Restoring rural cash flows

Low food prices hurt cash availability in the rural economy, and loan waivers make that worse

“Bazaar mein paisa nahin hai” (there is no liquidity in the market) has become a common refrain of distributors and wholesalers and, in particular, is heard in any discussion on agricultural markets. It is a phrase that makes little sense at first. Sales should just be driven by demand and supply after all; what does money have to do with it? But you need money to facilitate transactions, and the informal economy, which accounts for more than 40 per cent of the country’s GDP, only runs on cash — that is, physical currency. That nearly all of agriculture is informal makes it one of the most cash dependent sectors. In theory, the same amount of cash can support more economic activity if the velocity goes up (that is, the number of times a currency note is used in a year), but this does not change quickly, and to grow the informal economy by, say 10 per cent, the cash available should also rise by broadly the same amount.

What has driven this tightness in cash? Some observers have linked this to demonetisation; that despite the currency in circulation being nearly 14 per cent higher than what it was pre-demonetisation, the re-monetisation has not been smooth and there are pockets that still do not have enough cash. It is hard to do rigorous analysis given the paucity of granular data, but it appears that there may be other reasons.

Illustration by Ajay Mohanty

Cash starts its life in the formal economy: The central bank prints it and gives it to the banks. Once withdrawn from banks, it is hard to track its movement (at least for those not working for regulators), but one can think of some large pathways through which cash moves into the informal economy. The first is food procurement: Non-agricultural workers (the net consumers) purchase upwards of Rs 15 trillion from farmers (net producers) annually. Then, there are farm loans. After the farmer gets the loan amount in his account, he withdraws the cash to make the necessary payments for inputs like labour, seeds and fertilisers. Land purchases also transfer potentially large sums of money to the cash economy.

In the last few years, each of these pathways has narrowed. Weak prices for farm products  over four years have not only slowed the transfer of income from the mostly better off net consumers to the mostly poor farmers, they have also likely hurt the availability of currency in the farm economy. Loans have stagnated  too. Five years ago, the net annual increase in agricultural loans used to be well over a trillion rupees; this number today is lower even in absolute terms. Similarly, with green-field project announcements mostly absent and stress in the real-estate market, land acquisition activity has been weak too. 

Mismanaged farm loan waivers make this problem worse. Governments announce waivers in a hurry but then take years to execute them. The loan burden on the farmer eases for sure, but the benefit in terms of net cash availability is only the interest that was due (7 per cent annually on most of these loans). What makes things worse is that during the unduly long period of execution, banks are reluctant to issue new loans in these areas. The flow of funds to these areas thus slows, and, in fact, hurts the economy.

A farmer support scheme though may be hard to avoid. As an economy develops, one inevitably reaches a point at which the per capita income from farming falls behind non-farming income. Other than in countries such as  Australia and New Zealand, with large per capita land availability, agricultural income would struggle to compete with that in manufacturing or services. Therefore, subsidies to agriculture are common. Swiss agricultural subsidies, for example, are more than 80 per cent of Swiss agricultural output— that is how one of the richest countries in the world can afford to keep cows.

If it can be executed well, a direct income transfer scheme may be a better option to help farmers, as it gets cash flowing into this part of the economy. In the socio-economic caste census — it was used recently for the health insurance scheme and also quite successfully for the rural housing subsidy — the government has a tool to direct the transfers to the needy that was not available till a few years ago.

There is some fiscal space too, though not a lot. Beneath the apparent stagnation in fiscal consolidation over the past few years, there has been some under-appreciated improvement. Every 10 years, the ratio of government salaries and pensions to the country’s GDP rises sharply, and then falls till the next pay commission raises it again. In the fifth pay commission (1997-1999) the increase was about 2 per cent of GDP and in the sixth (2009-11) it was nearly 2.5 per cent. During the seventh pay commission (2017-19) the increase has been only about 1 per cent, and the aggregate fiscal deficit has not changed, unlike in prior decades. Going forward, as the growth in government salaries and pensions normalises (at least till 2027, when the next hike is due), the ratio may drop by 0.3 per cent next year, and 1.1 per cent by 2023. Next year, this creates more than Rs 60,000 crore of fiscal space between the Centre and the states.

If one assumes that the bottom 30 per cent of the rural population will be targeted, the second order effects may also be helpful: 60 per cent of the consumption basket in this segment is food. Demand for more expensive calories —such as milk, oil, meat and eggs — could pick up, providing some boost to prices of these primarily agricultural commodities and thus improve the transfer of income and cash  to the net producers.

These are, however, assumptions and the economy could react very differently too. A transfer scheme at this scale is untested and the potential impact on the economy is hard to assess. Necessary as it is, this is also not a cure to the problem of low farm incomes but only provides symptomatic relief. Unlike in the more prosperous economies that have farm subsidies, a very large part of India’s workforce is in agriculture. Finding them alternative employment as well as boosting farm exports are the only sustainable solutions.

The writer is co-head of Asia Pacific strategy for Credit Suisse