Kerala planning board study fears Rs 11,000 crore hit on state revenues due to demonetisation

A study on the impact of demonetisation, commissioned by the Kerala State Planning Board (KSPD), finds that the withdrawal of high denomination currencies by the central government on November 8, 2016, and the subsequent restrictions on cash withdrawals severely affected 56 per cent of the state's economic activity.

A study on the impact of demonetisation, commissioned by the Kerala State Planning Board (KSPD), finds that the withdrawal of high denomination currencies by the central government on November 8, 2016, and the subsequent restrictions on cash withdrawals severely affected 56 per cent of the state's economic activity. The cooperative sector, retail trade, hotels and transportation, tourism, agriculture, fisheries, coir, handloom and cashew processing were among the worst hit, the study says.

Post demonetisation, Kerala's gross state domestic product (GSDP) growth rate is expected to be much lower than 14.9 per cent (the annual average GSDP growth rate observed between 2011-12 and 2014-15), the study says.

"At a constant tax effort of 6.85, a decline in the GSDP growth rate by one percentage point means a shortfall in tax revenue to the tune of Rs 390 crore from the budget estimates (BE) of 2016-17. If Kerala's GSDP growth rate also hovers around the national GDP growth of 10 per cent, the own tax revenue shortfall will be to the tune of Rs 1,950 crore when compared with 2016-17 BE. A combination of declining GSDP and slow revenue growth can result in a shortfall in tax revenue much higher than Rs 1,950 crore. In fact if the tax to GSDP ratio is assumed to be 6.5 instead of 6.85, the shortfall in revenue due to one percentage point decline in GDP would be more than Rs 2,800 crore and aggregate own tax revenue shortfall in turn would be around Rs 11,000 crore if the GSDP growth plummets to 10-11 per cent," the study says.

This level of own tax revenue contraction, if not compensated, can result in across-the-board cuts in planning expenditure of the state, which will have adverse growth and development implications. This can result in a vicious circle of lower growth, lower revenue and lower level of development expenditure, the study warns.

Kerala is the first state to undertake such an exercise to analyse the impact of the central government's note ban. Although the Centre's demonetisation exercise came full circle with the Reserve Bank of India (RBI) withdrawing all post-demonetisation restrictions on cash withdrawals on March 13, 2017, the study suggests that it may take more time for the state's economy to bounce back.

The study outlines six key reasons why the state's economy was particularly vulnerable. First of all, cash transactions, as in other parts of India, were predominant in the state's economy. Second, millions of people were dependent on traditional sectors such as fisheries, coir, handloom and cashew processing as well as on crop and plantation agriculture. More than 2.5 million migrant workers work as wage labourers in the state. Third, the study points out that the three-tiered cooperative banking structure, with the Primary Agricultural Credit Societies (PACS) at the bottom of the pyramid, is an overwhelmingly large part of the financial structure. Fourthly, outside the financial structure, Kerala has a cooperative sector that is an important component of manufacturing and services activity, which banks substantially with the cooperative banking sector. A blow to tourism, which accounts for an important share of Kerala's state income, was another cause. Finally, it says that demonetisation caused disruption in remittances, again a key component of Kerala's economy.

"Cash-intensive sectors such as retail trade, hotels, and restaurants and transportation account for over 40 per cent of Kerala's economy, and the primary sector accounts for another 16 per cent of the economy. Thus 56 per cent of the economic activity of Kerala is immediately affected by the withdrawal of specified bank notes. Agriculture, whose growth has been low and constrained over the last few years, will be affected directly by the new policy. Any turnaround in construction, transport and storage, which have been decelerating in the recent past, will be delayed. The high growth sector of trade and hotels has been seriously hit by the cash crunch. As mentioned, a significant section of workers in manufacturing are in traditional industries. Overall, both leading as well as struggling sectors of the economy have been hit hard by demonetisation, pulling the economy down and affecting potential resource mobilisation as well," the study notes.

It also focusses on the distinct nature of its banking sector, in which the cooperative sector and the primary cooperative societies play a central role.

The study notes that PACS, spread over 1,642 rural centres, is almost equal to the number of banking centres covered by commercial and cooperative banks in Kerala. While at the all-India level, there are only 35 borrowers in PACS for every 100 credit accounts in the banks in Kerala, for every 100 credit accounts with banks, there are 184 borrowers in the PACS. The average size of deposits in cooperative banks is Rs 35,000 compared to Rs 10,000 at the all-India level. Almost 60 per cent of all deposits are in the cooperatives in Kerala compared to less than 20 per cent in India. Hence, the notification issued by the RBI on November 14, which kept the cooperative banks and societies out of the note exchange process, were particularly damaging for Kerala, it said.

These actions resulted in the closure of banking activities at the PACS level. It also impacted the credibility of the PACS, which had served as democratically run, participatory financial institutions. Depositors in the PACS were being forced to migrate to the commercial banking sector, thus undermining the role of some of the most successful examples of cooperative banking and financial inclusion, the study pointed out.

The committee that conducted the study was headed by C.P. Chandrasekhar, Centre for Economic Studies and Planning, Jawaharlal Nehru University. The members were D. Narayana (Director, Gulati Institute of Finance and Taxation), Pinaki Chakraborty (National Institute of Public Finance and Policy), K.M. Abraham (Additional Chief Secretary, Finance) and V.S. Senthil (Member Secretary, Planning Board.

With the BJP's resounding success in Uttar Pradesh elections, the debate over the politics of demonetisation seems to be settled. But the Kerala study hints that the debate over its economic impact will continue.