Demonetization – Impact on small business

An authored article of Kunal Sen in World HR Diary talks about how demonetization has impacted the small businesses.
The media generally believes that demonetization has been a political success and won the hearts of millions who think Modi is the only politician willing to take tough decisions to hit black money. Middle-class folks standing in long queues mostly seem to be willing to suffer a bit for a greater cause.

On the other hand, much has also been written about people dying for want of cash for medical care, of farmers unable to sell their produce, of weddings unable to function and of substantial distress in parts of India which function on currency notes.

What the media seems scarcely aware of is the change occurring in the small and medium enterprises (SMEs) sector.

Short term Impact

Of India’s 100 million shopkeepers, barely 2% have the machines to accept credit and debit cards: the rest are cash-based. Much the same is true for other small businesses, transporters and traders. These have all suffered a sharp drop in business. Many are parts of a value chain, starting from raw material producers and ending at the retail level. One the one hand, customers have reduced spending for want of currency notes. On the other hand, businesses do not garner enough currency notes to make cash repayments of loans or payments for weekly labour wages etc.

The enterprises have hailed the move to tackle black money circulation in the economy and expect that it will provide benefits to the sector in the long run. If their current problems last just a few weeks, they will recover. If the problems continue for longer, the damage will be substantial.

Many of these will not be wilful defaulters. They are willing to pay but cannot because of bungled demonetization. One top transport finance company says that only 60% of normal payments are coming in. Some of the smallest micro-finance loans, entailing a weekly repayment of a few hundred rupees, are being repaid because the women borrowers are able to garner notes worth Rs 300-400. But larger borrowers who need to repay instalments of over Rs 1,000 say they cannot find the currency notes to do so.

The RBI lays down strict rules for finance companies, which have to classify loans overdue beyond a point as dubious or bad loans, and set aside money to cover the gap. The RBI can relax its rules for financial provisioning, and create ample space and time for small businesses and small finance to recover. What look like defaults should be formally recognized as exceptional events arising out of demonetization, not as inability to pay?

Long term Impact

In the long term sense, the war on black money has hugely positive implications for India’s formal jobs because 100% of net job creation in the last two decades has happened in small, low-productivity enterprises; of India’s 6.3 crore enterprises, 2.4 crore do not have an office or address, only 85 lac have any form of tax registration, only 15 lac pay the mandatory Provident Fund, and only 18,000 companies have a paid-up-capital of more than 10 crores, only 45000 companies have ever posted a job on any job portal in the country

Most of our enterprises remain small and informal, 85% of our manufacturing is done in companies with less than 50 employees. This poses huge productivity challenges, if you rank manufacturing companies by size, firms at the 90th percentile and 10th percentile have a 22 times difference in productivity; firms that are not productive cannot pay the wage premium. Productivity comes from the access to talent and credit that comes from formalization. Over the next decade it is anticipated that the number of India’s enterprises will decline by over 50% ending the self-employment that is self-exploitation and low-productivity informal firms that operate in cash. The US economy is more than 7 times our size yet has 1/3rd the number of our enterprises because informal enterprises find it very hard to exist and exploit workers.

Entrepreneurs can create two kinds of companies– a baby or a dwarf. Both start small but one is going to grow. The difference between a baby and a dwarf finally comes down to not more food or money but their DNA. India has remained a country of corporate dwarfs.

Analysts suggest that many small businesses will not be viable in the white economy because their survival depends on tax or labour law arbitrage. A reduction in the number of enterprises may be welcome; the destruction of low productivity informal enterprises that don’t pay minimum wages or provide safe working conditions and leave is welcome. Demonetization destroys past gains of informality; complementing this with infrastructure building and ease-of-doing business interventions that reduce regulatory cholesterol could raise formal employment from 10% of our workers to 50% in the next decade.

This article was published in World HR Diary:


Kunal Sen

Senior Vice President
TeamLease Services Ltd

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