note demonetisation

Informal credit systems: Modi has crippled a very Indian way of doing business

The disruptive impact of the demonetisation policy is most evident in Varanasi’s sari-fabric industry.

Prime Minister Narendra Modi’s decision to demonetise high-denomination notes has delivered a crippling blow to the uniquely Indian system of financing business. This outcome is ironic for the prime minister whose party, the Bharatiya Janata Party, is forever engaged in extolling India’s contribution to knowledge in ancient times and singing praises of Indian culture.

From Delhi to Varanasi to Kolkata, there isn’t a sector that has not become sluggish because the demonetisation policy has cut off the flow of working capital to small and medium enterprises. The largest component of their working capital was in cash, popularly perceived to be unaccounted or black money.

The disruptive impact of the demonetisation policy, which became effective from midnight on November 8, is very evident in the sari-fabric industry of Varanasi, the prime minister’s constituency. A clutch of businesspersons provided insights into Varanasi’s system of financing business.

Based on trust and intricate knowledge of the local market, Varanasi’s system can be best explained through an illustrative example.

Varanasi’s battawalas

Assume there is Firm X in Varanasi. A small-scale enterprise, it has received five post-dated cheques of Rs 20,000 each from Firm Y, which has issued them because it is awaiting payment for the merchandise it sold recently.

Firm X must pay wages to workers, and its owner must also meet his personal expenses. To ensure his firm does not cease production, the owner will need to purchase thread from stockists. In other words, Firm X cannot wait for Firm Y’s post-dated cheques to mature.

To meet his immediate need for cash, Firm X’s owner, therefore, takes all the five bearer cheques to a battawala, which literally means “one who deducts”. Varanasi’s battawalas have information on the creditworthiness of 3,000 registered establishments, and an estimated 7,000 unregistered firms.

When Firm X presents the five post-dated cheques to the battawala, the lender mentally considers the firm’s history: Has Firm Y’s cheque ever bounced? Was this a solitary instance, or did Firm Y habitually default on payment?

The battawala then fixes his commission, ranging from 0.70% to 3%. The higher the creditworthiness of Firm Y, the lower the commission the battawala will charge. He deducts his commission from the Rs 1 lakh the cheques will bring and the balance is paid in cash to the owner of Firm X.

The world of battawalas is a shadowy, secretive one but one man agreed to speak to this correspondent over the phone.

He said there are big and small battawalas. “The biggies have a large stash of funds,” he said. “It is kept rolling and commissions earned increase your stash. It is not that we don’t maintain books as commission agents, but, obviously, you don’t show every transaction.”

The small battawala is typically a broker. On days he receives bearer cheques beyond his financial capacity, he contacts the biggie in the business. Intense bargaining ensues over the commission of the small battawala. Usually, he gets less than 20% of the commission at which the bearer cheque is finally discounted.

Demonetisation has more or less paralysed the battawala system. Stashes of old Rs 500 and Rs 1,000 notes have become “raddi” or waste paper, as the battawala said. This has starved the fabric industry of working capital. The pressure on banks is too severe to allow them to encash bearer cheques that have matured.

There is a grim prospect of small enterprises being driven out of business, and workers thrown out of jobs. The refrain among medium and small enterprise owners is: “Varanasi has been the BJP’s bastion. Modi’s move has been a great betrayal. Let him contest from here again.”

This practice of discounting post-dated bearer cheques is present in other towns of Uttar Pradesh as well. For instance, a trader in animal skin said many of his fellow suppliers secure post-dated cheques from tanneries, say, in Kanpur and encash it the same evening at battawalas.

Post-dated cheques as currency

In Varanasi (as well in many other cities), post-dated bearer cheques are also used for other purposes. Assume Firm X isn’t facing a severe liquidity crunch and needs just Rs 60,000 for his running cost. Its owner can, therefore, keep aside two out of the five bearer cheques till the time these mature, thus saving on the commission he would have otherwise paid to the battawala.

Of the remaining three cheques, the owner can choose to encash one with the battawala to pay his workers. He can use the other two as currency.

For instance, he can hand over the two cheques to Firm Z to purchase reams of thread from it. Firm Z can, in turn, pass those two cheques to Firm A – and so it goes.

“Often, a bearer cheque changes hands as many as five times,” an owner of a small sari producing enterprise told The fifth entity, Firm B, can encash the two cheques with the battawala, or if these have matured, present it to the bank.

In other words, Firm Y’s post-dated cheques helped four other entities to run their businesses.

The use of post-dated cheques as currency was one reason why Firm Y parcelled out Rs 1 lakh he was to pay to Firm X into five bearer cheques. Since a firm making payment of over Rs 20,000 is required by law to issue an account payee cheque – that is, the cheque can be credited only to the firm’s bank account – it cannot, consequently, be used as currency.

In fact, post-dated bearer cheques are issued in the name of random persons. “It can be Ram Avatar or Fakruddin Ahmad,” said the small enterprise owner. “Some people record it in their books, most don’t.”

But this practice is also resorted to because banks demand collateral for loaning even a small amount of money for a short period. “I can’t mortgage my house which is co-owned by my two other brothers,” said the small enterprise owner. “What do I offer as surety if I haven’t paid my previous loan and I still need money to buy raw material?”

Business in Delhi’s Walled City

Delhi’s Walled City is host to what is said to be Asia’s largest wholesale market. From dress material to cosmetics to electronics to motor parts to hardware to stationery to medical equipment, traders from different parts of the country flock here to buy these items at wholesale rates.

Transactions here, to a great degree, are conducted in cash, which, Chandni Chowk businessmen insist, cannot be universally classified as black money. “Many of them are not known to us,” said one Chandni Chowk trader. “We can’t take cheques from them. If we insist on demand drafts, a good many of us will be run out of business.”

There are buyers with whom Chandni Chowk wholesalers have had a business relationship for years. These are buyers who work on low margins and are caught in a perpetual cash crunch. Post-dated cheques are taken from them. “The buyer hopes he can pay us after he has sold his goods,” said the trader.

But post-dated cheques cannot underwrite current expenses of wholesalers in Delhi’s Walled City. They, therefore, take short-period loans from financiers at a whopping 12% to 18% interest. The interest rate depends on the borrower’s credibility and the amount of money he has taken.

(Photo credit: AFP/Indranil Mukherjee).
(Photo credit: AFP/Indranil Mukherjee).

The amount to be paid in interest is factored into the prices at which the wholesaler sells. A trader whose family has been in the wholesale business for 50 years said, “The price at which we sell is highest for a post-dated cheque maturing after three months. It is lower for two months, the lowest for one month and less.”

All cash transactions have come to a standstill because the supply of currency has become a trickle. The financier can’t be turned to because his stash of funds, which largely comprised high-denomination notes, has become worthless.

“The situation will go from bad to worse over the next couple of weeks,” said the trader, who often calls election results right.

Another trader added, “It is common sense: When a person doesn’t have much cash in hand, he hoards money to meet needs that can’t be postponed or for future emergencies.”

Woes of fruit and vegetable vendors

If the demonetisation policy has shaken wealthy wholesalers in Delhi, it has driven fruit and vegetable vendors and such like to misery. They raise money through loans from the market, as accessing short-duration loans is nearly impossible for them.

A vegetable vendor who requires capital approaches a financier of his area through a person known to both. This person is called the guarantor. The vegetable vendor has to provide a proof of his identity and sign a promissory note saying that he has borrowed money that he will pay back. The guarantor is registered as a witness to the transaction.

As such, the interest rate is calculated on a monthly basis and varies from 5% to 10%. The higher the amount taken as loan, the less the interest charged.

Assume vegetable vendor A borrows Rs 10,000 at an interest rate of 5% a month from financier B. As is customary in Delhi, the payment is made to A after deducting the first month’s interest. A, therefore, gets Rs 9,500 in hand. If at the expiry of one month, A cannot repay the loan, he must pay Rs 500 as interest to B. In fact, A can retain the principal amount as long as he continues to pay interest every month.

(Photo credit: AFP/Anil Dayal).
(Photo credit: AFP/Anil Dayal).

Typically, it is said that vendors take loans for a month, sell their produce and pay off the creditor. Thus, for instance, A takes Rs 10,000 (in reality Rs 9,500) from B, buys and sells vegetables for Rs 13,000, and returns the Rs 10,000 he took from B. The Rs 2,500 (Rs 500 he has already paid as interest) constitutes his profit.

No doubt, this is an exploitative system based on the economic vulnerability of A. But it is also true that A will have to spend an inordinately long time to procure a loan from a bank.

Post-demonetisation, the inability to access loans will hit vendors like A hard, as it already has the financier, who is now engaged in converting his stash of funds into new currency notes. Since the conversion, even if it happens, will take a long time, loaning has come to a halt. This will have a cascading effect – vegetable vendors won’t have stock to sell and prices will likely rise.

Contract labour

It is through the contract labour system that workers are hired for brick kilns, building roads and flyovers, and mining operations. Under the system, a brick kiln-owner advances money to a contractor who contacts people in villages willing to migrate out for undertaking labour-intensive work.

To those who agree to migrate, the contractor advances money for buying seeds and fertiliser, which others in the family can use. Their travelling expenses are met by the contractor. Usually, a person travels with his wife and children below seven years.

A brick-kiln owner in a town in East Uttar Pradesh said, “Once the contractor brings the labour, the owner has to provide for their shelter, wood for fuel, and meet the medical expenses of a minor nature. They are paid money to buy their weekly ration.”

The duration of work in a brick kiln is roughly seven to eight months, from the end of October to the first fortnight of June. A detailed account is kept for the period. “The weekly payment plus other advances a labourer may have taken is deducted – and the amount due is handed over to him at the season’s end,” said the brick kiln owner.

Migrant workers. (Photo credit:  Reuters/Adnan Abidi).
Migrant workers. (Photo credit: Reuters/Adnan Abidi).

Cash primes this system, which the demonetisation policy has wrecked overnight. “Since the funds with owners are in high-denomination notes, he has been busy trying to convert them into new currency,” said the brick kiln owner. “Simultaneously, workers are trekking to banks to convert the cash they posses. So the work has come to a standstill.”

He said he thought it was ridiculous to bring all forms of economic activities under the ambit of banking, which he claimed was the principal motive behind the demonetisation policy. “Can cheques be issued to labourers, who are mostly illiterate?” he asked. “Does every village have a bank where they can submit their cheques?”

In fact, 50,421 bank branches service India’s 6,38,596 villages. This means there is a bank outlet every 12.66 villages. This should provide a glimpse into the havoc the demonetisation policy is still to wreak on rural India, the story of which we haven’t yet heard.

The brick kiln owner was livid at how the national media has framed the demonetisation policy, portraying it as a crackdown on black money but not factoring in the disruptive impact it is bound to have on the economy.

“Because India doesn’t have adequate banking coverage, this push to undertake economic activities through banks is undemocratic and callously indifferent to the impact of demonetisation on people living outside metros,” he said.

He said unless the situation improved rapidly and money is pumped into the economy soon, the BJP would suffer a severe blowback during the 2017 Assembly elections. “If it continues the way it has, the BJP will be swept out of UP [Uttar Pradesh] as it was in Delhi.”

Modi has now asked for 50 days to rid the country of the black money. This is bound to compound the worries of people, many of whom, with just few thousands or even less in their pocket, are likely to become impoverished as they will have their livelihoods snatched away.

Ajaz Ashraf is a journalist in Delhi. His novel, The Hour Before Dawn, has as its backdrop the demolition of the Babri Masjid.

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Butterfly roof and cantilever (Image credit: Design Milk on
Butterfly roof and cantilever (Image credit: Design Milk on

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Exposed concrete wall (Image Credit: Getty Images)

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