Executive Summary

More than two years have passed since India’s demonetization policy — which removed high denomination banknotes from the economy — became a reality. That bold move was met with a mix of support, confusion, and criticism. But demonetization was only part of India’s larger, strategic digital transformation Since then, the institutional and economic evolution in India has accelerated in many ways and some of that change has been reactive and corrective. For example, despite a significant rise in digital payments since demonetization and Indian banks having issued a billion debit cards, many Indian consumers still rely on cash transactions. Obstacles and unanticipated detours notwithstanding, India is making continuous strides towards a digital-first economy. Looking at what’s worked and what hasn’t in that transformation offers useful lessons for India watchers and policymakers alike.

More than two years have passed since India’s demonetization policy — which removed high denomination banknotes from the economy — became a reality. That bold move was met with a mix of support, confusion, and criticism. In an analysis we wrote in November 2017, we argued that demonetization was only part of India’s larger, strategic digital transformation. Since then, the institutional and economic evolution in India has accelerated in many ways and some of that change has been reactive and corrective.

Despite a significant rise in digital payments since demonetization and Indian banks having issued a billion debit cards, many Indian consumers still rely on cash transactions. While no single move can make a country the size of India cashless, demonetization succeeded in significantly reducing the anonymity and lack of traceability of money in the Indian economy by routing all currency through a formal banking channel. Comparing the current demand for cash with the historic rate of growth of the economy we have calculated that the Indian economy is operating at an estimated $33 billion less cash than it would have without demonetization. (We computed this by taking the 20-year long term trend of growth rate of currency in circulation and extrapolating it post-demonetization. The difference between the predicted currency and the actual currency is an estimate of the reduction in circulation caused by demonetization.) Clearly, the behavioral changes required to accomplish a larger digital banking transition were not going to happen overnight or even in the span of a single year.

Meanwhile, the digital backbone of the world’s second-most-populous country and largest democracy has continued to develop. When compared with the status quo even five years ago, our view — one of us is an academic and the other a tech entrepreneur who has worked with and within the Indian government — is that India is leapfrogging into the Fourth Industrial Revolution, with government still at the center of that transformation.

Let’s look at a few examples of what has worked and what’s hasn’t in this massive transition:

Digital India and the India Stack. Digital India was conceived five years ago as a way to push the country’s digital transformation forward and empower citizens in the process. The base of these efforts has been the government’s emphasis on developing infrastructure to enable affordable internet access for all and for every Indian to possess a digital identity. Today, 99% of Indian adults have enrolled in Aadhaar — a goal that not too long ago would have seemed improbable.

Unlike a traditional driver’s license or the U.S. Social Security Card, the government sought to utilize Aadhaar as a platform for financial inclusion, the direct transfer of government benefits and low-cost citizen engagement. The Digital Identity project quickly transformed into what is now known as the India Stack, a set of interoperable software layers supporting digital payments, verified paper-less records, business and service transactions and finally, a still-in-progress user consent architecture, all seamlessly linked with Aadhaar.

Combining digital identity with the paperless layer provided by India Stack enabled the opening of over 350 million verified Jan Dhan (“zero-balance”) accounts. The government envisioned that Jan Dhan Accounts would serve as low-cost and hassle-free bank accounts encouraging participation in the formal banking economy. Over 85% of Jan Dhan account-holders now use these accounts to access credit and savings products. With more than half the country owning smart phones and accessing their accounts via mobile banking, the Jan Dhan-Aadhaar-Mobile (or JAM) trinity of service has been fundamental in encouraging financial inclusion. The Indian Government, which had to navigate a maze of offline infrastructure to effectively reach the beneficiaries of government benefits, has been able to leverage the JAM infrastructure to ensure prompt disbursement of funds with zero systemic leakage – this means that  when $100 leaves the government coffers, all of it reaches the intended beneficiaries.

The rapid adoption of India Stack by government, businesses, and citizens has led to public and legal debates about balancing privacy with innovation, service delivery, and technology. One such debate led to a judgement by the Supreme Court of India preventing the use of Aadhaar by the private sector due to privacy concerns. Given the enormous transformational impact of the platform — the technology had allowed for the opening of bank accounts in as few as 55 seconds and a decrease in customer on-boarding costs for telecom companies — the government later issued an ordinance ensuring the continued voluntary usage of Aadhaar by the private sector while emphasizing the norms set for use of the system, including how personal identifying information is stored.

Formalization of the economy and tax reform. Due to the requirement for each person to submit a unique ID to verify bank accounts, duplicity and anonymity in bank accounts has been alleviated post demonetization. This traceability of funds, whether flowing from personal accounts or businesses, has allowed the Indian government to identify over 225,000 “shell companies” with little activity but large flows of funds. These companies often used to siphon money and avoid tax liability.

Data generated by the digital economy also has affected individual taxation. Income tax buoyancy, which is a measure of fiscal sustainability calculated as the change in income tax over the change in GDP, is at a decade high of 2.20. This means that an increasing number of citizens are paying taxes. For a country where the income tax base has traditionally been in the lower single-digit percentage, digitization is beginning to solve the long-term and systemic problem of tax compliance.

Demonetization also set the stage for the implementation of a unified national Goods and Services Tax (GST) that occurred in July 2017. At that time, India removed over 17 national and state taxes that had been impeding trade and business in the country, replacing them with a single nationwide tax. While the initial deployment of the GST was hampered by excessive complexity and other challenges of execution, the uptake of the new system has nonetheless been rapid and widespread. As of our writing, over 12 million enterprises have registered with the GST.

Small and Medium Enterprises (SME) have been the primary beneficiaries of the introduction of GST through the benefits they have accrued by formalizing their business. The biggest benefit to these businesses of entering the formal economy has been the ability to leverage an “input tax credit” which allows business to offset output tax against the tax already paid at the stage of procuring the product, reducing their overall tax burden. Businesses enrolled with GST are able to seek credit of up to $150,000 from public sector banks by submitting their tax invoices and bank statements, with approvals in less than an hour.

Ease of doing business. India’s digitally-enabled policy initiatives have contributed to a significant shift in the country’s ranking in the World Bank’s Ease of Doing Business Index. Where India, four years ago, was ranked 142, it is now 77th, a jump of 65 places. India is one of the 10 economies that improved the most in the past two years; it is also the only large economy among those 10.

The biggest improvements have been in the ease of getting construction permits and the ease of trading across borders, both of which have been transformed by digitization and associated structural reforms. The process of starting and liquidating a business is today far simpler than it has ever been, as evidenced by India having become the world’s third-largest ecosystem for start-ups.

Another key dimension of India digital transformation has been the increase in the adoption of technology and the digital means of payments for businesses of all sizes. India now has the second-highest number of mobile phones in the world. The price of an entry level smartphone has come down to as low as $20, allowing for uptake across economic classes. Mobile manufacturers have recognized and seized this opportunity. Five years ago, India had two mobile manufacturing plants. Over 50% of the country was relying on imported phones. Today, the country has over 127 mobile manufacturing plants, with one of the biggest mobile manufacturing factories in the world now located an hour’s drive from New Delhi.

The cost of mobile data has also radically reduced, with Indians now paying around 20 cents per gigabyte per month for data. While much of this data consumption can be explained by the rise in availability of local content and videos, consumer transactions and business services of various types are on the rise through mobile devices.

Policymakers have to keep up. The speed of the changes we have described has challenged policy makers to keep pace, especially around data privacy and security.

The kickstart to the Indian digital economy two years ago has culminated into the draft version of the Indian Data Protection Framework, which aims to design data privacy standards for all intermediaries or companies that process, store and share data and empower individuals around use of their data. The vision is for the owner and creator of the data to have ultimate — and informed — authority on those with whom they want to share their data. For example, if an individual wants access to the best customized health insurance scheme and wants to share her health data with different insurance providers, she should be entitled to do so in a manner where she controls what data to share, which providers should have access to it, and for how long. This is the ultimate goal of the new data protection framework, which, when fully implemented, will complete the India Stack and make safer sharing of this data possible through a singular, secure, and easy to use platform.

The tectonic shifts that we wrote about in 2017 have continued their motion and they have been sometimes slow and grinding, sometimes sudden and sharp. But we are encouraged by the reach and possibility of this digital change. Obstacles and unanticipated detours notwithstanding, India is making continuous strides towards a digital-first economy.

At the crux of transformation are the investments that the country has made in its digital infrastructure. In India, as in other countries, technological advance has continued to outpace policy evolution. While India may be leapfrogging into the “Fourth Industrial Revolution,” the story of its societal transformation as driven by digital disruption has just begun.