3.7 Change in the role of Central Bank
Khalaf (2018) in his research article mentioned that the massive spread of cashless
payments and its increased use will generate significant effects on the demand for banknotes
issued by the central bank, thus reducing their revenues. In some countries or some areas the
central bank might play its role of lender of last resort but this lender may decline in a world
where information is transmitted immediately in almost every activity and institution.
Reddy (2002) also argued on how going cashless and emergence of electronic money
can limit the ability of central bank.
Fressman (2002), stated that electronic money replaces a portion of base money
which affects money multiplier but it is limited and can’t actually impact central banks' role.
Berentsen (1998) studied the effect of replacing central bank currency on narrowly
defined stock of money under various assumptions regarding regulatory policies and
monetary operations of the central bank including the reaction of the banking system.
3.8 Progress of Various Economies towards Achieving Cashless Society
Almost every country in the world is progressing towards achieving a cashless
economy like Sweden, Nigeria, India, Malaysia and many more. Simultaneously some
African countries like Kenya, Tanzania where using less cash in their financial transactions
has become a benchmark regarding the electronic payment system (Neyer, 2017).
According to Skaggs (2014) Canada has undergone various events and milestones to
convert itself from a predominantly cashless country to a pure cashless one. Canada achieved
a milestone when its government called for a coinage phase out which targeted penny
(Salerno, 2013). Canada is very high up the hill on its way to achieving a cashless economy
as according to a study conducted by MasterCard, 90% of the Canadian consumers spending
is cashless in nature. Thus, there seems no problem with Canada turning into a cashless
economy till the time consumers dictate the mode of transaction as cashless (Skaggs, 2014).
17
Impact of Cashless Transactions on Money Supply – Case of India
(Achor and Robert, 2013) Nigeria is drifting towards a cashless economy after the
introduction of ‘Cashless Policy’. Achor and Robert (2013) tried to study the stakeholders'
divergent views on the cashless policy using a survey method with a sample of 650
stakeholders consisting of civil servants, university students and businessmen. They
concluded that majority respondents supported the policy as they understood the benefits of a
cashless economy. Adu and Adurayemi (2016) in their study realized that ATM has been the
most common means of effecting the cashless policy in Nigeria by all types of individuals -
poor and rich, literate and illiterate. According to Babalola (2022), Nigeria is not ready for a
cashless economy as internet facilities and the entire concept of electronic banking is yet to
penetrate through the cracks of the Nigerian economy.
Sweden was the first country to make use of bank notes and the most eager economy
to replace them with cashless payments. As compared to other European Countries (EU),
Sweden is far less reliable on physical cash. Yet, it is observed through statistics individuals
in Sweden do not intend on further decreasing their use of cash despite the push of banks and
government policies (Skaggs, 2014). Further, Skaggs highlighted how the country’s bus
system is already intolerant of cash, stipulating that such aggressive movements have been
raising concerns in the country especially by the elderly who are less familiar with electronic
banking.
Despite the best efforts of monetary authorities, banks, and the payments sector to
develop a world-class digital payments ecosystem modeled after South Korea and Sweden,
the march towards a cashless economy in Saudi Arabia and the UAE appears to have hit a
brick wall. Both economies are still significantly reliant on cash, with cash accounting for 67
percent of total payment value in the UAE and 64 percent in Saudi Arabia in 2019.
Infrastructure readiness, cybersecurity concerns, and high transaction costs, particularly
merchant service fees for small firms, are commonly cited as reasons for this trend by Srouji
(2020) in his research study.
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Impact of Cashless Transactions on Money Supply – Case of India
4. Methodology and Analysis
4.1 Theoretical Framework
According to volatility, our economy classifies currency at different levels - M0, M1
and M2. Here M0 includes cash in circulation, M1 includes M0 along with other money
equivalents easily convertible into cash, and lastly M2 consists of M1 as well as short term
deposits in banks and 24-hour money market funds and other. In our study we mainly focus
on M1, as we know electronic money can’t replace M2, as in our case digital payments is still
at the nascent stage.
Using data from Handbook of Statistics of RBI, we can analyse the growth rate of M0
and M1.
Source: Handbook of Statistics of RBI
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Impact of Cashless Transactions on Money Supply – Case of India
Source: Handbook of Statistics of RBI
Narrow Money shows a stark decline in year 2016, which can be attributed to
demonetisation policy undertaken by Indian government, along with the global economic
slowdown.
The Indian government announced the demonetization of Rs. 500 and Rs. 1000
banknotes in November 2016, accounting for 86% of the country's currency in circulation at
the time. Although the measure was intended to combat corruption, illicit money, and
counterfeit currency, it had a substantial impact on the country's money supply.
Demonetization resulted in an abrupt withdrawal of cash from the economy, reducing the
amount of money in circulation and, as a result, the money supply.
Furthermore, the global economic slowdown in 2016 impacted India's money supply. The
slowdown impacted India's exports, which fell, resulting in a drop in foreign exchange
reserves. This, in turn, had an impact on the country's money supply.
The main aim of this research paper is to study the impact of Cashless transactions on
India’s money supply, as mentioned earlier money is a vital commodity and there are
different forms of money having different impact on purchasing power over a certain time
period like cash and demand deposits. With introduction of electronic money, it is obvious it
will gradually replace traditional currency, i.e., replacing part of cash and demand deposits in
circulation, thus soon there will be a need to redefine the monetary levels.
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Impact of Cashless Transactions on Money Supply – Case of India
This paper attempts to provide a new definition of monetary level,
M0 = cc + E
M1 = M0 + E2 + D
Here,
cc - currency in circulation
E - cash converted to e-money
E2 - demand deposits converted to e-money
4.2 Description of Sample Data
The sample data used in the analysis of this paper are annual data from 2010 to 2021,
and include amount of M0, amount of M1, electronic money (credit card payment, debit card
payment, NEFTS, UPI Payments, pre-paid payment instruments, inflation). This paper
consists of cross-sectional data. All these data are taken from Handbook of Statistics of RBI
and Financial Sites.
4.3 Selection of Variables
1. Money Supply – M1 (M0) is taken as a dependent variable
2. E and E2, are independent variables depicting the digital transactions being taken in
our economy
3. Currency in circulation (cc) is another independent variable directly from the
Handbook of Statistics of RBI. If currency in circulation increases, money supply of
the economy increases.
4. Inflation is taken as a control variable (an independent variable) to study the impact of
inflation on money supply, which is according to theory a positive relationship.
4.3 Methodology
This study conducts regression of money supply on electronic payments to analyse the
extent to which it impacts the money supply of Indian economy, then we go about running
model specification test which includes RAMSEY-RESET test and Multicollinearity to check
the validity of the model.
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Impact of Cashless Transactions on Money Supply – Case of India
To analyse if there has been some change in money supply due to Covid19, paper
conducts Chow Test.
4.4 Results of Empirical Research
4.4.1 Regression of Money Supply (M0) on Electronic Payments (E)
In our analysis we have assumed inflation as a control variable, with currency
in circulation along with electronic payments as independent variables. The
theoretical model is as follows:
M0 = f(-E,+ inflation, + cc)
The mathematical function is:
M0 = 𝛽0 − 𝛽1E + 𝛽2inflation + 𝛽3cc
Econometrics Model:
M0 = 𝛽0 − 𝛽1E + 𝛽2inflation + 𝛽3cc + 𝜀t
*𝜺𝒕 = Normal distributed classical error term
This is a linear regression model, where the econometric model hypothesizes
that the dependent variable, M0 is linearly related to the explanatory variables (cc, E,
inflation) and the disturbance term represents all those factors which affects the
money supply but aren’t explicitly considered.
The results, using R - programming, are as follows:
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Impact of Cashless Transactions on Money Supply – Case of India
The sample regression function is.
M0 = 674000 − 1.44E + 15200inflation + 84.2cc
Interpretation of these coefficients are as follows: − 1.44 is the partial regression
coefficients of electronic payments and tells us that if all other independent variables kept
constant as E increases one unit, the volume of M0 goes down 1.44 . Similarly, other
coefficients as well indicates how much predicted volume of M0 will change with a unit
change in other independent variables.
When we look at the R-squared value, it is 0.997 means that 0.997 of the variation in
the growth rate of M0 is explained by electronic payments, currency in circulation and
inflation. A high value of the same gives us the goodness of fit of the estimated model.
In our model, all coefficients are significant at the 5% level or better, except for
inflation, which is significant at the 1% level.
F-statistic and p-value: F-statictic and p-value helps us analyse the overall test of the
model’s significance. The F-statistic is 839, which indicates that the model is significant
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Impact of Cashless Transactions on Money Supply – Case of India
overall. The p-value of 2.48e-10 is very small, which means that the probability of getting
such a large F-statistic by chance is extremely low.
In conclusion, the results indicate that the independent variables E, inflation, and cc
are all significantly related to the money supply (M0). The model accounts for a large
percentage of the variability in M0, and the whole model is extremely significant.
4.4.2 Model Specification Test
To check if the model taken is correctly specified or not, this paper conducts
RAMSEY-RESET Test. It is used to check for functional form misspecification in our
regression model.
H0: Model is correctly specified
H1: Model isn’t correctly specified
In our case the p-value is quite high from the conventional significance level 0.05,
thus, we fail to reject the null hypothesis, i.e. the model taken is correctly specified.
Multicollinearity Test
To check for correlation between the independent variables, as according to OLS
Regression there should be no correlation, we run Multicollinearity Test.
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Impact of Cashless Transactions on Money Supply – Case of India
The value if comes equal to 1 it shows there in no correlation between the independent
variables, thus in the output as well it is nearly equal to 1, showing no correlation and hence
the model is correctly specified.
4.4.3 Granger Causality Test
Next, this paper performs Granger-Causality Test to determine if Electronic Payments
is useful in forecasting another time series, i.e. M0. Or if electronic payments “Granger
Causes” money supply.
This output shows the results of a Granger causality test comparing Model 1 and
Model 2. Model 1 includes the lagged differences of both M0_2 and E1_2 as predictors of the
current value of diff(M0_2), while Model 2 only includes the lagged differences of M0_2 as
predictors of diff(M0_2).
The test compares the residuals of the two models to determine if the addition of the
lagged differences of E1_2 in Model 1 provides a statistically significant improvement in the
fit of the model compared to Model 2.
The output shows that the F-statistic is 7.3751 and the p-value is 0.03484. The p-value
is less than the conventional significance level of 0.05, which indicates that there is evidence
of a significant improvement in the fit of Model 1 compared to Model 2. Thus, the lagged
differences of E1_2 are statistically significant predictors of diff(M0_2), and we can reject
the null hypothesis that the lagged differences of E1_2 do not Granger-cause diff(M0_2).
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Impact of Cashless Transactions on Money Supply – Case of India
4.4.4 Chow Test
To study the impact of pre-covid19 and post-covid19 outbreak on Money supply
(M0), we use chow test.
The Chow test resulted in an F-value of 14.23987 with 2 and 8 degrees of freedom for
the two subsets. The p-value is 0.00231, which is less than the conventional significance level
of 0.05. Therefore, we can conclude that there is evidence of a structural break or change in
the relationship between the variables before and after 2019, signifying Covid19 outbreak did
impact the money supply.
4.5 Analysis Conclusion
On the basis of the analysis done in this paper, one can conclude that electronic
payments actually do have impact on money supply even though the magnitude of the impact
is very small almost Rs.2 change with a unit increase in the volume of digital payments.
Though, Granger Causality test used to check if digital transactions cause money supply
actually gave a positive result, i.e. digital transactions “granger causes” money supply. Thus,
it does impact money supply, hence validating the study conducted by Boeschoten and
Hebbink (1996) who argued that going cashless and making use of e-money does have an
impact on the money supply.
From the analysis we can also interpret that Covid19 did have an impact on the money
supply (from our Chow Test Analysis, as there was a structural break). This is true as in
response to the economic disruption caused by the pandemic, central banks across the world
have implemented measures to stabilize financial markets and support economic activity.
Some of the keyways in which COVID-19 impacted money supply in India are:
(1) Reduction in interest rates: To support economic activity during the pandemic, the
Reserve Bank of India (RBI) reduced the benchmark interest rate by 115 basis points
26
Impact of Cashless Transactions on Money Supply – Case of India
in 2020. This reduction in interest rates made borrowing cheaper and increased the
money supply.
(2) Liquidity infusion: The RBI also infused liquidity into the financial system through
various measures such as long-term repo operations, targeted long-term repo
operations, and open market operations. These measures helped to increase the money
supply and stabilize financial markets.
(3) Increase in digital transactions: The COVID-19 pandemic led to a significant increase
in digital transactions as people avoided using cash to reduce the risk of transmission
of the virus. This shift towards digital payments also impacted the money supply as it
increased the velocity of money in the economy.
(4) Increased Government Spending which led to increase in money supply as wel
27
Impact of Cashless Transactions on Money Supply – Case of India
5. Policy Implemented by Indian Economy
Digital transactions have come a long way from being introduced for the first time in
1996, i.e., the emergence of credit/debit card payments to when in 2005 NEFTS came and
now we have UPI, Wallets etc.
In India, digital payment transactions have grown at an unparalleled rate during the previous
three years. Easy and convenient modes of digital payment, such as the Bharat Interface for
Money-Unified Payments Interface (BHIM-UPI); Immediate Payment Service (IMPS); pre-
paid payment instruments (PPIs); and National Electronic Toll Collection (NETC) system,
have seen significant growth and have transformed the digital payment ecosystem by
increasing both P2P and P2M payments.
Source: RBI Annual Report 2021-22
Over time Indian Government has implemented various policies for the inclusion of cashless
transactions. Some of them are:
1. Digital Payment Incentives: The Indian government has also announced various
incentives and rewards to encourage the adoption of digital payment modes. For
example, it launched the Lucky Grahak Yojana and Digi-Dhan Vyapar Yojana in
2016, which offered cashback and prizes to consumers and merchants who used
digital payment modes.
2. Regulatory Framework: The Indian government has also introduced various
regulations and guidelines to promote cashless transactions and ensure their safety
and security. For example, it has mandated the use of two-factor authentication for all
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Impact of Cashless Transactions on Money Supply – Case of India
digital transactions and introduced the Payment and Settlement Systems Act, 2007, to
regulate payment systems and electronic funds transfer.
3. BHIM (Bharat Interface for Money) app: The BHIM app was launched by the Indian
government in 2016 to promote cashless transactions. The app enables users to send
and receive money using their mobile phones. It is a Unified Payment Interface (UPI)
based app, which allows users to transfer funds from one bank account to another
instantly.
4. Aadhaar Enabled Payment System (AEPS): The AEPS was launched in 2016 to
promote cashless transactions in rural areas of India. It allows customers to use their
Aadhaar number and fingerprint to make transactions at micro-ATMs (Automated
Teller Machines) in villages.
5. MDR (Merchant Discount Rate) waiver: The Indian government has announced a
waiver of MDR charges on transactions up to Rs. 2,000 to encourage small merchants
to accept digital payments. MDR is the fee charged by banks from merchants for
accepting card payments.
6. Policy Recommendations
Based on the analysis of the impact of cashless transactions on money supply in the
Indian scenario, the following policy recommendations can be made:
Encourage the use of cashless transactions: The government can provide incentives
to individuals and businesses for using cashless transactions, such as reduced transaction fees
and tax benefits. This would increase the adoption of cashless transactions and help in
maintaining an efficient and effective money supply.
Develop a comprehensive regulatory framework: A regulatory framework should be
developed to ensure the proper functioning of the digital payment industry. This should
include guidelines for data security, customer protection, and dispute resolution mechanisms.
Increase financial literacy: Financial literacy programs should be implemented to
educate people about the benefits and risks of cashless transactions. This would help in
increasing the adoption of cashless transactions and reduce the risk of fraud and other
financial crimes.
Improve digital infrastructure: The digital infrastructure should be improved to ensure
seamless and secure cashless transactions. This includes increasing the availability of digital
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Impact of Cashless Transactions on Money Supply – Case of India
payment options, improving internet connectivity and network infrastructure, and promoting
the use of digital wallets and other payment apps.
Enhance the role of the central bank: The central bank should actively monitor the
impact of cashless transactions on the money supply and take necessary steps to maintain the
stability of the financial system. This includes adjusting monetary policy, regulating the
digital payment industry, and providing support to banks and other financial institutions to
adapt to the changing landscape of cashless transactions.
7. Research Gap
7.1 Literature Review
The existing literature review on Cashless Economy has some limitations on both
theoretical and empirical front. Cashless Economy is not a new terminology, rather it’s been
prevailing since the last 8,000 years, yet these subject lacks proper development in various
areas.
The papers reviewed for understanding the benefits and challenges of cashless
economy are mostly theoretical in nature without proper empirical evidence making the
conclusion very generic and stagnant in all the papers.
Similarly, there is scope of further studies on after and before effect of cashless policy
on tax evasion/corruption, giving a statistical viewpoint to draw specific conclusions.
Demonetization and how it led to the beginning of India’s journey towards a cashless
economy is a subject area that is given a lot of importance and almost all papers discussing
India’s progress considered this as the main topic to dwell on. Whereas there are other policy
changes, new innovations, and launching of various e-payment methods that are not given the
suitable limelight they should receive under this subject study.
Lastly, it's been two years since covid-19 outbreak, which played a very crucial role
in the behavior of consumers towards cashless payment. Yet, there is very limited research
undertaken in this area. Thus, more literature should be published on re-emergence of
cashless economy due to covid-19 outbreak, to provide a more holistic view.
7.2 Limitations of the Study
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Impact of Cashless Transactions on Money Supply – Case of India
To begin with data collection for digital transactions has been done through addition
of credit/debit payment, BHIM etc. due to the unavailability of the data on the same. Digital
Payments data is only available from 2019 onwards, due to which manual manipulation of
data was conducted, thus giving a slight chance of invalid analysis.
Secondly, model has only been created for Narrow Money component and not for
Broad Money due to the unavailability of data.
Moreover, only one control variable has been added in our model, i.e., inflation and no other
variable like interest rates, financial crisis etc. haven’t been mentioned in the model to make
our model simple to analyse. Exclusion of these variables would have an impact on
regression and thus giving us a different analysis.
8. Conclusion
A cashless society is no longer just a part of the imagination. However important cash
is globally, there is a great progress towards cash lessness in various countries. There are
various benefits of a cashless economy with certain challenges as well but in the long run
achieving this strategy will lead to huge economic growth for countries and will make them
more transparent. Even the government will be able to fulfil its role of accountability.
Through the literature reviews we can observe that the cashless economy plays a positive or a
beneficial role for the government, businesses as well as to some extent consumers too, if we
look at it from the perspective of ease in the payment facility. As far as the financial situation
is considered, heavy literature talks about how cashless transactions are actually impacting
the money supply of the country with various instances taken from China, Bangladesh.
Indeed there is a mixed view on whether central banks’ role diminishes due to the emergence
of e-money as lenders’ last resort or it still stays in our economy. Moreover, there have been
various studies that are country specific to study the progress of a cashless economy. Yet,
there are little signs of the world going completely cashless. It is indeed a very slow process
and quite frustrating for policy makers and financial institutions. Our study did help in
establishing a negative relationship between the cashless transactions and money supply.
Using Granger Causality test we were able to infer that though the impact of cashless
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Impact of Cashless Transactions on Money Supply – Case of India
transactions is little it still does cause money supply, therefore should be considered a vital
component of money supply.
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10. Appendix
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Impact of Cashless Transactions on Money Supply – Case of India
