note demonetisation

Interview: Demonetisation has hit 80% of small businesses, the sector is staring at apocalypse

Just as an amnesty system was created for those with black money, there should be an amnesty scheme for micro, small and medium enterprises.

Anil Bhardwaj is the secretary general of the Federation of Indian Micro and Small and Medium Enterprises. It is to this group of enterprises, popularly referred to by the abbreviation MSMEs, that demonetisation has delivered a severe blow. It has devastated workers, brought the informal sector to a veritable standstill, and disrupted an economy greased by cash. In an interview to Scroll.in, Bhardwaj articulates the woes of his organisation’s members, why they run their businesses on cash, and what it would take for them to embrace cashless transactions. Excerpts:

How did micro, small and medium enterprises respond to Prime Minister Narendra Modi’s announcement of the demonetisation policy on November 8?
Initially, they welcomed it. There can be no two opinions that all those who are self-employed are vulnerable to extortion of money from income tax, sales tax, excise tax and labour departments. Not only do they lose their dignity, they have to also manipulate the system.

What do you mean by manipulating the system?
Assume there is a road that is to be built. To win the tender, pay-offs have to made. The person who gets the tender has to rotate the money (that is, find ways to make illegitimate payments, build the road and also make a profit). It is he who runs the risk of being caught. Worse, those who want to play by the rulebook get driven out of business – they can’t compete with the person who doesn’t pay taxes and manipulates the system.

That is why our organisation’s members thought demonetisation would help tackle corruption, and praised Modi for being decisive.

Since you used the word initially, you seem to imply that their mood changed subsequently.
The prime minister’s announcement of demonetisation was akin to someone blowing the whistle and the entire chain of business coming to a standstill. This meant nobody was going to take invalidated notes, nor were you expected to make payments.

Typically, most of our members have anywhere between Rs 1 lakh and Rs 10 lakhs of cash in hand. The only exceptions are owners of tannery and gems businesses. They keep a couple of crores of rupees in hand because these businesses are entirely run on cash.

So, in the first four-five days of demonetisation, our members tried to figure out what to do with the old notes of Rs 500 and Rs 1,000. They could deposit Rs 2.5 lakhs in their accounts and also in those of members of their families. By and large, our enterprises didn’t encounter much of a problem in disposing of their cash in a legal way.

Then began the second stage, I suppose.
The second stage saw us turn our attention to our business. We realised we didn’t have money to pay our suppliers, transporters, loaders and labourers. Payments to them constitute a large percentage of our expenditure. We didn’t have money because we had deposited it, but banks didn’t give us money in return. It is then we realised that we faced a bleak future.

Worse, rules regarding withdrawal and deposit of money were being changed all the time. The most important thing for business is predictability. A businessman takes corruption in his stride, whether in Bihar or the Northeast. For instance, the secessionist groups in the Northeast have a systematic way of extorting money – they calculate your turnover and decide what you have to pay. Businessmen simply add these payouts to their costs. Ultimately, it is the consumer who has to pay. Thus, for instance, a pair of slippers that costs Rs 60 in Delhi will come for Rs 100 in the Northeast.

Did the changes in rules accentuate the unpredictability in business?

Yes, and it also sent a message that demonetisation hadn’t been thoughtfully planned. For instance, the bulk of black money is in property and gold. To eradicate black money, the government should have gone after benami property. Since that wasn’t the case, businessmen thought it was a blunder.

Why was it thought as a blunder?

That’s because it has had an adverse impact on a lot of those who don’t have black money. Chemotherapy in cancer treatment is opted as a last resort. This is because chemotherapy also kills healthy cells. To eradicate black money, the micro, small and medium enterprises were thus hit badly.

Which was the first sector to experience the impact of demonetisation?

Handicraft.

Why?

That is because all economic actors in this sector rely on cash.

Can you give an example of how an entire chain of business in the handicraft sector was adversely affected?
Take the brass industry of Moradabad, Uttar Pradesh. The raw material for brass is supplied by people who deal in scrap. They sell scrap to the consolidator who buys it in cash. The consolidator is the one who combines three to four activities. The scrap is melted. It is turned into brass silli (slab or bar). The next stage involves making moulds – for instance, of a flower vase or a tap. The brass is melted and poured into these moulds. After this stage, there are craftsmen who make designs on it, then comes the stage of polishing, then of lacquering. Each of these stages is based exclusively on cash. Thereafter, the brass products come into the distribution network. That, too, works on cash.

There must be some segments that don’t rely on cash.
Only brass exporters don’t rely on cash and, therefore, escaped the blow of demonetisation. They, after all, get their payments in dollars. But the dollars are deposited in banks. Those who couldn’t make withdrawals, their money too failed to enter the chain (of the brass industry).

What is the difference between the consolidator and a unit-owner or exporter?
The latter will be registered with the sales tax department and will issue bills for the purchases you make. Ordinarily, consolidators are not registered with any government department. The consolidator works on cash, so do those in packaging and transportation.

How long can different actors in this chain sustain without cash?
Those at the lower end of the chain – the person who makes the brass silli or prepares the mould or the engraver – can sustain themselves without cash for a week at best.

The consolidator?
For a month, perhaps. But remember, he can sustain his family but not his business. Nearly 60% to 65% of brass enterprises in Moradabad are based on cash.

What is the Moradabad brass industry’s total turnover?
Around Rs 6,000 crores a year.

Would it be correct to say that 60% of it would be starved of cash?
Yes, but there are also others who are connected to this 60% whom we can refer to as principal economic actors – for instance, the person who supplies paint or diesel or blades. He may be small but he is a supplier nevertheless. Typically, purchases are made from such suppliers as and when enterprises run short of material. Then you have people who ply push-carts. There is no work for him and, therefore, no cash either. Then you have grocery storeowners from whom people purchase foodstuff. They can give credit for a week or two, but not beyond it.

After handicraft, which sector has been most affected?
Ask me which sector isn’t affected. Workers in micro, small and medium enterprises are migrants from across the country. They are there to make money. Often, they get up from their workstations to sleep. They are paid piecemeal, in cash, not cheque. Their number is enormous.

How enormous?
About 7% to 8% of people are employed in government and corporate sectors. Of the remaining 92%, take out 60% of those who are farmers or linked to the rural economy, though they too work on cash and not cheques. So, the remaining 32% or a little more are employed in our enterprises and depend on cash.

What is the percentage of micro, small and medium enterprises that has been affected severely?

Eighty per cent.

Hasn’t your organisation communicated the woes of its members to the government?
Yes, we have approached the government and said that it is a fact that the Indian economy has been functioning in a certain way for the last 70 years. There are several reasons why our economy is dominated by the informal sector – we have regulatory excesses, inspection raj, corruption, outdated laws. The fact remains that 90% of business enterprises are in the informal sector.

What are the implications of having such a huge informal sector?
This means they are mostly unregistered. They are not registered with the sales tax, labour or such regulatory authorities. But they are doing legal business. They are not thieves or dacoits. Theirs is mehnat ki kamai.

Do these enterprises file tax returns?
Most of them don’t, or they underreport their incomes.

I will give you an example of how the system works. For instance, when we talk of labour in India, we have thresholds. There is a threshold of 10, then of 20, then of 100 and so on. Different laws apply depending how many workers a unit employs. There is only one exception – the minimum wage law. Thus, for instance, if you have 10 workers, you don’t have to pay provident fund, don’t have to have a group insurance scheme. Thus, if a unit employs 200 workers, it will show it has employed just nine.

A delegation recently told me that their association wants to switch, post-demonetisation, from do numbari kaam (illegal) to ek number kaam (legal). But they face certain problems in executing the contemplated switchover.

Like what?
The delegation said that for 15 years they have shown their units employing nine workers as against the 250 they have in reality. So, if they turn their business legal, the labour inspector would come to them and accuse them of not having paid provident fund for 15 years. Not only would there be a penalty imposed on them, they would certainly risk being jailed. There are such issues regarding the excise tax as well.

So what do you want?
Our organisation has prepared a document in which we have said that just as an amnesty system was created for those who possess black money, similarly, there should be an amnesty scheme for our enterprises – all past infraction of laws have to be condoned. Then only would there be benefits from demonetisation. You may take away black money but if you haven’t taken care of the machinery that generates black wealth, then what is the big point of amnesty?

Give an example of the kind of administrative reform you would want.
Labour reforms. If social welfare constitutes 30% of my labour cost, and I have to deduct Rs 3,000 from a worker’s pay of Rs 7,000, then he will receive only Rs 4,000 in hand. If I explain to him that the deductions are meant to secure his future, he is likely to tell me, “Forget my future, I have to negotiate my present first.”

The component of social cost is so high in the wage structure that the formal sector can afford it but not the small sector. It will, to stay in business, resort to under-reporting.

Some people suggest going cashless is the way out. What meaning does going cashless have for the informal sector?
To a great extent, the role of cash in the informal sector is played by trade credit. I buy raw material from you in the morning and give you a slip of paper. In the evening, I give you cash. I am dependent on cash because the supply chain I am part of is dependent on cash. Why cash? That is because all other instruments are not as trustworthy as cash is.

What do you mean by that?
For instance, I give you a cheque, it bounces tomorrow. Earlier, it used to take seven days to 10 days for cheques to get credited. It still takes two to three days now. It should be credited in a matter of hours. It is the bank that fattens itself on the float (of money) for two to three days.

In a presentation made to the Finance Ministry recently, our organisation’s president said that in order to move from a cash-based economy to a cashless one, the first challenge is to restore faith in the instrument of cheque. It should be as good as cash.

We suggested that the bouncing of cheques should not be considered a criminal offence. Instead, if a person’s cheque bounces, his account should be frozen until such time he makes the payment to the person he owes money. That would be a big step towards making India’s economy a cashless one.

Yes, but people are being asked to switch to eWallets.
Because of eWallets, the banking system could lose its numero uno status and importance. If you send money from an eWallet to someone, there is no bank between the two of you. There are innumerable technology-based intermediaries other than banks that have surfaced. Such a trend, obviously, has implications.

What could these be?
The money that you deposit in the bank is what it lends out. Suppose the current volume of money that comes to the bank diminishes in the future. There could be a scenario that has you investing in stocks through banks. Otherwise, to make all other payments, you use the eWallet. Won’t this have repercussions?

Then again, 70% to 80% of the money in the Indian banking system is controlled by the government, which uses that money for its own purposes. What will happen if the money stops going to banks in the same volume as is happening today? There can only be two scenarios – either the government will learn to live within its limit or it will go bankrupt.
Assume another populist leader comes and commits a blunder. Today, the government controls money – and can even scoop 5% of gross domestic product from banks. But suppose banks no longer sit on such liquidity, then?

Because of the government’s control over money, we have such a high-cost economy. That is why we don’t invest in capital and productivity. And productivity is everything.

What does the future look for micro, small and medium enterprises?
It is apocalypse for micro, small and medium enterprises. And that is because the entire sector is predominantly cash-based. If the government realises it has created a blunder, it can seek to undo the blunder through reforms commensurate with the problems these enterprises encounter.

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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