Dear PM Modi, Save Informal Sector from a Post Note Ban Recession

Four economists write an open letter to PM Modi, urging him to save the informal sector from a recession.

The informal sector has suffered after demonetisation, as its vital lifeline, cash credit has dried up. (Photo: Harsh Sahani/ The Quint)

Dear Prime Minister,

We appreciate your intentions behind the announcement of a high-value note ban on 8 November 2016.

No one can deny the importance of tackling corruption, widening the tax net, promoting cashless transactions, neutralising counterfeit currency and delivering a deathblow to terrorism, human trafficking and drug trade. We are also happy at your admission that these goals cannot be achieved in a costless manner.

In this letter, we summarise available evidence to highlight that the major brunt of your policy, so far, has been borne by the informal sector, an extremely important part of our economy.

Developments in this sector are often missed by government radars due to lack of regular official information, thus constraining prompt and effective government action. We appreciate your concern for the poor engaged in this sector. We also suggest policy options that we hope will get your full attention.

Also Read: Post-Demonetisation Budget: The Hits and the Misses

Informal Sector Badly Hit

Economists often use the terms ‘informal sector’ and ‘unorganised sector’ interchangeably to refer to unregistered and therefore unregulated enterprises. We adopt a slightly broader definition for the informal sector: all the economic actors in the unorganised sector as well as wage and other casual labour working in the organised sector. The informal sector accounts for 92 percent of our total employment and about 50 percent of GDP.

The informal sector accounts for 92 percent of our total employment and about 50 percent of GDP.

The large and positive difference between the shares of this sector in total employment and GDP is indicative of low incomes, which we argue have been impacted southwards by demonetisation due to the sector’s dependence on cash based transactions.

With the sudden ban on 86 percent of the country’s currency and an extremely slow pace of remonetisation, the sector has suffered badly as its vital lifeline, cash credit (hundi, nidhi, chit funds etc.), has simply dried up.

However, its capacity for large and rapid employment generation makes it a vital component of the Indian economy. Thus, its early revival is the need of the hour.

Also Read: RBI Didn’t Want Demonetisation, But Modi Govt’s Bullying Worked

Drop in Growth Rate

No matter how forcefully the digitalisation of our financial sector is pushed forward, it is realistic to assume that cash will remain the medium of trade in the informal sector in the foreseeable future.

Therefore, digitalisation must be accompanied by additional policy measures that target the poor more appropriately and support small value transactions in cash.

At this point of time, though the benefits of digitalisation and demonetisation have not yet materialised to any significant extent, the same is not true of costs as negative impacts have been large and immediate, mostly invisible to the government, and threaten to leave a lasting adverse effect on already high levels of poverty and inequality.

Fortunately, various economists have offered a number of estimates of aggregate, regional and localised costs.

Macroeconomists Dipankar Dasgupta of Ashoka University, Amartya Lahiri of the University of British Columbia, and Ashok Lahiri of NIPFP have all argued that GDP will slow down due to demonetisation, a view that has been accepted by the international community of economists and even by your government. Question is: how much?

Amartya Lahiri estimates a 1.5-2.0 percentage point drop in the GDP growth rate for 2016-17 from the reference point of 7.6 percent in 2015-16. Ashok Lahiri gives a much lower estimate of the drop (0.7–1.3 percentage points), which is pretty much in line with the IMF forecast and the government’s own projection.

Also Read: Did the PM Admit to the Nation That Demonetisation Has Failed?

There is now a real risk of the informal sector getting choked in a vicious circle of stagnation and recession. (Photo: The Quint)

Caught in A Recession Cycle

We fear that the loss in the informal sector has been grossly underestimated, while the performance of the export sector has possibly been overestimated, given some newspaper reports of significant and continued disruptions in exports and imports following demonetisation.

Thus, your expectation of a 6.5 percent growth rate may be misplaced. We project a growth rate in the range of 5 to 5.5 percent. We shall be happy if posterity proves us wrong.

A number of city level and regional surveys reveal that the informal sector has bled in terms of jobs, wages, sales or profits. This is not surprising as sales and purchases in the informal sector are almost entirely cash driven and the sector meets its credit needs from informal cash based sources.

Before the note ban, such sources accounted for credit that equaled 40 percent of bank lending and 26 percent of GDP, a very large magnitude.

After the note-ban, there was an immediate and obvious adverse effect on both the mentioned cash based sales and purchases as well as the supply of informal credit to this sector. There is now a real risk of this sector getting choked in a vicious circle of stagnation and recession.

Fall in Earnings

From Delhi, Vyom Anil of Jawaharlal Nehru University reports that small shopkeepers and casual labourers have experienced a substantial drop in their average income – about 60 percent – after demonetisation. This is consistent with the finding of another Delhi-based study by the social activist Harsh Mander who notes a 60 percent drop in the supply of casual jobs with concurrent decline in wages and profits for small shops. Vyom Anil also reports a severe income loss for domestic workers (72 percent from the pre-ban level).

Similarly, from Mumbai, Deepa Krishnan of SP Jain Institute of Management and Stephan Siegel of University of Washington report that the self-employed in slums have suffered a loss in earnings equalling 44 percent of the pre-ban level.

In smaller cities, the picture is no different. A survey in Ranchi led by Jean Drèze, of Delhi School of Economics and University of Ranchi, reveals a 45 percent average decline in earnings of small shopkeepers/businesses. Prateek Sibal’s (Sciences Po, Paris) survey in Amritsar reports an almost identical figure (46 percent) for small businesses. From Jaipur, PUCL reports huge income losses for casual workers – in the order of 50-70 percent.

Too Little, Too Late

We are aware of your concern for this badly hit section of the economy. However, we are afraid that the policies announced by you on 31 December will not be very effective for the unbanked population. The Finance Minister’s latest announcements in the 2017-18 budget include an enhancement of agricultural credit and the coverage of the Antyodaya scheme, catering to the poorest of the poor, as well as a 25 percent increase in allocation to NREGA.

Given the overwhelming pain felt by this sector, these measures also seem inadequate. Antyodaya will not protect those living close to the poverty line, either above or below it, from the ravages of demonetisation while the 25 percent increase in allocation to NREGA is certainly inadequate in view of the reported 60 percent increase in demand for NREGA jobs after the note ban.

Spike in NREGA Jobs

A much larger survey by India Development Foundation (IDF) covering SMEs in nine states reports significant evidence of ‘perception’ of output and employment losses as well as return of migrant workers to their native places. When asked whether there has been any loss of production, 61 percent of respondents in Telengana, 94 percent in Andhra and 80 percent in Gujarat answered affirmatively.

Against a similar question on job losses, the affirmative response was of a similar order in Telengana and Gujarat, slightly lower in Andhra, but very high in UP (87.5 percent). UP also reported significant wage declines.

The results of the above surveys are consistent with the picture that emerges from the official statistics of jobs demanded in NREGA. A 60 percent spike in such demand in December 2016, as reported by the Indian Express (9 January, 2017) can only be explained by return of migrant labourers to their native places.

In these troubled times the role played by NREGA can be likened to divine intervention in the absence of which a massive increase in poverty and deprivation is inevitable.

A number of city level and regional surveys reveal that the informal sector has bled in terms of jobs, wages, sales or profits. (Photo: iStock)

Corrective Measures

We, therefore, recommend three policies for immediate implementation using the existing infrastructure:

1. Enhancing the NREGA provision from 100 to 150 days in 2017-18 with a doubling of budgetary allocation for this scheme.
2. A significant increase in the supply of essential items at subsidised prices through the Public Distribution System to both rural and urban areas in 2017-18.
3. An urgent intervention to expand the reach of formal finance to prospective borrowers in rural and semi-urban areas (for example, the introduction of mobile bank branches, simplification of the procedures of applying for bank accounts and loans, enhancement of financial literacy among the poor, and the assignment of a larger role to microfinance institutions in the financial system).

We stress that the above measures are absolutely essential to bring the informal sector on track again. Measures 1 and 2 together will improve the quality of life and also generate direct and indirect benefits. Measure 3 will boost new investment, output and employment.

Together these measures will help boost both demand for and supply of output, thus nursing the informal sector back to health. While some of these policies may impose a temporary strain on government finances, we believe that the strain is bearable.

In the article above, four economists (Kaushik Bhattacharya, Professor, Indian Institute of Management, Lucknow, Siddhartha Mitra, Professor, Jadavpur University, Sarmistha Pal, Professor, University of Surrey, UK, and Bibhas Saha, Reader, Durham University, UK) seek the Prime Minister’s intervention to alleviate the adverse effects of demonetisation on the informal sector. The petition can be signed here.

(The authors are affiliated to Indian Institute of Management Lucknow; Jadavpur University; University of Surrey; and University of Durham respectively. This is a personal blog and the views expressed above are the authors’ own. The Quint neither endorses nor is responsible for the same.)

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