Vol. XLI No. 11 March 12, 2017

Study on the impact of demonetisation on Kerala economy: WHAT CAN BE DONE?

On November 23, the Kerala State Planning Board appointed a Committee to study the impact of demonetisation on the economy of Kerala. The committee has come out with a report, the excerpts of which were published in the issue dated. Below are the recommendations of the committee.

117.     Despite the damage it has done, the central government is politically unwilling to reverse its demonetisation decision. On the other hand, full “remonetisation” of the economy is unlikely before the third quarter of 2017. As of now ceilings on withdrawals remain in place. So, Kerala, led by the state government, must find ways to limit the adverse consequences of the policy, especially with regard to the livelihoods and welfare of the poorest among its people.

118.     One priority is to ensure that Plan expenditures are maintained at targeted levels despite the budgetary difficulties created by the impact of demonetisation. To realise this joint effort by state governments to demand compensation from the centre in the form of discretionary transfers to support the Plan is called for. In addition to this, the centre must be called upon to relax ceilings on borrowing by the states so that to the extent that compensation from the centre is short of the stimulus needed to counter the recession, the required expenditure can be financed with loans from the market.

Another set of policy measures must address the problems of cooperative institutions, particularly in Kerala, where the cooperative credit societies and cooperative banks have played a crucial social and economic role. An immediate requirement is to consolidate and replicate experiments of the kind conducted in Kozhikode, where government institutions, businesses, cooperating banking agencies, and citizens came together. Their objective was to work out systems that allow for settlements of transactions through means other than cash, in order to protect the employment and purchasing power of workers (especially in the informal sector), limit the adverse effect of demonetisation on economic activity, and support the revenue-generating capacity of the state government. The issue here is not to replace cash settlements with digital payments by encouraging the use of mobile phones and digital wallets. Those who expect a transition to digital payments on a scale that will meet the problem created by 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 that link people, businesses, institutions, and the government and the trust between them to settle transactions through the existing financial framework but without cash. Cards, identity markers, information sources, and other instruments can build and consolidate the trust needed for the operation of such networks.

120. Medium and long-term policies are also necessary. Policies to reverse the standstill in business at the PACS are crucial. While legal recourse to reverse the decision that partly or fully freezes the operations of cooperative banking institutions at different levels in the state has been taken, other measures too are needed. Members of individual PACS should be encouraged by PACS and DCCBs to open mirror versions of their accounts in the district cooperative banks to which the concerned PACS is linked, and use those mirror accounts to disburse cash against the deposits held by members in the PACS or against the loan accounts opened in the name of individual members in the PACS.

121. Another set of medium-term initiatives must be aimed at supporting the primary cooperative societies. Primary cooperative societies have been badly hit by the demonetisation and have been excluded from exchange and deposit of the specified bank notes (SBNs). This exclusion from cash transactions has challenged their viability and posed a threat to their survival. There are many ways in which support to counteract this can be provided. Public sector entities and government agencies can be asked to bank with the PACS where possible so as to send out a message that PACS are trusted entities with government backing. Some PACS claim that dues from the government to the PACS, such as payments to compensate for loan waivers provided as part of past government programmes, have not been disbursed as yet. These should be immediately cleared so as to give the concerned PACS financial support that is legitimately due to them. In addition, schemes to provide some subvention of interest rates for borrowers from cooperatives who have a good debt servicing record can enthuse members to continue their association with the cooperatives.

122. One issue that arises in this context is the regulatory jurisdiction of the registrar of cooperative societies in the state. The Reserve Bank of India took a unilateral decision to exclude the PACS from SBN exchange or acceptance of SBN deposits, and chose to treat them as equivalent to individual depositors in the scheduled commercial banks when setting ceilings on withdrawals. In this situation, the state-level regulatory authority had no option other than to comply and issue the necessary order or notification. They had to do so despite the fact that such decisions froze operations in the PACS and damaged their credibility, since PACS were now seen as “different” from the banks and their operations as possibly suspect. It is necessary to make suitable changes in the post-2006 Task Force regulatory framework to give a degree of autonomy to state-level regulators of the PACs, especially in states with a vibrant cooperative sector like Kerala, where the PACS play a crucial role in the rural credit infrastructure.

123. These initiatives from outside the cooperative sector should be accompanied by internal measures by cooperative credit organisations at the local level to strengthen their institutional basis. Technological modernisation should be accompanied by an effort to go beyond adopting core-banking solutions among branches belonging to individual cooperative credit societies. Shifts to technological solutions that allow all PACS and their branches to be connected and networked and link that network to the larger world of the scheduled commercial banks are needed. This shift requires investment in electronic hardware. It also requires a common core-banking software platform that allows (1) cooperatives to link their banking with their chitty and other operations, (2) all cooperatives to integrate their operations, (3) PACS to connect to the DCBs and state cooperative banks, and (4) the cooperative banking sector as a whole to connect to the commercial banks.

24. Technological modernisation should be accompanied by managerial and operational reform. Central to such reform must be the introduction of practices such as ensuring KYC compliance, requiring PAN card registration, and deducting tax at source (TDS) on deposits that are eligible. This would imply information collection and reporting procedures that can prevent allegations that the PACS are vulnerable to exploitation by tax evaders, money launderers, counterfeiters and those engaged in criminal activities.

125. 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. More can be done to restore confidence in the PACS so that deposits held in accounts can be used for payments through transfers to payees. If there is a fear that some PACS are likely to fail because they are unable to undertake business and could face a run in the form of transfers to accounts held by members in commercial banks and elsewhere, counterparties may be unwilling to accept promises of payment through transfers, especially from those PACS that have not adopted electronic banking solutions. The state government could consider the possibility of providing a government guarantee for such transfers, making them a safe means of settlement for all.

126.     Relief measures that aim to address the pain caused by unemployment and loss of livelihoods that have occurred as a result of demonetisation are needed urgently. All state governments must be called upon to make an estimate of the loss incurred as a result of the demonetisation, which was a wholly central initiative. Kerala must, as it has done by constituting this committee, take the lead and conduct a comprehensive study to assess demonetisation-triggered losses and provide a template on how that is best done. A similar study across states should be followed by a conference of chief ministers that computes the size of the compensation that the centre must provide the states and the principles and formulae that must be adopted for the allocation of compensation to different states.

127.     It is clear from the prime minister’s speech on December 31, 2016, that the centre does consider such measures necessary. His speech focused on special ameliorative programmes including: (i) an interest rate subvention of 4 percent for housing loans of up to Rs 9 lakh and 3 percent for loans up to Rs 12 lakh; (ii) a grace period of 60 days on interest on rabi loans to cultivators from DCBs and PACS; and (iii) an increase in the limit of loans taken by small-scale enterprises that are eligible for underwriting support from the government of India from Rs 1 crore to Rs 2 crore. These are, in fact, not all new, but mere restatements or enhancements of schemes already under way.

128.     To implement more effective measures the centre should be called upon to constitute a “National Demonetisation Impact Relief Fund” to which the states can address their demands. Transfers from the Fund can be used to finance direct benefits to the most severely affected sections of the populations, which, in the case of Kerala, would consist of informal and migrant workers in vulnerable sectors such as fisheries, vegetable and horticultural production, cashew and coir production, the brick and tile industries and construction. They could also be used to finance Plan programmes that are targeted at the worst-affected in these sectors. The population targeted can be identified using data from the socio-economic and caste censuses that have been undertaken in the states, and other supporting information. The government of Kerala, based on advice from the State Planning Board, should adjust appropriately chosen and funded plan programmes to benefit these sections in particular.

129.     The centre has advocated measures aimed at making a quick transition to a “less cash” economy where digital transactions dominate. The declared objective is to shorten the unavoidable lag in remonetising the economy. Framing the policy in these terms ignores several costs of digitisation, which should not be forced on citizens. The first such cost is the cost of connectivity. The second cost is the charge imposed by banks and the financial technology (or “fintech”) companies for hosting and facilitating digital transactions. The third cost is the danger of security breaches, which may result in losses for clients. And, finally, there is the potential for the invasion of privacy of various kinds. If a transactor voluntarily chooses to go digital despite these costs there should be no difficulty. But if a transactor is forced to go digital by depriving her of currency or is persuaded to go digital without full knowledge of costs, the move must be resisted. The centre should be encouraged to invest in the technological and security infrastructure for an increase in digitisation. But it is necessary to ensure that the transition does not end up facilitating the extraction of super profits by private fintech operators. Regulation should ensure that charges imposed by financial intermediaries are reasonable and minimal. And informed transactors should be left to either voluntarily go digital or refrain from doing so.

130. It needs to be noted here that even when digital payments are encouraged, a substantial cash economy will continue to exist, especially in large parts of the informal sector. Besides issues like connectivity and safety, the spread of digital payments in the informal economy will be constrained by cost factors. As elsewhere in the financial sector, a few firms demanding high payments for the services they offer will soon dominate digital payments. The informal sector survives because of low overheads and no or low taxes. For that reason, people in the informal sector may not be able to embrace the digital future. For them the ultimate solution is the return of cash. All the government can do is to offer some support in the interim to prevent demonetisation from triggering a collapse of the informal economy.