Merchant Payments: A Key to India's Drive for an Inclusive Digital Economy?

In the aftermath of the 2007–2008 global financial crisis, we have become increasingly aware of the unique and often heavy costs borne by the poor to use the financial services many of us take for granted. This is just as true in the world’s wealthiest nations as it is in its poorest. But in emerging markets, cash-based economies can impose additional costs on the poor.

Consider Rambabu, a tea vendor in Kota, India. He sells over 500 cups of tea a day, and one of his biggest challenges is providing small change to his customers. To make the small change he needs, Rambabu pays beggars 100 rupees to exchange 1,000 rupees into small denominations. That’s a 10 percent surcharge. Rambabu also struggles to safely transport and store his earnings at the end of the day.

Rambabu isn’t the only one impacted by India’s cash economy. High fees in the informal market can further reduce the disposable income of those who are already poor. And the time that could be spent on more productive activities can be lost traveling to pick up a benefit check or waiting in line to have it cashed. Additionally, the cost to government is not always visible, but can be enormous. It’s been estimated, for instance, that the Indian government could save $22 billion a year by transitioning to digital payments.

India has made significant financial inclusion progress in the past two years, but cash is still dominant with over 97% of retail transactions conducted in cash or check and only 6% of merchants accepting debit cards or mobile payments.

India certainly is not alone. The international community is increasingly recognizing that digital approaches are critical to achieving meaningful financial inclusion and to meeting a variety of other development objectives. Last year, the World Bank set a goal of achieving universal financial access by 2020 and world leaders agreed to 17 sustainable development goals (at least seven of which are conditional on deeper financial inclusion) intended to end poverty by 2030. Realizing these aspirations requires moving beyond conventional approaches and identifying pathways to financial inclusion that deliver real value to consumers and merchants.

With this goal in mind, the US Agency for International Development (USAID) and India’s Ministry of Finance have partnered to test new ways of increasing merchant and consumer use of digital payments. To help guide our efforts, we recently conducted a qualitative and quantitative research effort and released a report, Beyond Cash, to build the knowledge base and framework for understanding the behaviors and preferences of Indian consumers and merchants, particularly those whose needs for relevant, accessible and affordable financial services have not been adequately met.

What have we learned as a result of the research? First, increasing the use of digital payments between merchants and consumers is a chicken-and-egg dilemma. Merchants told us they don’t accept digital payments because consumers don’t demand it while consumers told us they don’t think about paying digitally because merchants don’t accept digital payments. Our research suggests that although efforts must focus on both sides of this issue, the biggest impact will come from creating more compelling incentives for consumers. Merchants in our study indicate they will accept digital payments when consumers demand it.

Second, the cost of testing these services must decrease for merchants and consumers. Merchants, in particular, feel that the cost is simply too high to compel them to accept digital payments. The good news is that merchants and consumers who do use digital payments tend to be very happy with the experience and recommend it to others.

Third, digital payment experiences may be more compelling when they mimic what consumers and merchants like about cash or checks while also fixing what they don’t like. Our research finds that merchants sometimes prefer to pay suppliers via check because they know it will take several days to clear, providing them an extra window of time before the funds will be accessed. Replicating this type of experience in the digital realm could be one way of making such payments feel more familiar and retain their utility as cash flow management tools. Digital payments can also address many of the pain points experienced with cash. As we see in the case of Rambabu, dealing with small change is a persistent challenge for both consumers and merchants. Demonstrating the effectiveness of digital payments for high-frequency low-value transactions – such as bus fares – could be one compelling reason for more individuals to join the digital economy.

Fourth, payments are seen as just a means to an end for merchants and consumers, so it’s essential for them to get what they need or want in a simple and effective manner. If our goal is to increase consumer use of digital payments – and, by extension, increase financial inclusion – we might find more success if we draw more attention to new digital economy opportunities that can only be accessed through digital payments. Consider the share economy services that rely on seamless digital payments in the background and require users to have accounts with formal financial institutions. Or e-commerce, which is creating similar reasons for consumers to open accounts for the first time and join the digital economy. Our research finds that consumers place significant value on the modernity of digital payments and the opportunity it gives them to participate as full economic citizens in the digital economy.

Over the next year, we will be using these research findings to test the most effective approaches for expanding digital payments at points-of-sale in India. While our goal is greater financial inclusion, we must also keep in mind the goals of consumers themselves, which are far more likely to be tied to economic opportunities that deliver specific and tangible benefits to their lives.