Demonetisation’s devastating impact on rural India

George Orwell once wrote that “in our times, political speech and writing are largely the defence of the indefensible” that takes the form of “arguments which are too brutal for most people to face”. Public statements of the Minister for Agriculture, Radhamohan Singh, reminds one of Orwell’s words; he said: “Seventy-five per cent [of rural] people have not been affected by [demonetisation]. In a village economy, 80 per cent of the people take Rs.50 and Rs.100 notes to local mandis and do trading, with hardly two to three people using the bigger currency notes of Rs.500 or Rs.1,000.”

Radhamohan Singh appears to be totally out of tune with the realities in rural India, which has been thrown into a deep crisis because of the ill-conceived and poorly implemented demonetisation scheme. It should have been a no-brainer that in an economy in which about 85 per cent of all transactions happen in cash, a net withdrawal of about Rs.6.5 lakh crore worth currency—worth about 46 per cent of all currency circulation, as on November 27—would have a crippling contractionary impact on everyday economic transactions. In rural India, where dependence on cash is higher than in urban areas, the impact is likely to be most acute. All available information suggests that the impact would be on multiple spheres: agricultural production, rural incomes, rural demand and rural credit.

Agricultural production

An important impact of demonetisation is likely to be on crop production in the rabi season of 2016-17. The Ministry of Agriculture has claimed that sowing in the rabi season is unaffected. The Ministry has stated that 127.2 lakh hectares of rabi wheat was sown until November 25, 2016, which was higher than the 117.3 lakh hectares sown until November 25, 2015. However, these figures give no room for satisfaction.

First, dates of sowing are dependent on soil moisture conditions, and a date-to-date comparison has less meaning than an estimate for the whole rabi season. In 2015-16, a drought year, the rabi area sown with wheat was less than normal. If about 305 lakh hectares of wheat was sown in the rabi season of 2014-15, only about 293 lakh hectares of wheat was sown in the rabi season of 2015-16 (as on January 28, 2015). The Ministry’s year-to-year benchmark, then, might be convenient, but poor. Only final estimates would tell if wheat was sown in at least 300 lakh hectares in 2016-17.

Secondly, even if sowing is on track, it is at a cost to the peasantry. The cash crunch has limited the ability of farmers to purchase seeds and other inputs on time and at reasonable prices. Farmers purchase seeds and fertilizers largely from private traders and cooperatives and not government outlets. To sow wheat in one acre, a farmer would require about Rs.2,500 to buy seeds, about Rs.700 to buy fertilizers and about Rs.1,000 to meet labour costs: a total of about Rs.4,200 per acre. Thus, a five-acre wheat farmer would require at least Rs.20,000 to complete sowing, which is extremely difficult to mobilise given the limits on cash withdrawal. Reports suggest that traditional village networks between farmers and traders are being revived to meet the emergency and most transactions are running on credit. Farmers have also borrowed from moneylenders at high interest rates to pay for inputs. Hence, surely, costs of sowing have risen.

Thirdly, in many regions where wheat sowing has taken place, farmers have used a part of the previous year’s harvest as seeds. Farm-saved seeds yield, on an average, 20 per cent less than purchased certified seeds. In other words, the quality of sowing in the rabi season is likely to have been poorer than in earlier years.

India’s agriculture has hardly grown after 2011. If we consider the gross value added in agriculture, annual growth rates over the previous year were 1.5 per cent in 2012-13, 4.2 per cent in 2013-14, -0.2 per cent in 2014-15 and 1.2 per cent in 2015-16. That is, except over 2013-14, gross value added in agriculture did not grow at more than 1.5 per cent a year. But 2016-17 was to be different. In 2016, the rainfall received was higher than in previous years. If 46 to 49 per cent of the 629 districts in India received less than normal rainfall in 2014 and 2015, the corresponding share in 2016 had declined to 33 per cent. Consequently, there was much hope placed on agricultural growth rates in 2016-17. These hopes have been dashed by demonetisation.

Rural incomes

Average incomes of Indian agricultural households are extremely low. According to a survey of the National Sample Survey Office (NSSO) in 2012-13, the average monthly income of an agricultural household was Rs.6,426. The average monthly consumption expenditure per agricultural household was Rs.6,223. Averages hide internal variations. Aparajita Bakshi of the Tata Institute of Social Sciences, Mumbai, has estimated that, in 2012-13, about 50 to 70 per cent of the agricultural households survived on incomes that were inadequate to meet their requirements of consumption expenditures.

Demonetisation has disrupted agricultural supply chains and hit even the meagre incomes agricultural households earn. November is the month when kharif harvests arrive in mandis. But the cash crunch has prevented the smooth sale of harvest by farmers. In some regions, traders have not picked up farmers’ harvest from fields and yards. In other regions, farmers are forced to sell at a lower-than-market price to traders or sell in exchange of the demonetised currency of Rs.500 and Rs.1,000. Those producing perishable commodities and who do not have access to storage facilities are among the worst affected.

A striking indicator of supply-chain disruption is the sharp decline of arrivals in agricultural markets. Nidhi Aggrawal and Sudha Narayanan of the Indira Gandhi Institute of Development Research, Mumbai, have shown that in the first week after demonetisation, market arrivals in select major States fell by 87 per cent for soybean, 55 per cent for paddy, 61 per cent for guar, 51 per cent for maize, 38 per cent for tur dal and 23 per cent for cotton. If we take the second week after demonetisation, the fall in arrivals over the week preceding demonetisation was to the extent of 61 per cent for paddy, 77 per cent for soybean and 29 per cent for maize.

Farm incomes have slumped just when farmers were expecting better returns after two consecutive years of poor returns. According to a pre-demonetisation analysis by CRISIL, Indian agriculture was projected to grow at 4 per cent in 2016-17 over 2015-16; it also expected “the favourable monsoon to revive rural incomes”. After demonetisation, however, a 4 per cent growth rate in agriculture appears unduly optimistic and a revival of rural incomes appears doubtful. If we assume that incomes of agricultural households decline by about 10 per cent, and use income data of 2012-13 as an illustration, it would imply that even at the average , the monthly income of an agricultural household would fall short of its monthly consumption expenditure.

Rural demand

As growth rates in capital investment are slowing down, India’s gross domestic product (GDP) growth in 2016-17 and 2017-18 is crucially dependent on growth in consumer demand (and government spending). Quick estimates show that about 68 per cent of India’s population lives in rural areas; 54 per cent of the total consumption expenditure comes from rural households; about 35-40 per cent of the GDP comes from rural areas; and about a third of the total savings comes from rural areas. Though agriculture contributes only about 15 per cent to India’s GDP, there continues to be a fairly high correlation between gross value added in agriculture and total value added in the economy.

As higher rural incomes would lead to higher consumer spending, the CRISIL report of October 2016 was optimistic. It projected that “the upturn in rural incomes should push private consumption [growth rate] above 8 per cent in fiscal 2017, compared with 7.4 per cent in fiscal 2016”. Higher rural income growth was expected to lead to higher rural sales of television sets, electric fans, motorcycles, tractors and multipurpose vans. For most of these goods, there was “de-growth” in 2014-15 and 2015-16 because of poor agricultural growth. However, for 2016-17, the report pointed to “green shoots”, and projected that “the recovery [of rural demand] is likely to gain strength in the coming months”.

Demonetisation, however, has poured cold water on such optimistic assessments. Preliminary estimates suggest that sales of fast-moving consumer goods fell by 30 per cent in November 2016 compared with November 2015. Over the same period, car sales declined by 15-40 per cent. In small towns, sale of mobile phones declined by 70 per cent. The consumer goods giant Hindustan Unilever has reportedly stated that “trade is down due to the liquidity squeeze” ( Hindustan Times , December 2, 2016).

Government spokespersons agree. Finance Minister Arun Jaitley has stated that people may suffer hardships for one or two quarters. According to Arvind Panagariya, Vice Chairman of NITI Aayog, there may be an adverse impact on GDP growth in the third and fourth quarters of 2016-17. Arvind Subramanian, Chief Economic Adviser to the government, has stated that he expected “uncertainty” in the third quarter of 2016-17. The worst assessment was from Ambit Capital, which has projected the possibility of negative GDP growth in the third quarter of 2016-17 and an overall agricultural growth rate in 2016-17 of just 0.8 per cent. Reality may vary from these estimates, but the tension is palpable.

Access to rural credit

Cash crunch in rural areas turned more acute owing to the near-shutting out of the cooperative bank network from the purview of cash exchange. In rural India, cooperatives accounted for about 15 per cent of the total debt outstanding of agricultural households in 2012-13. In States like Kerala and Maharashtra, cooperatives accounted for more than 40 per cent of the total debt outstanding of agricultural households. These figures reveal the strong dependence on cooperatives for cash in rural production and exchange. In States like Kerala, cooperative banks have historically emerged as part of a struggle against usury capital; they play a central role in financing agricultural and non-agricultural activities in rural areas, as well as in lending to the landless poor.

Yet, after November 8, primary cooperative societies were not allowed to either exchange old notes for new notes or provide fresh crop loans with new notes or even accept repayments of outstanding debt in old notes. The primary societies were also not allowed to exchange their existing stock of old Rs.500 and Rs.1,000 notes with either the Reserve Bank of India (RBI) or banks. Reports suggest that primary societies in Maharashtra are sitting on Rs.40,000 crore worth of old notes, which the RBI has not yet accepted for exchange. In the absence of cooperative credit, moneylenders are emerging as new sources of finance for many rural households.

In sum, the government has created a major credibility crisis for the century-old cooperative banking network. There are reports that customers are eager to withdraw deposits from cooperative banks. Any prolonged crisis might even lead to a run on these banks. Collapse of cooperative banks would immediately open up India’s rural credit market to usurious moneylenders and traders.

On its part, the government claims that the recent expansion of the rural bank branch network has ameliorated the adverse impacts of cash crunch in rural areas. Nothing could be farther from truth.

The number of brick-and-mortar rural bank branches in India did increase between 2011 and 2016. Still, crores of households continue to remain without access to bank branches. As on December 31, 2015, there were about 5.55 lakh unbanked centres—defined as centres without a brick-and-mortar branch—in India. Of these, about 5.54 lakh unbanked centres were in rural areas. The population that resided in the unbanked centres in rural areas amounted to 62.9 crore. In other words, about 81 per cent of the rural population did not have access to a bank branch within their centres.

The RBI might respond by noting that most unbanked centres have a banking correspondent (BC) to undertake banking activities. However, the BC model has been totally incapable of dealing with the huge pressure of cash demand in the villages. On November 14, the government raised the cash holding limit of BCs to Rs.50,000 a day. However, as adequate number of new notes was not printed, most BCs never obtained the higher cash holdings. Even if they did, assuming a withdrawal limit of Rs.2,000 per person, one BC would serve only about 25 persons a day. In other words, the BC model has been a poor substitute for bank branches.

To conclude, demonetisation is likely to affect agricultural growth adversely and shrink rural incomes and consumer demand. It has already created a serious credibility crisis for rural cooperatives. Radhamohan Singh may do well to consult a few sensible advisers, who would tell him how wrong and callous his remarks were.

R. Ramakumar is Professor, School of Development Studies, Tata Institute of Social Sciences, Mumbai.