How demonetisation in India crushed the informal economy

The informal economy, which has strong links with the formal economy, has been hit hard and this may have catastrophic implications for society as a whole.

Published : Dec 07, 2016 12:30 IST

Several traditional  jaggery-producing units in Mandya district of Karnataka have temporarily suspended production following demonetisation.

Several traditional jaggery-producing units in Mandya district of Karnataka have temporarily suspended production following demonetisation.

No economic policy announcement in India in recent times has affected almost all Indians instantaneously as the one made on November 8 by Prime Minister Narendra Modi that all Rs.500 and Rs.1,000 denomination notes will cease to be legal tender (with some exemptions) within four hours. It is anybody’s guess as to how long it would take for the Reserve Bank of India (RBI) to replenish the notes already withdrawn. What is proving to be a catastrophic dimension of the decision is that the total amount of currency withdrawn constituted around 85 per cent of the total currency in circulation while the replacement by new notes, even after three weeks, is only a small fraction of it. This is like sucking 85 per cent of the blood from the body in one go and injecting new blood drop by drop.

The ostensible objectives of the new policy are the elimination of fake currency in circulation as well as black money, i.e., legal money amassed without paying taxes. There is certainly a one-off benefit in the case of fake currency since it will become immediately invalid. But this policy need not stop the production of fake currency of the new type. As for the second, there has been considerable discussion that black money is not a stock but a flow as in the case of national income. There is no certainty that even the stock portion of the black money will be eliminated by this action because the underlying assumption that all black money is kept in the form of Rs.500 and Rs.1,000 notes is a seriously flawed one. Going by the raids of the Income Tax Department, it has been reported that the currency component of black money is around 6 per cent of the black income. If that is the case, the question is, do you have to burn the house to catch a mouse?

Not all Indians are suffering from this shock treatment meted out to the economy. There is hardly a problem for those in the cashless economy because a well-functioning infrastructure is in place and continues to evolve with new instruments. These are predominantly, if not only, the richer sections of society—more educated, mostly urban and, more often than not, well-employed or in well-earning businesses and professions. Even then the Indian economy is predominantly run by cash. According to the RBI, cash transactions account for 90 per cent of all transactions in the country. Given the organic link between the vast informal, read livelihood, economy and the formal economy, even card holders have to resort to cash transactions for a variety of requirements. Therefore, the major as well as immediate impact of the currency withdrawal policy is a severe hit on the informal economy of the aam aadmi . Just look at some basic features of this informal economy and there should be no surprise why the economy is dependent on cash.

It is no exaggeration to say that India is a very large economy consisting of a very large number of tiny entities engaged in the production of goods and services. That there are a few large private corporate entities and public sector establishments accounting for a significant share of national output is also a fact. But the livelihoods of an overwhelming proportion of Indians depend on the vast low-income informal economy.

Life in the ‘informal’ world

From the establishment’s point of view, the informal economy consists of all the unincorporated enterprises employing fewer than 10 workers. The latest Economic Census, conducted during 2013-14, puts this figure at 576.92 lakh, or 98.6 per cent of all establishments in India other than agricultural crop cultivation and public administration. This includes nearly 420 lakh self-employed, classified as Own Account Workers or Establishments, some of whom might be assisted by their family members. This is in addition to the small and marginal farmers in agriculture who constitute around 84 per cent of all farmers.

The informal economy is understood not just by the size of the establishments or enterprises but also by the employment dimension, which refers to those working without any employment or social security provided by the employer. Of the 472 million Indians identified as workers, 82 per cent work in the informal sector in enterprises employing fewer than 10 workers; 10 per cent are informal workers in the formal or organised sector and the remaining 8 per cent are formal workers in the formal sector, i.e., those with some employment and social security. Taking agriculture and non-agriculture together, the informal economy of employment includes a vast segment of the self-employed, constituting 52 per cent of the workers (247 million), and another 30 per cent are casual workers (138 million).

Most of the self-employed eke out a living in activities such as street vending, rickshaw pulling, auto and taxi driving, small-scale trading, and running small tea shops and eateries, or as independent workers such as plumbers, electricians, artisanal workers such as weavers, handicraft workers and a vast pool of poor women in “putting out” systems as in beedi -rolling, food preparation, agarbattis , chikan work or whatever work they can lay their hands on. This, of course, is in addition to the vast mass of small and marginal farmers numbering well over 125 million. Their livelihood is anchored on cash transactions on a daily basis. They need cash to buy their inputs such as, for example, fuel for vehicles or vegetables, eggs, and fruits for street vending. They need customers or consumers with cash to pay for their goods and services. While some basic and minimal transactions will be managed by whatever little cash they can get hold of for personal consumption, business will not be as usual in most parts of the country. In several industrial clusters such as the glass industry in Firozabad, Thane in Maharashtra, Surat in Gujarat, Kollam in Kerala, to mention only a few, the cash crunch has already begun to take its toll by way of loss of work, since employers do not have the cash to pay wages.

The other major category of casual workers live by their earnings of daily wages. They are paid either on a daily or on a weekly basis. For them, there are hardly any savings to draw upon. For the first few days they queued up in front of the banks to change the old notes given by their employers. But now the employers do not have enough cash to pay them. In the cashew industry, for instance, employers were forced to negotiate with workers who demanded payment of wages. Since there was no cash, only part of the wages was paid. There are around 25 lakh migrant workers in Kerala alone and some of them started returning to their villages since they find it difficult to get their daily consumption goods on credit.

There have been similar reports of migrant workers returning from the construction sector in Bengaluru, the garment sector in Ahmedabad and the powerloom sector in Surat. Reports of closure of small-scale units in many parts are pouring in, as for example, in jaggery-making in Mandya in Karnataka, owing to paucity of cash to pay wages and procure inputs. The otherwise vibrant garment industry in Tirupur in Tamil Nadu now reports worker attendance of just about 60 per cent because of the cash crunch. This is likely to affect exports. The local economy that depends on the vibrant garment industry is similarly grinding to a slowdown as many shops wait for customers to come and buy their wares and goods. There is a vicious cycle here because small establishments need cash to pay their employees and they also feel the pinch from the demand side when their business goes down owing to the lack of cash with the public.

Some establishments and retail shops provide goods on credit because they function in a moral economy that has been built on trust over time and arising from mutual familiarity. But this kind of moral economy breaks down beyond a temporary period because the small-scale producers and traders need to replenish their stocks by purchasing from elsewhere, very often with cash. While the trickle-down process of cash unloading may give some temporary relief here and there, there is an emerging sense of a generalised slowdown of the economy. The staying power of the informal economy is too weak and brittle that it feels the pinch immediately and directly. But its link with the formal economy is beginning to feel the pinch through the cascading effect: a whole range of goods produced in the formal economy are procured from the informal sector and is also sold in the informal sector as in the case of personal products, garments, small vehicles, fuel and so on.

Formal-informal linkage

The links between the formal and informal economies work through two main effects. One is the consumption effect in which people living by the informal economy consume a range of products produced in the formal economy. In turn, people in the formal economy also consume a lot of products of the informal economy, whether it is the simple grocery shop, paanwallah , autorickshaws or taxis or small eateries, the barber, the carpenter or the plumber. The second is the production effect in which the formal economy depends to a significant extent on products and services from the informal economy. Thus, agricultural products, construction materials such as sand and granite, spares and parts of the automobile and similar manufactures or a whole range of personal products that are later branded and packed for sale are all impacted.

The informal economy is also needed for its production in a range of products and services, be it agricultural inputs of fertilizer, machines and fuel or the yarn for the weavers and a range of raw materials that are often handed over to the subcontracting firms or workers engaged in the “putting-out” activity, which has gathered pace in the name of outsourcing by large units. This is because of the character of the Indian economy as a complex web of multi-structural, multilayered and multi-technology system, from the most primitive activity of gathering tendu leaves to the making of supercomputers, reflecting the uneven development of the Indian economy and society.

It is this generalised effect that perhaps forced, in my view, former Prime Minister Manmohan Singh to talk about a decline in the growth rate of the economy by 2 per cent. Depending on the speed at which the replenishment of new notes happens, the decline in growth rate could vary; if the current and the coming quarter do not register a positive growth rate, the economy could well settle to a growth rate of 3.5 per cent arising out of the 7 or so per cent growth rate achieved in the first two quarters.

Informality and inequality

Many corporate honchos, who often double as policy advisers, are going gaga over the current impasse as an opportunity to push the agenda for a cashless economy, which is now touted as the latest objective of the Central government. They talk about the emerging digital infrastructure and its adoption in many urban areas. What they ignore is the ground reality of India’s society and economy that is unequal in many respects, with a vast pool of illiterate and less educated people and sparse banking facilities (not even 10 per cent of the six lakh villages have a bank branch), not to speak of digital infrastructure, in thousands of villages. Take, for example, the educational attainments of Indian adults. The latest figures from the 68th Round of the National Sample Survey tell us that 30 per cent of adults are illiterate while another 21 per cent do not have an education beyond the primary level.

That is to say, those with practically very little education constitute 51 per cent of adult Indians. Another 17 per cent do not have more than middle-level school education, although some would say, rightly so in my view, that they have seen young migrant workers use mobile apps to transfer money to their households. This is small consolation as a generalisation on this basis could lead to dangerous conclusions.

If the class of educated is to be taken as those with at least a secondary-level pass, then one-third of the adults could be deemed as such. That the share of graduates is less than 10 per cent among adult Indians is something that many living in the “shining” segment of urban India may not be aware of.

Although there is a proliferation of debit cards to an incredible 615 million, the RBI says that 88 per cent of their use is for cash withdrawal from ATMs which accounts for 94 per cent by value. The number of credit cards, on the other hand, is reported to be around 22.7 million.

A study by Fletcher School of Business of the Tufts University conducted a couple of years ago reported that fewer than 35 per cent of Indians above the age of 15 ever used a bank account. Less than 10 per cent ever used any kind of non-cash payment instrument. On the other hand, ATMs have become popular as a place to store cash and withdraw the required amount of money without carrying it around. Another study by the same institution, based on a field survey in Delhi and Meerut in Uttar Pradesh, reported that the average percentage of people in the sample having a credit card was just 7.4 while the average for Delhi alone was 26. Even the educated had only limited access to credit cards; 19 per cent among graduates and 36 per cent among postgraduates.

Despite great advances in the spread of banking and financial technologies, India is a deeply unequal society. By the estimates of the 70th Round of the National Sample Survey Office, 60 per cent of total assets were held by the top 10 per cent and 75 per cent of assets by the top 20 per cent in 2013. The bottom 20 per cent had just 0.68 per cent of the total assets while the bottom 50 per cent had a little more than 6 per cent. Such unequal distribution of wealth has a cascading effect on the ability to acquire education, health care, decent work and consequent capabilities to handle sophisticated information technologies, including financial instruments. They live hand to mouth on daily earnings and wages, travelling as “footloose labour” from one end of the country to another in search of paltry wages under miserable work conditions. Even the relatively better off, the small producers and some self-employed, eke out a living by earning small amounts on a day-to-day or week-to-week basis, which requires the economy to provide a free flow of small amounts of cash in large quantities for the large working and non-working population.

As the economy lurches into a prolonged period of uncertainty, it is evident that the vast mass of the population engaged in informal activities will bear the brunt of demonetisation. But to imagine that this would remain confined to a vast underclass of Indian society would be a fatal assumption, for, the strong linkages between this section of society and the relatively more organised sector would result in a catastrophe that the well-heeled seem to be blissfully unaware of now.

K.P. Kannan is ICSSR National Fellow and former Director, Centre for Development Studies, Thiruvananthapuram. He served as member of the National Commission for Enterprises in the Unorganised Sector, which was chaired by the late Arjun Sengupta.

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