While demonetisation will benefit the organised sector, the government has to find a way to channel the upcoming revenue buoyancy towards job creation to balance out job losses in the informal sector, says Akash Prakash.
Surveys show that small and medium enterprises even today are unable to access enough cash to pay their vendors, workers or fill channel inventory. Photograph: PTI Photo.
Demonetisation has clearly been a very controversial move. The critics will argue that none of the black money actually got immobilised, with all the cash being deposited, and there has been no lasting impact on corruption.
As cash is coming back so are the demands of the corrupt. The bulls will point to increased digital payments, lower interest rates due to cash coming back in the system and eventually a rising tax base.
Both sides have valid points, but be that as it may, there are two clear benefits of the demonetisation and more broadly the war against black money.
Firstly it has undoubtedly increased the allure of financial savings. We are seeing record inflows into all types of financial assets as household savings move from gold, cash and real estate into stocks, bonds and bank deposits.
Most banks believe 35-40 per cent of the cash deposited will remain, permanently improving their funding. Once into the formal financial system, this cash will find its way into various financial assets.
This shift improves access to, and lowers cost of, capital for Indian companies and makes us less dependent on foreign capital flows.
The second clear shift is the move towards a greater formalisation of the economy. Through a combination of demonetisation, introduction of GST, disallowance of cash transactions over Rs 300,000 and other steps to reduce the cash intensity of the economy, we are seeing pressure on the informal sector.
That part of the economy which does not pay taxes, does mostly everything in cash and has little paper trail.
The informal sector is almost 40 per cent of the Indian economy and employs almost 75 per cent of the labour force. This is where all the job growth has been, these companies are the only ones which can do the mass hiring of lower skilled employees that India needs.
Unfortunately for most of the companies in this space, their main competitive edge was their ability to evade taxes and disregard minimum wages, statutory benefits and labour legislation.
Lacking in technology and scale, this was the only way they could compete with the large, organised sector players. Unfortunately for them, the war on black money unleashed by the Modi regime, has taken away much of the arbitrage.
Surveys done by various brokers like Ambit show that small and medium enterprises (SMEs) even today are unable to access enough cash to pay their vendors, workers or fill channel inventory.
Rules are being put in place to compel all industrial units to pay workers through bank accounts and no counter-party today wants to deal in large volumes of cash.
To operate going forward, these SMEs will have to use non-cash, above-board payments to both vendors and workers and thus expose their books and existence to the authorities.
The implementation of GST will only further reinforce this structural trend of rapid formalisation of the economy. The paper trail will be strengthened and most companies will not be able to operate unless they are a part of the formal economy.
While demonetisation was targeted against black money and corruption, I am not sure accelerated formalisation of the economy was an objective fully thought through.
What are some of the likely impacts of this accelerated formalisation? Clearly we will see large job losses in the informal sector. As these units lose share to larger organised players or are forced to pay higher wages (covering all regulatory costs) they will be forced to shed workers.
Where will the jobs for the 10 million young adults entering the workforce every year come from? The large organised private sector in India is not hiring.
It has not been hiring for many years now, with all job creation coming from the unorganised players. In sectors like IT and telecom we may even see a shrinkage of the workforce in coming years, forget hiring.
As real estate flounders, with the savings shift, we may see mass layoffs in construction as well. Formalisation will make our crisis of jobs only worse.
There will also be an adverse credit cycle in the space, as the economics of many of the smaller players get squeezed. This may be more a problem for the NBFC players than the banks thankfully.
If these units were doing mostly cash-based transactions, with limited official profitability, it is unlikely they would have been large customers of the PSU banks.
The banks would need audited accounts justifying the credit. There will be pain in the LAP (loan against property) book and SME finance portfolios of most NBFCs.
On another note, the edge NBFCs have historically had is their ability to handle cash, either for disbursement or collection as well as their ability to assess credit, independent of the numbers shown in the accounts of the small enterprises.
Both of these sources of edge become far less important in the days ahead. Will the banks be able to make a far greater play for these customers as they formalise? Will the market share gain of the NBFCs stall? Something worth thinking about.
As these less-skilled workers lose their jobs, lower-end consumption will come under pressure, undershooting growth rates of more premium products. We may be in for a period where the premiumisation trend across categories slows. Companies more focussed on budget products, rural and semi-urban consumers may find business more challenging.
The tax base of the government is bound to go up as the economy formalises. We will see the government have much greater resources to spend on infrastructure, health and education, while the fiscal deficit will be stable.
Government expenditure may remain the driver of the economy for some more time to come. Tax buoyancy will surprise positively.
As the organised players gain share across the economy, it will benefit the equity markets. The stocks listed will almost all benefit from this shift. We will see higher growth rates in both top line and earnings due to formalisation.
We will also see a high dispersion in corporate performance. In some industries the informal sector players are almost 50 per cent of industry. In other areas they have no presence.
We will see a real stock-picking environment, as investors will try and bet on those companies which benefit disproportionately from this move towards formalisation.
Whether by design or default, we are going to see accelerated formalisation of the Indian economy. This will benefit the organised, listed part of the economy and government finances, but really crunch jobs. The government has to find a way to channel the upcoming revenue buoyancy towards job creation and improvements in skills.
Akash Prakash is at Amansa Capital. These views are his own.
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