While recent measures announced by the government indicate some awareness of the hardships inflicted on the informal sector by the note ban, more needs to be done. In this article, Kaushik Bhattacharya, Siddhartha Mitra, Sarmistha Pal and Bibhas Saha summarise the emerging evidence on the significant adverse impact of demonetisation on the informal sector, and suggest policy measures to ensure a steady recovery

Bhattacharya, Kaushik

Mitra, Siddhartha

Pal, Sarmistha

Saha, Bibhas

LSE Research Online

2017-2-28Reviving the informal sector from the throes ofdemonetisationblogs.lse.ac.uk /southasia/2017/02/28/reviving-the-informal-sector-from-the-throes-of-demonetisation/While recent measures announced by the government indicate some awareness of the hardships inflictedon the informal sector by the note ban, more needs to be done. In this article, Kaushik Bhattacharya, SiddharthaMitra, Sarmistha Pal and Bibhas Saha summarise the emerging evidence on the significant adverse impact ofdemonetisation on the informal sector, and suggest policy measures to ensure a steady recovery.More than three months have passed since the announcement of demonetisation. While we appreciate thegovernment’s intentions behind the move, we cannot overlook the real hardships inflicted, particularly on theinformal sector. In view of the overwhelming evidence of such pain (that is also consistent with economicarguments), we discuss the inadequacy of recent government responses, and recommend some urgent remedialmeasures. We feel that these measures are necessary to ensure that the pain is only transitory and does not spillover to the formal sector and impede the projected economic recovery.Informal sectorIf defined as consisting of hired labour and self-employed individuals working in the unorganised sector(unregistered enterprises) as well as wage and other casual labour working in the organised sector, the informalsector accounts for 92% of total employment and about 50% of GDP (gross domestic product). The significantcapacity of this sector for employment generation – especially at a time when the formal sector is experiencingjobless growth and facing considerable domestic and international challenges – necessitates its revival.Largely excluded from the formal financial world, the informal sector falls mostly outside the ambit of digitaltransactions. The demonetisation move on 8 November 2016 withdrew 86% of the cash in the economy; however,remonetisation in the immediate post-ban period has been extremely slow, resulting in significant adverseimplications for expenditure, especially of low-income households and small business units. Digital paymentsconstitute only a partial solution to the problem as there is still a strong case for sustaining small-value transactionsin cash, especially by the poor. While it is premature to assess the benefits of digitalisation and demonetisation, thesubstantial costs borne by this sector need closer attention before rushing to policy formulation, especially becauseshort-term changes in the sector are beyond the government radar.Economic argumentsTextbook macroeconomics does not point to major economic benefits of the note ban. Accordingly, economistsDipankar Dasgupta (Ashoka University) and Amartya Lahiri (University of British Columbia) use the aggregateddemand-supply framework and the money supply equation respectively, to highlight that demonetisation will lead toa significant reduction in the growth rate of GDP. Amartya Lahiri estimates this reduction to be 1.5-2 percentagepoints (from a base level of 7.6% in 2015-16) while Ashok Lahiri (National Institute of Public Finance and Policy(NIPFP)) has estimated a drop of 0.7–1.3 percentage points. Arvind Subramanian, the government’s Chief EconomicAdviser, has lowered the growth projection to 6.5% (slightly lower than the International Monetary Fund forecast, and0.6 percentage points lower than government’s earlier projection) for 2016-17. This estimate, however, does notaccount for the recessionary impact of demonetisation and, therefore, the actual growth rate for the year is likely tobe much lower – probably around 5%.Arguably, the growth rate of the informal sector would be even lower because of the predominant use of cash insales and purchase in this sector, and its overwhelming dependence on informal cash credit (that equalled 40% of1/4total formal bank lending and 26% of GDP before the note ban), which has now reportedly dried up. In fact,economic reasoning suggests that all major economic variables (example, prices and profit incomes; wage andemployment rates; input and infrastructure expenditures; and expenditures on essential items, consumer durables,and health and education) would be affected adversely. Further, strong backward and forward linkages imply that theinformal economy would be entrapped in a vicious recessionary cycle. The growth expectation for the sector in thepost-demonetisation period would therefore be low – possibly negative.Emerging evidenceThe above propositions are not just based on armchair theorising, but are supported by newspaper reports andindependent surveys. In Ranchi, a survey led by Jean Drèze (Delhi School of Economics and University of Ranchi)reports a 45% decline in earnings of small shopkeepers/businesses; in Amritsar, Prateek Sibal (Paris Institute ofPolitical Studies) reports a similar figure of 46%. In Delhi, a survey of small shopkeepers and casual labourers byVyom Anil (Jawaharlal Nehru University) finds a much larger drop in average income about 60%. Another study forDelhi, by social activist Harsh Mander, points to a 60% cut in supply of jobs to labourers, a decline in wages, andloss in profits for small shops.In Mumbai, Deepa Krishnan (SP Jain Institute of Management) and Stephan Siegel (Michael G. Foster School ofBusiness, University of Washington) report a very significant loss of 44% in the earnings (relative to the pre-note banperiod) of the self-employed in slum areas. Some of the surveys also indicate huge income losses for casualworkers: 50-70% in Jaipur (conducted by PUCL Rajasthan), and 72% among domestic workers in Delhi (by VyomAnil). A larger survey by India Development Foundation (IDF) covering nine states asked owners of small andmedium enterprises (SMEs) whether there were output and job losses (Chaddha et al. 2017). With regard to outputloss, 61% of respondents in Telengana, 94% in Andhra, and 80% in Gujarat answered in the affirmative. For joblosses, the corresponding incidence was similar in Telengana and Gujarat, slightly lower in Andhra, but very high inUttar Pradesh (87.5%), which also saw significant wage decline.The income losses reported by these independent surveys are large and mutually consistent. There is also no signof remission over the weeks since demonetisation; some newspaper reports even suggest that the ban is bitingmore with the passage of time and there are spillover effects on the formal sector. These adverse changes havebeen accompanied by a 60% spike in the demand for MNREGA (Mahatma Gandhi National Rural EmploymentGuarantee Act) work in December 2016 (as per report of the Ministry of Rural Development), confirming theaccuracy of independent surveys, and necessitating urgent policy action.Way forward While the government announcements on 31 December and 1 February reflect some awareness of the pain sufferedby the poor, there are some obvious inadequacies. We, therefore, recommend three palliative policies for immediateimplementation, using the existing economic and financial infrastructure. Otherwise the poor – hard hit by the ban –would not be in a position to take advantage of government’s proposed investment in credit markets, infrastructure,and housing.Increase supply of formal finance Given the drying up of informal finance, there is an urgent need to expand the reach of formal finance to prospectiveborrowers in rural and semi-urban areas. Unfortunately, government response in this respect has been inadequate:all the announced policies for helping small and medium farmers and small businesses cater to those with bankaccounts or Kisan credit cards1. While the impetus provided to cashless payments is desirable, we strongly believethat forcing poor people to adopt the cashless mode in making small transactions is not only unfair but might crashthe economy. Given that only about 50% of Indians have bank accounts and 40% of the rural Indian population2/4(27.2% of total Indian population) does not have access to banking services, the announced policies appearvacuous. Thus, measures to expand the reach of formal finance to rural and semi-urban areas are urgently neededto break the vicious recessionary cycle. These would involve, among others, a simplification of the procedures forapplying for bank accounts and loans, introduction of mobile ATMs, promotion of financial literacy among the poor,and enhancement of the role played by microfinance institutions.Given that it may take time for the rural credit market to boost investment, output, and employment, there is also aneed to adopt measures that provide immediate safety nets against losses of jobs and incomes (which in turn causelosses in consumption, nutrition, and health). Therefore, we make two further recommendations.Raise MNREGA entitlement MNREGA is a well-run social security measure in operation since 2005 that offers at least 100 days of wageemployment in a financial year to every household whose adult members volunteer to do unskilled manual work.Given the 60% increase in demand for MNREGA jobs after the note ban (associated with an estimated 50% loss, onaverage, in informal-sector earnings and casual jobs), the latest budget announcement of a 25% increase inallocation to MNREGA seems woefully inadequate. Our recommendation would be to increase MNREGAemployment guarantee from 100 to 150 days, with a doubling of 2016-17 budgetary allocation immediately.Expand PDS The expansion of MNREGA needs to be accompanied by augmentation of subsidised essential supplies to the ruraland urban poor through the Public Distribution System (PDS), which has a proven track record of providing relief tothe poor. This would help in raising the level of consumption, nutrition, and quality of life almost instantly and alsoenable the poor to undertake other expenditures, thereby generating direct and indirect economic benefits.While these short-term recommendations will impose a temporary strain on public finances, we believe that they willboost both demand for and supply of output over time, thus arresting the downward spiral of the informal sector (andalso the overall economy) following the note ban.Note:1. The Kisan Credit Card (KCC) programme was introduced in India in 1998. Initially, it was just meant to be acredit line with a bank where farmers had to visit a bank branch to withdraw cash and use it at their discretion.Eventually, it graduated into a full-fledged credit card with features such as ATM withdrawal and the ability toswipe at the point-of-sale. The idea was to give out these cards to farmers all over the country with theobjectives of providing easier access to credit via simpler eligibility norms, more flexible credit via loosermonitoring criteria, and cheaper credit via lower interest rates.Cover image credit: Travel Aficionado CC BY-NC 2.0The authors are grateful to Jean Drèze and Udayan Roy for their comments on an earlier draft. This article originallyappeared on Ideas for India and is posted with the Editor’s permission. It  gives the views of the authors, and not theposition of the South Asia @ LSE blog, nor of the London School of Economics. Please read ourcommentspolicy before posting.About the AuthorsKaushik Bhattacharya is currently Professor of economics at the Indian Institute of Management(IIM), Lucknow. Prof. Bhattacharya did his Ph.D. from Indian Statistical Institute (ISI) and his post-doctoral research at University of Bonn. Earlier, Prof. Bhattacharya had worked in statistics andmonetary policy departments of the Reserve Bank of India (RBI). He had also been a visitingresearch fellow at the Bank for International Settlements and a recipient of DAAD (GermanAcademic Exchange Service) fellowship.3/4Siddhartha Mitra is currently Professor of Economics at Jadavpur University, Kolkata. In his earlierappointments, he has been Director (Research), CUTS International and a Reader at the GokhaleInstitute of Politics and Economics, Pune. Prof. Mitra has also taught at the University of Melbourne;and Indian Statistical Institute, New Delhi. His research interests lie in the field of developmenteconomics, environmental economics, agricultural economics, political economy and economics ofpeace.Professor Sarmistha Pal is an applied economist working on issues pertaining to both economicsand finance. Her primary research interests relate to analysing the impact of law, institutions andpublic policy on various economic agents. Her research has been funded by the Economic andSocial Research Council (UK), Leverhulme Trust, World Bank, European Bank for Reconstructionand Development and also the International Finance Corporation. She is an IZA (Germany)Research Fellow and also an external research affiliate at the Centre for Studies of the AfricanEconomies, University of Oxford. She is an editorial board member of the Journal of DevelopmentStudies.Dr Bibhas Saha is Reader in Economics at the Durham University Business School, UK. Previouslyhe has worked at the University of East Anglia, UK and Indira Gandhi Institute of DevelopmentResearch, India. His research interests are economics of corruption, development economics andprivatisation.Copyright © 2016 London School of Economics4/4

Reviving the informal sector from the throes of demonetisation

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