In an earlier
In an earlier article, I had examined some of the economic consequences of the recent demonetisation of Rs. 1,000 and 500
The point that I had made earlier was that the demonetisation will have serious supply-side effects involving loss of both production and employment, especially in the informal sector. The measures that have been taken by the government so far are mostly designed to address the demand-side issues in an orderly and equitable manner. This is no doubt essential, but the hope that the liquidity released will rapidly percolate to the production side is seriously questionable. The greater likelihood is that most people will curtail their current consumption and try to rebuild their precautionary cash holdings as quickly as they can. The net result is that the currency in active circulation will be significantly lower than the currency pumped in, which means a continuing lack of liquidity in the informal sector. So what are the alternatives?
The first best and most elegant option is to do what should have been done in the first place – announce that both the old and the new currencies will be legal until 31 December, after which the former will become so much scrap paper. If all the procedural checks that have been imposed are kept intact, as they should, I do not see how this would be less effective in addressing counterfeiting and in penalising black money holders than what is happening now. However, far too much political capital has been invested in the current design, and any back-tracking will involve
Let me begin with the sector that needs the most help and needs it fast – agriculture. Crop agriculture is at a critical juncture (this does not apply to animal husbandry and fisheries, whose problems are more akin to those faced by informal manufacturing). In the North and the West, the summer crop (kharif) has been harvested and, for the most part, sold. The farmers are thus holding large amounts of what is now funny money. A rough estimate of the amounts involved is that a farmer cultivating 1 hectare of land would have sold his surplus produce for around Rs. 6 lakh – it’s very unlikely that this would have been paid in Rs. 100 notes. The lucky ones would have settled their debts, but it would still leave a tidy amount
The situation is even worse in the South and the East, where harvesting will begin around the end of November, and sowing of the next crop towards the end of December. Will there be enough funds with the mandi traders; or will there be distress sales in all places and all products where the Food Corporation of India (FCI) does not have
Mobilising and providing sufficient liquidity to the non-moneylender agricultural credit system should
If the farmer’s position is bad, that of the agricultural labourer is dire. He is staring at the prospect of unemployment at a time which is usually his peak work period. Given the liquidity position of the farmer, it is more than likely he will resort increasingly to using family labour instead of hired hands. This is a serious livelihood issue, and one that crops up every time there is a monsoon failure. Fortunately, there is a mechanism already in place to address this problem – the Mahatma Gandhi National Rural Employment Guarantee Scheme (MGNREGS). The government’s attitude towards this scheme in the last two-and-a-half years has been somewhat desultory, but it may be the only effective instrument it has to stave off a backlash against a calamity that is not natural but policy-induced. This should immediately be projected aggressively and implemented effectively, again in coordination with state governments.
The informal manufacturing sector, which includes handlooms and handicrafts, is perhaps even more dependent on informal credit than agriculture, and therefore faces an imminent threat of massive disruption. And, like agriculture, very little of the money in this sector is black since all of them are below the excise threshold and most would be below the income tax threshold as well. Nevertheless, it also is going to suffer collateral damage. The only saving grace is that the credit needs of this sector are less ‘lumpy’ (or seasonal) than that of agriculture, which makes it more tractable in terms of gradual adjustment. Moreover, the only supply-side measure
Prime Minister Modi had taken a path-breaking initiative in this area with the launch of MUDRA (Micro Units Development and Refinance Agency) loans, which were low volume unsecured loans issued by commercial banks that would be increased step-wise in tandem with credit compliance. After the initial push, however, MUDRA has dropped out of the limelight. This is an opportune time to revive its standing in the public eye and emphasising the government’s commitment to providing formal credit to micro manufacturing units.
Trade and transport
These two activities sit at the heart of any market economy and together constitute the largest component of the service sector by a wide margin. Any disruption in these activities has ripple effects which affect the entire economy: none is immune. The problems being faced by these two sectors from the demonetisation, however, are very different.
The trade sector is by far the largest repository of cash at any given point in time. Most of this is money in transition, that is, cash received from the buyer waiting to be remitted to the supplier, but there is a substantial component of own and borrowed funds as well. The first category is completely
The road transport sector, on the other hand, though highly dependent on cash, probably has very little black money. More than 90% of this sector comprises single truck
In conclusion, I believe that the government needs to realise that production credit is at least as, if not more, important than providing liquidity for consumption. If it does accept this point of view, it should continue with the restrictions on exchange and withdrawals for consumption purposes for a longer period, and redirect much of the new notes being printed for production purposes.