By Ridham Desai
India’s digital leap – consisting of a combination of Jan Dhan, Aadhaar, rising mobile penetration and a Goods and Services Tax regime – is generating deep social impact, promising reduced income inequality, increased financial inclusion, better quality of life, and higher agricultural productivity.
India’s Starting Point
India is in the midst of a transition from an annual per capita income of $1,700 to $4,135 (our projection) over the next 10 years. Just to put in context what low per capita income signifies, we note that some Indian companies talk about how basic necessities, such as fruit, are still classified as discretionary consumption, with the biggest competition to such consumption being non-consumption, suggesting that affordability remains low in India. These two examples illuminate the backdrop for this article:
Reliance Industries – Q4FY18 investor presentation: “Fruit, a completely discretionary item, is consistently showing high growth in Reliance Fresh and Smart.”
Pidilite Industries – Bharat Puri, CEO, in a May 25, 2018, interview: “My job on water-proofing is to compete with non-consumption. Two out of ten homes in India do proper water-proofing when they construct. If that goes from 2 to 4, we double the category.”
Reducing Income Inequality
The growth in India’s output over the coming years is likely to be the key source for a reduction in income inequality. Apart from the benefits of reduced costs and improved efficiency in doing business leading to higher productivity as well as creating new growth channels, digitisation is providing three shifts that could reduce income inequality: improvement in public finances, greater efficiency in government benefits transfers, and a boost to trading across various income classes.
Higher tax-revenues-to-GDP and lower public-debt-to-GDP ratios
The GST should help boost the tax-revenue-to-GDP ratio, consequently reducing the public-debt-to-GDP ratio. A rising tax-to-GDP ratio favours lower income strata, as it entails the transfer of income from higher- to lower-income groups, although such transfers have to be accompanied by good governance standards. India’s ratio of tax revenues to GDP is lower than the average for emerging markets, and this has been a key reason why India’s fiscal deficit has been relatively higher versus peers. GST will likely increase compliance on both indirect and direct taxes, even while the tax rates are, in and of themselves, revenue-neutral. If India’s primary deficit becomes a surplus as a consequence of higher growth and greater tax compliance, there will be a rapid fall in debt/GDP.
Such a fall would give the government greater flexibility to undertake infrastructure spending, which, in turn, would boost growth and jobs. It is via this channel that GST is likely to help narrow income inequality.
Greater efficiency in government transfers to low-income people
The other source of potential reduction in income inequality comes from direct benefit transfers, which, in turn, are linked to two pillars of digitisation – Aadhaar and Jan Dhan. Hitherto, government transfers were conducted physically, through government networks and agents. But India’s digital identity initiative has increased state capacity to expand the beneficiary base for public goods and services, and it is reducing corruption and ‘leakage’ from fake or duplicate beneficiaries. Leakages to intermediaries were common and thus intended beneficiaries received only a fraction of the targeted benefit from government programs. Jan Dhan has led to the opening of nearly 300 million bank accounts since 2014, bringing a completely new class of previously unbanked people into the banking system. These are the people who are largely the intended beneficiaries of government transfers.
Now armed with bank accounts, they are in a position to receive benefits directly from the government, bypassing agents and avoiding leakage.
Aadhaar enables such transfers, since it can uniquely identify beneficiaries. Over the past three years, the government has significantly scaled DBT. 433 government schemes are now conducting their transfers via DBT. In FY18, 124 crore transfers were affected, involving Rs 1.9 lakh crore ($28 billion). Since FY14, DBT transfers have amounted to Rs 3.88 lakh crore ($58 billion). This breadth of delivery is unprecedented in India’s history. Its impact on inequality could easily be underestimated, in our view.
The DBTs represent two kinds of flows:
- Conversion of existing subsidies given in kind to cash, and
- Subsuming of several other government benefits (such as pensions) into the Aadhaar system, thereby reducing leakage and corruption.
The net effect is that intended beneficiaries are receiving their due without middlemen, and all of it in cash directly into their bank accounts. This, in turn, opens up an opportunity for the recipient to decide how to spend the cash – rather than the government deciding.
DBT and other governance reforms have led to the removal of duplicate/fake beneficiaries and plugging of leakages, helping the government target intended beneficiaries. More detail can be found here.
Greater intra-country trading, driven by e-commerce
Trading and specialisation are key to economic progress. The two are interdependent. Most of India has been deprived of access to the market because of archaic physical infrastructure, barriers to entry to marketplaces created by large businesses, and inefficient government intervention. These constraints are breaking down as India goes digital. Growth in e-commerce is facilitating this.
We are expecting e-commerce sales to grow to $200 billion by FY27 from $15 billion now.
E-commerce opens up supply chains, taking them deeper. This brings several small suppliers into the marketplace. These suppliers are otherwise not competitive, as they lack distribution channels and because of poor physical infrastructure to transport goods. For example, Amazon in India has 160 million products listed on its platform, growing on a daily basis. This growth in trade helps increase specialisation, in turn combating income inequality. In addition, several merchants on e-commerce platforms in India are finding customers abroad. This further improves terms of trade for these small merchants and enterprises, deepening and broadening job creation. As per Amazon India, 50 percent of its sellers come from Tier-2 and Tier-3 cities, and more than 65 percent on the customer side are from Tier-2 and Tier-3 cities.
Broadening and Deepening Financial Inclusion
Household balance sheets likely to increase exposure to financial assets
On the asset side, financial inclusion driven by digitisation is set to alter the household balance sheet towards financial assets, and likely boost overall saving. As saving rises – also as a consequence of India’s demographics – investments will be facilitated, leading to improved growth rates. As noted, the Jan Dhan scheme has led to the opening of 30 crore bank accounts, boosting financial penetration by an estimated 100 percent. This means that almost 85 percent of Indian households today have a bank account versus 45 percent in 2014. These bank accounts are showing impressive growth in balances, which have risen from Rs 4,200 crore in 2014 to around Rs 78,500 crore in FY2018. The bank accounts will facilitate saving into deposits, insurance, small savings schemes of the government, and eventually into equity markets.
Liabilities to see a big shift in coming years
Still, the big story in financial inclusion is what could happen on the liability side of household balance sheets. Digitisation, through a combination of digital payments and GST, as well as regulatory changes, will likely increase the share of lending to micro and small enterprises (also boosting investment) and to households.
The digitisation of the economy enables smaller loan sizes because of the accompanying lower cost of customer acquisition and broader dissemination of credit arising from an enhanced capacity for credit assessment.
Historically, India’s banking system has primarily catered to large corporates and wealthy individuals. The costs of taking banking to the masses had been fairly elevated, driving banks to focus on areas in which revenue generation was high. However, this is now changing for consumers by:
- Reducing the cost of opening accounts and hence expanding the reach of banks. Aadhaar and the associated electronic know-your-customer measures have cut the cost of opening a deposit account by 90 percent. In FY18, eKYC-based verifications rose to 13.8 crore versus 4.8 crore in FY17.
- Enabling faster loan delivery. We think consumer credit could expand at around a 17 percent CAGR over the next decade. Even after such growth, total consumer loans would still be low, at 25 percent of GDP.
For micro, small and medium enterprises, GST is playing an important role: MSMEs account for 80 percent of employment generation in India. Hitherto, because of a lack of reliable financial data, MSMEs were largely excluded from the formal banking system for credit, and thus accounted for around just 14 percent of credit from banks, we estimate. But the online infrastructure of the GST Network enables any taxpayer to securely share tax payment records (and therefore cash flow data) with anyone else.
For the first time, India’s banks can obtain reliable data on MSME cash flows. Combined with the rise in the use of digital payments (and their data trail), a credit provider can now make a much more informed decision on the creditworthiness of such small borrowers.
We expect lenders to reduce spreads on MSME lending by up to 300 basis points as they get access to reliable and better-quality data. We think this will drive MSME loan growth at a high-teen CAGR for the next decade.
Improving Quality Of Life
There are three ways in which quality of life improves as a result of India’s digitisation program:
- Income growth: As India’s growth story – which is premised on favorable demographics and reforms – gains traction, we think per capita GDP will rise from its current level of $1,700 per annum to $4,135 in the coming decade. The average Indian currently spends a disproportionate share of income on food, given the low levels of income. But, as India’s per capita income rises, subsistence spending will fall, lifting the disposable income among lower-income households to spend on things such as education and health.
- Penetration of insurance: Digitisation facilitates increased penetration of both life and non-life insurance, bringing affordable healthcare services to more households.
- Other benefits of Aadhaar: One example is the Ujjwala program that has provided new liquefied petroleum gas connections to nearly 4 crore poor rural women over the past four years. These rural women had been using polluting fuels that were both more expensive (given the time consumed in accessing them) and a health hazard. Such changes are likely to bring about significant change in the quality of life for people on the lower end of the income and wealth curve. India aims to increase LPG usage to cover 80 percent of its households by March 2019, against 72.8 percent in 2017.
Still, we note that India’s demographic dividend, from a status quo standpoint, could morph into a demographic threat, based on the current lack of skilled workers, healthcare issues, automation, and large-scale migration of unskilled labor from farmlands to urban areas.
But while India is still solving these problems, the likely improvement in the quality of life that is expected from digitisation should mitigate some of these risks. Nonetheless, more work remains to be done.
Enhancing Agricultural Productivity
India’s farm sector suffers from low productivity
A key to agricultural productivity is for the states of Bihar, Madhya Pradesh, Rajasthan and Uttar Pradesh, which were labeled BIMARU due to the lack of development, to reduce the share of agriculture in their economies and thus increase the share of industry and services. Even more important will be reducing the number of farmers in the country at large without shrinking the area under agriculture. Currently, India has around 13.9 crore landowners and about 12 crore landless laborers working in agriculture, producing about 18 percent of India’s gross value added. The key is to reduce this number substantially in the coming decade by creating jobs in other sectors. Ultimately, the number of people that each farmer feeds, needs to rise.
In 1920, the average farmer fed 20 mouths in the US. This number rose to 250 by the 1960s.
In India, the average farmer/landowner feeds about 10 mouths, including five in the family. If this doubles in the coming few years, it would set the stage for a major shift in India’s output. As an aside, food prices would also become less volatile, a positive for lower-income households. The cumulative effect of various reforms—most pertinently, India’s digital leap—should indirectly help by creating jobs in the formal and informal economies. That said, Digital India also has a direct impact on agriculture.
DBT and Soil Health Cards set to bring about change
One of India’s biggest challenges in agriculture is low productivity. For example, the average rice yield is 2.4 tonnes per hectare, placing India 27th out of 47 countries.
Reasons for low productivity in India include poor soil nutrition, small land holdings that cannot take major technology inputs, and uncertainty in the water supply. Less than half of India’s farmland receives irrigated water – again because of small land holdings. And, as a result of persistent urea subsidies, India’s nitrogen-phosphorus-potassium (NPK) ratio is skewed, at 7.5:3:1 versus an ideal ratio of 4:2:1. The government launched a national soil health card program in 2014 aimed at testing every farmland holding in India for nutritional content. 13.9 crore soil health cards have been issued, covering almost 100 percent of India’s farmland holdings. The soil health cards prescribe nutrition for each landholding. With DBT in fertiliser rolling out this year linking the farmer to his identity, we believe that, over the coming years, India’s NPK ratio should start adjusting to a more productive level of 4:2:1.
The quantum of fertiliser supply to individual farmers would be linked to the recommendations made in the soil health cards. Addition of other nutrients could also help improve soil productivity. Separately, growing urbanisation may cause marginal farmers to sell their lands to other farmers and look for opportunities in the cities. This may trigger land consolidation, which, along with improved soil nutrition, constitutes our bullish case for agricultural productivity in India. Maharashtra becomes one of those rare states in India where farmland can be purchased for non-agricultural purposes, setting the stage for land consolidation in the farm sector as well as an exodus of marginal farmers into the industrial and services sectors.
Addressing Data Privacy
India’s Aadhaar debate is being closely watched across the world. Aadhaar’s approach to digital identification is appealing to many countries. It collects simple biometric data—fingerprints and retina scans—in a centralised fashion with open source technology, as distinct from the fragmentation of databases and use of proprietary technologies in the private sector. Aadhaar has significantly reduced e-KYC costs, allowing expansion in financial sector footprint, reducing leakage in government payments, and improving authentication of individuals. However, a heated privacy debate about Aadhaar is currently underway.
There are two issues about privacy relating to Aadhaar. The first is a possible compromise of the Aadhaar system itself, leading to a leakage of data. The second is a potential loss of data through third-party users. While the first risk is somewhat mitigated by sophisticated encryption standards, the second risk is harder to control – third parties collecting biometric data could be compromised, leading to possible data exposure. The Unique ID Authority of India, which is the custodian of Aadhaar’s database, introduced ‘Virtual ID’ to overcome this risk by providing users with the ability to authenticate against a variable number.
However, there is no legal framework for the collection, usage, and protection of biometric data that is being collected by third-party users.
The government has made Aadhaar authentication mandatory for accessing a variety of public services; this is also a matter of public debate and has been challenged in the country’s highest court for its constitutional validity. The Supreme Court has formed a five-member bench to examine all these aspects, and it is expected to deliver a judgment in the near future that would establish a framework for the use of Aadhaar. A risk is that it could curtail the use of such data, thereby diluting the various benefits that Aadhaar is currently delivering in order to balance the privacy risks.
This article is based on research published for Morgan Stanley Research on June 24, 2018. It is not an offer to buy or sell any security/instruments or to participate in a trading strategy. For important disclosures as of the date of the publication of the research, please refer to the original piece. Contact Morgan Stanley for a copy of the published report. For important current disclosures that pertain to Morgan Stanley, please refer to the disclosures regarding the issuer(s) that are the subject of this article on Morgan Stanley’s disclosure website.
Ridham Desai is managing director at Morgan Stanley India and also serves as head of equity research and India equity strategist.