Aug 30, 2014

Uber-mess - Why RBI is right ?

 Reserve Bank of India has kicked up a storm by preventing the use of foreign payment gatways in local transactions.. The first casuality of the move is Uber. Traditional media & social media is up in arms against RBI quickly for killing innovation with archaic laws. Even some of the most learned economists have written against RBI move ( )

In reality, is the RBI really a regulatory villain in this case ?
Here's the link to the original circular

There are three main things that are emphasized in this circular, directly or indirectly

(1) Transctions between two residents of India should be in INR. 
(2) The INR credit card transaction should be acquired by an Indian bank through an Indian payment gateway if the card is issued in India. .I.e, there should not be any forex flow in such transactions.
(3) There should be a two-factor authentication in Card -not - present (CNP ) transactions.

Make no mistake, Uber is a great step forward in terms of convenience.The iphone-app based billing is a true innovation. Taxi cabs across the world is feeling the heat of market disruption resulting in strikes in London , Paris and many more.

From a consumer's perspective, the convenience that Uber brings about is really un-paralleled.
However RBI has multiple responsibilities. Its not a pure consumer rights watch-dog. One of its mandate is to ensure currency stability. While, advocates of free market mechanisms scorn against this role, the reality of India is that your INR exchange rate has a great bearing on inflation. 

And, insisting that the transaction between two residents ( driver and the passenger ) should be entirely in INR is perfectly justified. Why should such a transaction cause a foreign exchange flow ? In Uber- model, the credit card transactions are routed through a gateway in Netherlands, and the payment to the driver comes from a different US / EU bank account. Meaning, in every transaction, there is a foreign exchange inflow or outflow that puts Indian banks at the possible risk of gain/loss depending on the exchange rate fluctuations. Add to that, the settlement risks in CNP's is much higher. Any chargeback claims will additionally result in forex flows.

What I find more disturbing about this model of currency flows is that the state loses its right to tax such transactions. These transactions are not going to hit Uber - India's bank account, and there is no way for the taxation authorities to assess the flows as gateways, banks etc are located abroad.
There's this well known method of tax avoidance in movie industry in India. If you look into the financial statements submitted by actors, production houses etc, you would see that the lead actor/actress was paid, only about say , 1 million INR.  In reality, much of the actual financial transaction takes place in tax havens outside of India. 

To curb volatility in currency markets, it is essential that these forex flows are controlled . To me , the spirit of this ruling is more on forex flows than on two factor authentication.

The point on two factor authentication is more from a consumer protection front to prevent incidents of card cloning and reducing chargebacks. From a systemic perspective, how do you build more faith in the credit card system - by reducing chargebacks and making consumers feel that the card is secure.
Two factor authentication does bring more comfort to that front, at the cost of convenience.

If Uber routes all these transactions through Indian gateways and Indian banks, then the concerns of RBI on forex flows is addressed. The only remaining point would be this consumer protection argument  of two factor control. If adequate auth controls and checks are present at the time of enrolment into this app, then the two factor auth at the time of actual transaction can be done away with .

As I put it initially, this ruling is more about forex flows. On that front, RBI is fully justified.