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The way forward for 'plastic money'...

Dec 5, 2011

The Thanksgiving weekend was a blockbuster one for retailers in America. This year, despite the 9% unemployment rate, the Americans did not deprive themselves of the pleasure of retail therapy. US retail sales during the weekend jumped 16% to a record US$ 52.4 bn. The average shopper spent US$ 398.6 over the weekend, up from US$ 365.3 a year earlier according to the National Retail Federation.

Ironically, the Thanksgiving weekend was the same time that FDI in retail was being debated in India. But various states are voicing their opposition for this reform and foreign firms are now wary of entering. The major point of contention is that mega retailers will put small 'kirana' shops out of business. FDI will bring a number of long term benefits in terms of back end infrastructure and logistics. However a number of smaller details still need to be taken care of. But, with the logjam in the parliament, it is very likely that this bill may not see the light of day anytime soon.

But first let's go back a few steps and start with the very basics of shopping. You need a buyer, a seller and very importantly a medium of exchange, in other words money. But, while Americans seem to be moving to a completely cashless system of exchange Indians are cutting back on the use of plastic money.

America has a completely plastic society

What are the two things that you cannot leave your house without today? Most people would now say their wallet and their phone. Square, a US based company started by Twitter co-founder Jack Dorsey is trying to eliminate one of these essentials. Since the IQ levels of our phones are increasing, why not make them do more intelligent things? Square lets anyone take credit card payments using smartphones or tablet computers, by just plugging in a small card reader. Barely a year into operation and it is already used by 750,000 merchants and handles US$ 2 bn in transactions annually. It charges a flat service fee of 2.75% per swipe for all major credit cards.

This works out much cheaper than setting up a point of sale terminal. Square has no start up costs, it is purely plug and play. Small businesses or consultants like masseurs, fruit sellers, hair stylists etc do not need to deal in cash anymore. It increases the ease of doing business for both the buyer and the seller. Now the startup company is aiming for the 26 m American small businesses that currently don't accept credit cards to enroll for their services and is also planning to expand outside the US next year.

But, can such a model work in India?

India has a fear of plastic money

In India, the number of active credit cards has dropped by almost 35% over the past three years. Banks have now withdrawn cards from defaulters and became a lot more cautious in issuing new ones. Credit cards reached their peak numbers in 2008 when there were 27.5 m cards in the hands of consumers. Now this number has dwindled to 18 m according to an article in the Economic Times. This amounts to just a 1.5% penetration in a country of over a billion people. But, even while the numbers of cards have declined, spending per card has increased.

The four top players HDFC Bank, ICICI Bank, State Bank of India (SBI) and Citibank - control almost 71% of the Indian credit card market. Out of these ICICI Bank, Standard Chartered and Citibank have been paring down their numbers. On the other hand HDFC Bank and Kotak Mahindra have been more aggressive. But some players are seeing this unsecured credit as risky business. Deutsche Bank sold its credit card portfolio to its Indian peer IndusInd Bank. Growth in credit card numbers may continue to be muted over the next few years on account of the high prevailing interest rates and asset quality fears. But is this really justified?

Digitization necessary for the retail revolution to succeed

India is on the brink of an online as well as a brick and mortar retail revolution. According to a study by Avendus, the Indian e-commerce market is expected to touch US$ 24 bn from US$ 6.3 bn currently. Earlier, transactions used to mainly take place on travel sites. With the advent of Flipkart and a host of other web stores, online retailing is also gaining traction. With customers willing to fork out Rs 15-25 as convenience fees websites such as bookmyshow.com and kyazoonga.com are seeing increased business. Easing of FDI in retail, if it clears the parliamentary blockade, is also set to be a big game-changer for the brick and mortar retailing industry.

However, there is more to it than the reluctance to use credit cards. Half of India's 1.2 bn people do not have a bank account. There is massive untapped potential for banking and financial services in the country. Penetration of banks and financial intermediaries into rural areas is essential.

Currently most transactions in India are on cash basis. But, for retail (both online and physical) to really be successful a transition is required from paper to plastic money. Banks need to be more disciplined in issuing credit cards and people need to be better educated in how to use them. More importantly, unlike in the US, Indian credit card holders should ensure that their leverage position is not worsened with the use of plastic money. Financial literacy is extremely important, and fees and other charges need to be properly disclosed. India can learn from the mistakes made by debt consumed nations like the US and UK and work on a slow and steady model. Plus since Indians are inherently conservative, we believe that the movement to plastic money will be a gradual process. Unless banks invest in a robust payment system there will only be buyers and sellers in the market with nothing connecting the two. As India's economy grows, it needs to move out of simply being a cash based economy. With Indians having the ability and the propensity to spend, they need the right tools. But without proper knowledge on how to use them, these tools can also turn into weapons.

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