The financial inclusion programme launched by the Narendra Modigovernment, the Pradhan Mantri Jan Dhan Yojana (PMJDY), is a welcome move that will pave the way for erecting the infrastructure required to roll out direct cash transfers in the country. The Jan Dhan Yojana, which promises a bank account, insurance cover, and overdraft facility to each Indian household within the next two years, will finally allow the government a chance to institute a universal basic income transfer to all citizens, and thereby reconfigure the country’s leaky and dysfunctional welfare system.
While one can disagree with the mechanics of the scheme, in particular the reliance on state-owned banks for reaching the unbanked, there can be very little disagreement on the two key end goals—greater access to the formal banking system and a move towards replacing India’s myriad welfare schemes with a simple non-discretionary income transfer to all citizens.
The government has emphasized the first goal in its announcements relating to the scheme but it is the second understated goal, which holds real transformational promise. Governments in India have been characterized by weak delivery systems that promise a lot to the poor but deliver infrequently and erratically, while supporting an army of government officials who live off the myriad welfare schemes.
Even targeted transfers, whether of the in-kind or cash variety, suffer from huge leakages and waste: they include the undeserving, and leave out the deserving.
The solution that many economists propose to avoid targeting errors and leakages is a kind of a negative income tax, or basic universal income support, which takes away discretionary power from government officials, and allows citizens to choose what they want to spend on. The key problem in instituting such a basic income transfer scheme in India is that nearly half of Indian households lack a bank account. The Jan Dhan Yojana strikes at the root of the problem by mandating universal access.
To be sure, the use of state-owned banks seems a throwback to the 1970s style of state-directed developmental banking, which created several perversions in the banking system. It is important to keep in mind two key lessons from that era while designing policies today. First, despite its ills, it was the singular stroke of bank nationalization which enabled India to raise its savings rates in the seventies, and growth rate in the subsequent decades. Yet, despite the success in mobilizing savings, there still remain large differences across different parts of India when it comes to savings behaviour, with many people in the rural hinterland eschewing formal banking channels to save money. As the 2010-11 economic survey pointed out, 41.7% households in rural India preferred to save in cash at home rather than use a bank deposit, as opposed to 23.4% of such households in urban India. Micro-savings products for the unbanked are direly needed today, and expanding the formal banking system will help.
The second lesson from the earlier era worth keeping in mind is that the problems in the banking system arose largely from misguided attempts at providing easy credit. The more recent history of the microfinance industry also illustrates the limited potential of credit interventions. Indeed, evidence from around the world shows that easing access to credit without addressing real economy constraints is unlikely to either boost growth or help fight poverty. While access to basic financial services does help the poor, throwing easy credit at them rarely raises prosperity in a sustainable way.
The key to the sustainability of the latest scheme will therefore lie in being able to focus narrowly on products such as micro-deposits and micro-pensions, and in being able to share costs transparently. The Union government will have to pick up the tab on the costs banks will incur in the initial phase in expanding their reach, and in operating low volume accounts.
As long as the government is able to close the multitudes of welfare schemes, which have proliferated in recent years, and utilize the funds saved to fund a universal income support programme, the financial access scheme will pay for itself.
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