Taking a Broader View
How shortage of money is crippling the economy
Columnist Ashok V. Desai explains how shortage of money is crippling the economy
Demonetisation caused widespread distress, which the media covered profusely with stories of how common people suffered, and uncommon rulers revelled. It is only now that we have some basic figures about what happened to money supply.
Money consists of currency and bank deposits. There was ` 124.2 trillion of it on October 28 – `17 trillion in currency, `10 trillion in demand deposits, and ` 96 trillion in time deposits. On November 11 – three days after demonetisation – it was `383 billion less. That does not sound much; but currency was ` 1.75 trillion or 10 per cent less, while banks had `1.37 trillion more in deposits. People had rushed and deposited a lot of demonetised cash in banks.
By November 25, 17 days after demonetisation, the picture was very different. Money supply had fallen by `2.4 trillion, or 2 per cent, in four weeks. Currency in the public’s hands had fallen by `7.9 trillion, or a whopping 46 per cent. Bank deposits had gone up `4.5 trillion – 57 per cent of the fall in currency stock. In the beginning, people who had bank accounts had rushed to their banks and deposited their cash. But then there were millions – poor people, villagers, itinerant workers – without bank accounts. The money in their hands had become useless; they were penniless. And there were businessmen who gave work or business to these people; they could not get enough cash; they could not do business or pay people.
As monetary theory says, shortage of money will reduce economic activity. That is precisely what happened; but the economic contraction was concentrated in the informal sector. This sector is very large. To take the latest available figures for April-September 2016, GDP was `71 trillion. The mining, manufacturing, utilities and finance sectors, and government use banks; they would be relatively less inconvenienced by demonetisation. They accounted for about `40 trillion, or 55 per cent of the GDP; some `31 million or 45 per cent came from the informal sector, which depends on cash. It includes agriculture, construction, trade, transport and other services. They would have borne the brunt of demonetisation; their activity must have shrunk by a half or more. And they give work to a lot more than 45 per cent of the people; the figure could be three-quarters or more.
The foremost sector that uses cash is agriculture; it is little realised how difficult its situation is. After two bad years, the country has seen a good monsoon. That is good news for us consumers of agricultural produce, but not for agriculture. Vegetable prices have been falling since September. More recently, something unheard of has happened: arhar prices have fallen. India is traditionally short of lentils; the normal is for them to go up and up. That era may be coming to a close. If farmers run short of cash, they will do distress selling.
The formal and informal sectors do not live in different worlds: they do business with each other, and the misfortune of one affects the other. The formal sector has not been doing too well either; the proof is in the high level of loans it has not paid back to banks. In the third quarter of 2016, the rise in such bad debt was close to `2 trillion. The most dangerously indebted industries are iron and steel, telecommunications, power and transport. Banks may have worse days to come. Foreign portfolio investors saw nothing good in demonetisation and started pulling out money, especially out of the stock market; as a result, shares crashed.
So the way I read the figures, the economy was having problems, to which demonetisation only added. The problems were mainly in the financial sector; now they have spread to the informal sector. There is a ruling elite that looks down on this sector, and thinks it is the home of tax evaders. It may be; but it is also the home of millions whose income is just not sufficient for them to come into the tax net. They will suffer collateral damage from demonetisation.
If that were the only worry, we could try and live as best as we can with what has happened. But the Prime Minister has promised more. He has declared a war against black money, so more campaigns may be expected. But if they are as poorly targeted as demonetisation, we have something to worry about. ~