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The world is moving towards a cashless economy whereas cash-based transactions are rampant in Pakistan. Ratio of currency in circulation to bank deposits has always been high in the country and is still growing in this digital age. There is a limit to what the private sector and the regulator can do to move towards digital economy. In absence of a whole-of-the-government approach and the right incentives structure, the digital ecosystem cannot be developed.

Bottlenecks persist throughout the value chain - from manufacturers/importers to wholesalers, and retailers to consumers - all prefer paper-based transactions. Interoperability across payment systems is missing. Digital transactions costs are exorbitantly high. Similarly, perception of regulatory/taxation cost of moving away from cash is also high. Moreover, an overall digital culture must be inculcated.

In retailing segment, Punjab Revenue Authority (PRA) took an excellent step of charging low GST on card-based transaction (5 percent versus cash-based at 16 percent) for restaurants and beauty parlors. The two-tier system became applicable in July 2020, and already demand for Point of Sale (POS) machines in Punjab has increased. "Demand of POS machines from restaurants and beauty parlors has increased from 10-15 to 200-225 per month," according to a POS acquirer.

It's good to see the impact. Yet, it covers a small segment of a potentially enormous market. Some push is coming from consumers, but there is no pull from retailers. That is the key area where right incentives are required. Back in 2008, the number of installed POS machines across the country stood at 56,000; it reduced to 35,000 after Standard Chartered Bank (SCB) and Citi Bank exited the business. It is now close to 60,000 and may reach 70,000 by end of 2020. POS machines are installed at 26,000 retail outlets across the country.

There has been some progress; but there is still a long way to go. For instance, despite issuance of 40 million+ cards, transactions on ATMs are 20 times that on POS machines. More conversion is needed. In India, before demonetization, there were around 0.9 million POS machines. Within a year after demonization, 1.8 million new machines were added. And today, over 5 million machines are operational.

Without advocating for something as dire as de-monetization (which has its own repercussions), a similar whole-of-government approach is required in Pakistan. SCB and Citi exited from acquiring business because the burden of market development lay with them, while other card issuers benefited in terms of profitability. Meanwhile, merchants have no incentives whatsoever.

In most cases, acquirers are giving machines to retailers for free. This is in sharp contrast to the model prevalent across the rest of the world, where merchants either buy the machine or pay rent on use. State Bank is cognizant of the situation and has attempted to align the acquirers' incentives by increasing its share in merchant discount rate (MDR). Earlier, MDR was skewed towards the issuer. Thus, SBP's policy change and PRA's initiative have given some impetus to the market; but there is still a long way to go.

The real challenge is to align merchants' incentives with digital transactions. Many believe that POS is a niche market, and it is better to invest on wider adoption of QR code technology and mobile wallets acceptability. Both are important, as they complement each other. Even so, POS could be a much bigger market. For instance, in China, the ratio of POS to QR code is 80:20. Whatever mode of digital transactions ends up becoming prevalent across the country, the core objective must be making the economy cashless. Merchants' incentive to transact in cash must be taken away.

Tax authorities need to provide GST incentives on digitization to merchants along the same lines as PRA. PRA is already giving 11 percent advantage for certain segments to consumers. Even if a 3 percent incentive on a larger domain is given to merchants, it can go a long way. For example, FBR attempted to impose a CNIC requirement for any transaction beyond Rs50,000. An even more powerful tool could be a ban on cash transactions beyond Rs50,000. Once transactions are digitized, there will no longer be a need for CNICs.

Along with complementary carrot and stick approaches to simultaneously entice and compel merchants to move towards digital transactions, the government should also make POS machines cheaper. This can be done by lowering taxes and duties on import of POS machines. Currently, 30 percent+ taxes and duties are paid at import stage.

Another element that needs an overhaul is functioning of branchless banking. Telcos ventured into branchless banking using donor money. But its only main advantage is domestic remittances. It does not end cash. Furthermore, there is a high transaction cost associated with branchless banking operations. For example, if an employer remits Rs15,000 salary through a bank account to the mobile-wallet of his driver (using a service such as Easy Paisa or Jazz Cash), he would first be required to pay IBFT charges (Rs 50-100) while the recipient would pay Rs250-300 to the agent at the time of cash withdrawal. This raises transaction cost to up to 2.5 percent, while the driver still ends up using cash.

The real success would be to reduce the transaction cost to minimal and developing a system that allows using the mobile wallet credit to transact for buying grocery at mom-and-pop stores, paying bill for tea or meal at dhabas, or service charges at a local mechanic shop for motorbike repair, etc. For that to happen, interoperability of various systems needs to be seamless. The settlement must be made swift. SBP is working on a micro-payment gateway which will address some of these issues. But it may take another 12 months before it becomes operational.

Until then, the government should work on giving tax and other incentives to merchants for cashless transactions. Without doing so, no matter how much SBP or industry tries to improve digital infrastructure, the economy's reliance on cash and paper-based instruments will persist.

Copyright Business Recorder, 2020

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Ali Khizar

Ali Khizar is the Head of Research at Business Recorder

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