Impact of Demonetisation on Kerala's Economy

The committee to study the impact of demonetisation on the state economy of Kerala appointed by the Kerala State Planning Board on November 23, 2016, submitted its interim report to the chairman of the board, Pinarayi Vijayan, chief minister, government of Kerala on December 20, 2016.

Professor C P Chandrasekhar (Centre for Economic Studies and Planning, Jawaharlal Nehru University) is the chairperson of the committee. The other members are Professor D Narayana (director, Gulati Institute of Finance and Taxation), Professor Pinaki Chakraborty (National Institute of Public Finance and Policy), Dr K M Abraham (additional chief secretary, Finance), and VS Senthil (member secretary, Planning Board).

The interim report points out that demonetisation has brought about a huge cash shortage, with severe restrictions on access to currency. The shortage has a significant impact in the Indian economy, which has a relatively high cash-to-GDP ratio and in which more than 90 percent of transactions are estimated to be in cash. The immediate consequence of the cash crunch has been a severe curtailment of effective demand. As a result, transactions in many markets have been reduced or brought to a halt, casual and temporary workers paid in cash have either experienced a fall in employment or have been forced to accept deferred payments or payments in demonetised notes, persons with limited access to banking services have not been able to meet their daily needs, farmers who have just harvested their crop have not been able to sell all of it and buy seeds and inputs for the next crop, many among India’s sick have not been able to pay for medical services, and persons in need of cash for occasions such as weddings or other events were unable to draw it from their accounts.

A number of features of Kerala’s economy have made it particularly vulnerable to the adverse impact of the poorly planned and implemented demonetisation exercise. First, cash transactions are predominant in the state’s economy. Secondly, some of the major contributors by sector to the state’s economy are in the informal or unorganised sector, where cash transactions dominate. Millions of people in Kerala are dependent on incomes gained in the traditional sectors of fisheries, coir, handlooms, and cashew processing as well as in crop and plantation agriculture. More than a two and half million migrant workers work as wage labourers in the state. Thirdly, the three-tiered cooperative banking structure, with PACS at the bottom of the pyramid, is an overwhelmingly large part of the financial structure. Fourthly, outside of the financial structure, Kerala has a cooperative sector that is an important component of manufacturing and services activity, which banks substantially with the cooperative banking sector. Fifthly, earnings from tourism are an important share of Kerala's state income. Lack of access to cash deals a blow to tourism. Sixthly, remittances play an important part in Kerala's economy, and the economic constraints caused by the present policy can cause disruption in the flow of remittances. These features, inter alia, contribute to the intensity of the impact of the demonetisation on the state’s economy and its people.

The impact of the demonetisation in terms of the cash deficit and its consequences has been particularly severe in Kerala also because of the distinct character of its banking sector, in which the cooperative sector and the Primary Cooperative Societies play a central role. Overall, the cooperative banking sector is much more active and vibrant in Kerala than elsewhere. As a result, over 70 percent of the deposits in PACS in India come from Kerala; over 70 percent of the non-agricultural loans and advances made in India are made in Kerala; and over 15 percent of the agricultural loans and advances disbursed in India are disbursed in Kerala. Thus, the notifications issued by the Reserve Bank of India after the November 8 withdrawal of 500 and 1000 rupee notes (especially on November 14), which kept the cooperative banks and societies out of the note exchange process, was particularly damaging for Kerala.

Besides being excluded from engaging in exchange of demonetised notes, the access of PACS to currency was cut off, forcing these institutions – which are central to financial intermediation and inclusion in Kerala – to shut down their operations. As compared with an average outstanding deposit base of Rs 19.9 crore per branch and Rs 28,000 per individual member, each PACS was treated as an individual and its daily/weekly withdrawal limit set at Rs 24,000 a week. What was consciously ignored was that it was not each PACS that was being denied access to cash, but that lakhs of members who held deposits in these institutions were being denied access to any of their money. There cannot be a single other instance of expropriation of the purchasing power of a population of this magnitude.

REPRESENTATIONS FROM VARIOUS SECTIONS OF PEOPLE

The committee met with or received representations from cooperative society representatives and others associated with the construction, dairy, vegetable and fruits, fisheries, and handloom sectors. It became clear that given the multiple levels and varying values of the transactions involved in the informal sector, not all transactions can be made cashless, and definitely not in the short run. The result has been an inability to make payments, even for wages. Moreover, in sectors trading perishables such as vegetables and fruits, the pressure to sell the product results in falling prices. Despite the decrease in prices offtake remains low because of the cash crunch, leading to loss of produce because of spoilage. In the dairy industry, farmers are not being paid in time for milk supplied and they, in turn, are unable to access adequate cattle feed because of the cash deficit. The fisheries sector has been particularly hard hit because, starting with payments for fish auctioned at the point of landing, most transactions including payments of wages by boat owners, supply to wholesalers and retailers, etc. is in cash. As business has declined, workers get less work and lower earnings and have had to get into debt to meet their daily expenses.

Tourism and remittances are important drivers of growth in Kerala’s economy. But as news of the serpentine queues at money exchange counters in airports and outside and the limits on the amount of Indian currency that can be obtained in exchange for foreign currency spread, cancellations have been on the rise and tourist arrivals are falling. The cash shortage has affected domestic tourist arrivals as well. As per quick estimates from the Department of Tourism, Kerala, relative to the corresponding month of the previous year, domestic tourist arrivals fell by 17.7 percent in November 2016 and foreign tourist arrivals by 8.7 percent. The corresponding figures for October 2016 were a positive 5.2 percent and 6 percent respectively.

Cooperation and primary cooperatives are Kerala's strength, a rich legacy of our freedom movement. People's confidence in these institutions is part of Kerala's historical heritage. Given the ways in which the demonetisation has affected the state, the principal effort of the government and others has been to find ways to ease the cash crunch for the poorest and seek to limit the damage that will be inflicted on the cooperative sector, especially the cooperative banking sector. A significant measure adopted aimed at facilitating access to their deposits to account holders in the PACS, which were unable to service demands for withdrawals because of the Rs 24,000 per week limit on their own access to cash. This was done by creating a special window in the District Cooperative Bank (DCBs) to which individual PACS were linked. To facilitate access to cash, all PACS members were allowed to open a “mirror account” in the concerned DCB, and the PACS was to provide a debit note to the DCB against sums due to the account holder. Against that the PACS account holder was permitted to gain access to the equivalent of Rs 24,000 per week -- the limit applicable to account holders in the “formal” banking system.

Besides seeking ways in which government policies could mitigate the hardship, the Government has sought to facilitate independent efforts to enhance cashless transactions among holders of accounts in cooperative and scheduled commercial banks. The issue here is not to replace cash settlements with digital payments through encouraging the use of mobile phones and digital wallets. Those expecting any such transition to occur on a scale required to address the problem created by the current demonetisation are making hugely overoptimistic assumptions on the state of connectivity, digital literacy, and the digital security infrastructure in the country. The method in Kerala is to use local networks linking people, businesses, institutions, and the Government and the trust they are built on to settle transactions through the existing financial framework but without cash. Cards, identity markers, information sources, and other instruments only help to build and consolidate the trust needed for the operation of such networks.

Report Courtesy: Government of Kerala