Demonetisation: A painful shift in rural economy, but all could be well by January

The rural economy is an important segment of the ecosystem and accounts for around 70 percent of employment and 50 percent of GDP with agriculture being the main driver followed by services and manufacturing. It is largely unorganized and hence those working in rural India or consuming in this economy are a different category of economic agents driven by different factors. The economy is quite complex in so far as the fact that cash dominates in terms of transactions and while there has been some intrusion of the use of credit (kisan) and debit cards and ATMs, dependence on technology driven payments system is limited. This has hence also become a haven for routing black money both in terms of seeking tax exemptions by channelling funds, to convert to legitimate funds. But a lot of black money gets into land and ‘apparent rural activity’.

Representational image. Reuters

Representational image. Reuters

Now consider some aspects of this economy and the cash conundrum. Almost all transactions in the mandis (there are above 7,000 organized ones and over double the number that is unorganized), are based on cash as it is easy to use. The farmers prefer to receive cash and while some do take in cheques there is a sense of doubt if the counter party is unknown. Hence one reason why electronic mandis is a good idea is that payments can also be made through the electronic mode as all transactions would be e-enabled. The recent demonetization has caused significant distortions as farmers are unable to sell their goods. This has happened just when we are in middle of the kharif harvest which involves rice, soybean, cotton, maize, sugarcane, bajra, besides fruits and vegetables which are all year through.

The second issue for Indian agriculture is the rabi season which has begun where farmers start sowing their seeds. The issue here is less serious as a large part is backed by credit where the prevalent cash crunch may not matter. It would only be at the margin that farmers may be impacted, and hence the pain here would be secondary.

Next let us look like services. A noticeable example is the cobbler who makes footwear. His business has stalled as there are few people who are able to buy his product given the cash crunch. The value is low being less than Rs 1,000 and sold locally. There are no cards involved in sale of these products. He cannot make more shoes as he cannot pay for the leather. The leather dealer cannot source from the tannery because of the cash issue. The tannery has an issue with the raw material as the cash economy has gotten stifled. The same holds for the transport operators who have to move farm products or for that matter any other product produced by the organized sector. This impasse has led to trucks getting lined up with cash issues on both ends.

How about the SMEs, which have a large presence in the rural sector? Here again business is mainly through cash. They have limited access to finance from banks except when it gets mandated through the priority sector lending. They source material based on cash though most of their payments are linked with large enterprises which would be through cheque. This mismatch will create temporary problems as the issue is access to cash, which is the ultimate problem for rural India.

Penetration of banks in rural areas
The penetration of banks in rural areas is remarkable. Almost 65 percent of branches are in rural and semi-urban areas with around 38 percent in just the rural segment. The problem is not infrastructure but the blockages caused by the inability of banks to deliver cash in adequate quantities and denominations on time. Metro cities have been witnessing sharp problems for almost two weeks now with challenges of recalibrating ATMs and getting cash to the teller. This is a bigger issue in places which have bank branches but not easy access for ensuring adequate supplies. This is the crux in the functioning of the economy.

Withdrawing cash or exchanging notes are the major challenge here. People are not habituated to using the e-channel mode of payments and are in the throes of difficulties in keeping their households ticking. This is where using localized banking structures like state, central or district cooperative banks will help. But given that some of them have political patronage, the Reserve Bank of India (RBI) has kept them away or else there could be channelling of black money.

Will the present cash crunch push this economy back significantly? The answer is that it will not be very different from the urban economy. Services output lost will be permanent. But other product purchases and sales will largely be deferred. However, at the micro level the population will be sharply affected in terms of being aware of what is happening, understanding the ethos behind this move, getting hold of currency and probably realizing the necessity of moving away from currency. The inconvenience caused here will be higher as even today bank ATMs in metro cities have not been calibrated. Several branches are still not receiving adequate cash. In rural areas it will be even more distressing.

But on the positive side one can be fairly sanguine that by December 31, conditions will return to normal once again and it will be back to business for farmers and the rabi crop should be running well on course. In fact going ahead, this move, howsoever painful it is, will help in integrating the non-agri economy in rural India into the GST module.

Two thoughts here: How will the rural people react to this move? Will they agree with the motivation or will they become suspicious of the banking system and hold more cash in future in lower denominations? Or are they sophisticated enough to understand that there is black money which is affecting the government’s fiscal arithmetic and has distorted the economic system and is fostering terrorism? If this is true, then they will appreciate what has been done and support wholeheartedly. Otherwise, once again it will be the case of the weaker and poorer people bearing the brunt of any reform in the system. Only time will tell.

(The author is Chief Economist, CARE ratings. Views are personal)