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Impact of Demonetisation in Kerala

R Mohan ( was a former commissioner of income tax.

The report by the committee constituted by the Kerala State Planning Board to study the impact of demonetisation clearly delineates its effects on state revenues, capacity of the government to intervene in the social sector, and the hardship faced by the cooperatives and the traditional and service sectors.

The report of the Committee to Study Demonetisation on the State Economy of Kerala (GoK 2017) prepared by an expert group headed by the eminent economist, C P Chandrasekhar, on behalf of the Kerala State Planning Board is a comprehensive document covering every aspect of the impact of demonetisation of ₹500 and ₹1,000 notes announced on 8 November 2016. The Left Democratic Front (LDF) in Kerala was in the forefront of mobilising people across the state in a human chain to express resentment against this decision. Apart from organising protests, the LDF government also made a serious attempt to analyse the impact of this decision.

The committee was to study the short-run and the long-run impact of the demonetisation on (i) employment, income, and economic activity in the major sectors of the state; (ii) economy and livelihoods of different sections of the labour force; (iii) cooperative sector in Kerala, and the banking sector and credit provision in general; (iv) government revenues; and (v) gross state domestic product (GSDP) (in general and sector-wise).

Strained Fiscal Space

The report also discusses in good detail, the lesser highlighted impacts of demonetisation. It demolishes the myth that a bulk increase of cheap funds in the form of current and savings accounts (CASA) with the banks would lead to lower lending rates, which would catalyse private investment. The report points out how excess liquidity with the banks resulted in a rush to invest in government securities leading to the decision of the Reserve Bank of India (RBI) to impound the entire incremental deposits as cash reserve ratio (CRR). After this temporary measure, the RBI and the Government of India decided to absorb these in government securities under the Market Stabilisation Scheme (MSS).

MSS was originally brought in as a measure to mop up excess money supply in the system arising from burgeoning foreign exchange reserves. As part of the agreement between the government and the RBI, the former could not utilise it for expenditure, and the same would also not form part of the fiscal deficit of the government. The interest payable on these would be the revenue expenditure of the government. The limit for MSS was raised from ₹30,000 crore to ₹6 lakh crore after demonetisation.

As rightly pointed out by the report, the straining of fiscal space subsequent to rising interest expenditure would lead to contraction of expenditure in social and economic sectors, as deficit targets seem to be held as sacrosanct under all circumstances. This does not augur well for an economy exhibiting signs of a slowdown for quite some time (through falling investment GSDP ratio from 34% to 29%) and hit by knee-jerk contractionary effect of withdrawal of 86% of value of currency in circulation. In short, the situation is one of a coerced fall in private final consumption expenditure (pfce), and a fiscal stance with contractionary elements dominating. A fall in economic growth is a necessary consequence of this.

Eroding Share in Taxes

Despite claims of the central government, the overall tax revenue is set to grow at 12% during 2017–18 as against 17% for 2016–17. The states’ share in union taxes, which is based on the “pain or gain principle,” is set to suffer an erosion in the coming year. For a state like Kerala, where consumption expenditure is a major determinant of economic growth, it is a double whammy.

Kerala’s own tax revenue, which is based on consumption expenditure will decelerate and the central tax share would also decline. With a higher level of commitment on social and economic services, the state would be compelled to run higher revenue deficits and would have little to spend for capital expenditure from budgetary sources.

The report discusses alternative scenarios of revenue deceleration for Kerala. Now that the budget documents are published, the revised estimates for 2016–17 are available. The own tax revenue has fallen short of the budget estimates by ₹3,066 crore for 2016–17. The targeted growth rate was 19.89% against which the revised estimate is at 14.23%, with the tax to gross domestic product (GDP) ratio remaining at 6.71% as against 6.85% expected in the budget estimate. After a robust period of revenue growth from 2006–07 to 2011–12, Kerala’s own tax revenue started experiencing a state of sclerosis by falling to 10% growth rate from 2013–14 to 2015–16.

The efforts to raise the rate of growth of revenue to almost 20% would have succeeded as a part of revenue-led fiscal consolidation had not the demonetisation decision of 8 November 2016 come as a bolt form the blue. As expected by the report, the revenue-led fiscal consolidation process has been derailed at least till 2018–19. This is a serious setback, but the Kerala budget of 2017 chalks out a path towards fiscal consolidation for Kerala, albeit a delayed one.

Focus on Cooperatives

The report next focuses on the cooperative sector, which has not only been an integral part of the rural and urban economy, but also of the social and cultural ethos of Kerala. With the illustrative example of Kasargode district, the report succinctly points out how the cooperative movement has moved into areas unbanked by scheduled commercial banks, even after five decades of bank nationalisation. By prohibiting exchange of demonetised notes, the cooperative sector was virtually shut down, putting a large number of people to hardship.

The report points out that the findings of the task force of the RBI on cooperative banks and societies should have addressed state- and region-specific sensitivities and peculiarities instead of making one-size-fits-all comments. The cooperative movement in Kerala has several pro-people interventions in educational, health, and consumer protection areas. The report also addresses the campaign against the cooperative sector as a haven of unaccounted money and parallel economy. It makes positive suggestions such as improving computerisation, permanent account number (PAN) card registration, tax deduction at source (TDS) and know your customer (KYC) norms as prerequisites for improving the cooperative credit structure. The report prepared after interacting with a wide range of people having domain knowledge in this area, is worth a detailed reading. Temporary measures to overcome the crisis by the primary agricultural credit societies (PACS) by opening mirror accounts with the district cooperative banks has been discussed in the report. It is suggested that government agencies should bank with the PACS in this hour of crisis.

Hardships Multiply

As far as the Kerala economy is concerned, the report examines the hardship faced by traditional sectors like coir and handloom, and agricultural and related sectors. Currency shortage has brought their activities to a standstill for the time being. The committee has examined the plight of the construction sector, where substantial segment of the labour force are migrants from other states. Due to the stalemate of activities, the migrant labourers were returning in large numbers to their native states. The agriculture and allied sectors in Kerala have been exhibiting negative growth rates in real terms in 2013–14 and 2014–15. Undoubtedly, these cash dependent sectors would suffer a setback in meeting the payment requirements of labour and other inputs, and in effecting sale of output. The report reveals the gravity of the situation in the traditional and informal sectors in the immediate future after demonetisation.

It became clear that, given the multiple levels and varying values of the transactions involved in the informal sector, not all transactions can be made cashless, and definitely not in the short run. The result has been an inability to make payments, even for wages. Moreover, in sectors trading perishables such as vegetables and fruits, pressure to sell the product results in falling prices. Despite the decrease in prices, offtake remains low because of the cash crunch, leading to loss of produce because of spoilage. In the dairy industry, farmers are not being paid in time for milk supplied and are unable to buy adequate cattle feed because of the cash deficit. The fisheries sector has been particularly hard hit because, starting with payments for fish auctioned at the point of landing, most transactions, including payments of wages by boat owners, supply to wholesalers and retailers, etc, are in cash. As business has declined, workers get less work and lower earnings, and have had to get into debt to meet their daily expenses (GoK 2017: 9).

The workers and small producers in the informal sector in Kerala are facing yet another issue. Due to the lackadaisical approach in operationalising the Central Food Security Act by the previous government, there is a huge shortfall in allocation of foodgrains under the public distribution system and rise in the price of different varieties of rice in the open market. The sharp decline in incomes along with jump in price of foodgrains is adding to the woes of the poorer sections in the traditional and informal sectors. Intervention by the state government, which it is doing on an emergency basis, is putting additional stress on state finances, especially in the face of demonetisation that has induced slowdown of the own tax revenues such as commodity taxes, stamp duty, and registration fees.

Tourism Adversely Affected

Kerala is one of the acclaimed tourist destinations and the “trade, hotel and restaurants” sub-sector of the GSDP is substantially dependent on tourist arrivals. The report points out that the arrival of domestic and foreign tourists declined by 17.7% and 8.7% respectively, during November 2016 over that of corresponding month in 2015. During October 2016, the month immediately prior to demonetisation, there was a positive growth of 5.2% and 6% of domestic and foreign tourist arrivals respectively.

The share of trade, hotels and restaurants (which is highly dependent on tourist arrivals) is 15.82% of GSDP, and is the single largest contributor to the services sector. An adverse impact on the growth of this sector will lead to an economic downturn, and the palpable indication of decline in domestic and foreign tourist arrivals is a clear pointer to an economic slowdown in the short-run.

This comes on top of other grey spots like return migration from Gulf countries and falling commodity prices (which has started rallying again recently). The nominal GSDP growth projected is 13% in the Macro Economic Vision Statement of Government of Kerala, 2016 (GoK 2016). If this falls to the all-India average of 10%, there would be serious adverse consequences on the revenue as well as expenditure side of the state budget, as genuinely apprehended in the report.

Slowdown in Growth

The concerns expressed by the report turn out to be substantial with the estimates of gross value added (GVA) at the national level showing a slowdown of 1 percentage point for 2016–17 at 6.7%, as against 7.7% for 2015–16. At the national level, growth rate of many sectors like manufacturing, construction, finance, real estate, and other professional services has fallen in the third quarter of 2016–17, while growth in agriculture is due to a low base effect. But one has to wait for the revised estimates of GVA at national level, which is more reliable than the quarterly estimates, to see whether a further downturn from 6.7% would result or not. Nevertheless, the stark reality is that there is at least 1 percentage point downturn in GVA (at constant basic prices) growth during 2016–17, when compared to 2015–16. Signs of slowdown in the immediate run are clear.

The report makes the suggestion of relief grants to be disbursed by the centre to the states to overcome the economic fallout of demonetisation by constituting a National Demonetisation Impact Relief Fund. The suggestion is worth considering as the measure of demonetisation has placed a heavy economic and social cost on the states. With the prevailing view of fiscal orthodoxy at the centre, which has stymied even a modest increase in fiscal deficit to 3.5% as suggested by the committee on Fiscal Responsibility and Budget Management Act (FRBMA), the centre is unlikely to give it the serious look it deserves.

But Kerala’s budget, presented on 3 March 2017, after the report came out, has taken a cue from this and has proceeded to deviate from the beaten track of fiscal conservatism by increasing spending for 2017–18, even in the face of rising revenue deficits, while retaining the hope that increased revenues later would ameliorate the situation.

The report is a rare initiative to address the issues involved seriously and flag the same in public domain. The content is rich both in substance and data and is devoid of rhetoric of any sort. The report has a positive approach towards digitalisation but raises the pertinent questions of right to privacy of a citizen and where a line has to be drawn. The forced prevention of use of cash is not considered a desirable method. Use of cash has strong linkage with the culture of the people, states the report, citing cross-country examples. Our cash–GDP ratio at 12% does not seem abnormally high when compared to 18% in Japan and 6.5%–7% for the United States, given the level of currency substitutes available in comparison with these countries.

Concluding Remarks

The impact of demonetisation is now clearly emerging. At the national and state levels, the economy has been exhibiting signs of slowdown, even prior to demonetisation. Along with a deficit target centric fiscal policy, the abnormal contraction of cash availability (which has come to be called monetary vacuum cleaning) has hamstrung the levers of growth. In a federal set-up, states are more or less followers of imposed priorities and receipients of adverse impacts of policies like demonetisation. Under these constraints, Kerala has taken a lead to analyse the issues arising out of the sudden announcement of demonetisation and has taken some bold steps in the state’s fiscal policy.

At a time when high decibel slogans drown the scope for any serious discussion on the impact of demonetisation, the report is a sound voice. This is a useful addition to the debate along with the Economic Survey and the RBI’s study on Macroeconomic Impact of Demonetisation (RBI 2017). The report of the Kerala State Planning Board is more extensive in its coverage, as it benefits from the consultative approach with as many stakeholders as possible, unlike the other two.


GoK (2016): “Macro Economic Vision Statement,” Budget 2016–17, Government of Kerala.

— (2017): “Committee to Study Demonetisation on the State Economy of Kerala,” Kerala State Planning Board, Government of Kerala, February.

RBI (2017): “Macroeconomic Impact of Demonetisation—A Preliminary Investigation,” Reserve Bank of India, 10 March.

Updated On : 8th Nov, 2017


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