Will note ban dry up informal loans in rural India?

Nearly 40% of loans taken by agricultural households come from informal sources, shows data


In the long run, it remains unclear how demonetisation will change the informal credit market in rural India. Photo: Hemant Mishra/Mint
In the long run, it remains unclear how demonetisation will change the informal credit market in rural India. Photo: Hemant Mishra/Mint

New Delhi: Demonetisation of high value currency has impacted the rural and agriculture sectors in several ways. In the days following Prime Minister Narendra Modi announcing withdrawal of Rs500 and Rs1,000 notes, trade in wholesale markets took a hit due to the acute cash crunch and farmers resorted to distress sales of perishables like fruits and vegetables. There were concerns that the cash crunch will impact planting of winter crops but that is settled now since farmers have managed to sow their fields.

The fact that agriculture markets did not collapse entirely and supply chains are functional is likely because transactions are taking place on the basis of credit, barter and trust. Most of these shocks are short-term in nature and are likely to normalise once the supply of paper currency is restored.

However, in the long run, it remains unclear how demonetisation will change the informal credit market in rural India. The numbers are staggering here. Nearly 40% of loans taken by agricultural households come from informal sources with moneylenders advancing 26% of the credit, shows the situation assessment survey of farm households released by the National Sample Survey Organisation (NSSO) in December 2014. For marginal land-holding households, the numbers are more skewed with just 15% of the credit coming from formal sources like banks and cooperatives.

So will the shortage of paper currency lead to shrinkage of informal loans?

No doubt that note ban is a severe blow to the rural commercial capital (cash and wealth with the rural elite like moneylenders, traders and input dealers who evaded the tax net till now and may be forced to reduce their cash transactions), but will it change entrenched rural relations? For instance, will the local input dealer who sells fertilisers and seeds to a farmer on credit on the condition that the harvest is pledged to him, mend ways and transact via formal channels?

Also read: 30 days of demonetisation

“The next Kharif season (in June 2017) will be a real challenge as the amount of cash flowing to the rural economy will take time to restore and it may take as long as two to three years for the rural rich to recreate their cash hordes (which they on-lend),” said Pravesh Sharma, former head of the Small Farmers’ Agribusiness Consortium, a specialised agency under the agriculture ministry.

Sharma added that the void in informal credit is an opportunity for institutional capital to step in with agility. “It will need coordinated effort to replace informal loans with formal ones and institutions like the Nabard (National Bank for Agriculture and Rural Development) can play a leading role.”

Sharma agreed it may take more than a year to put in place an alternative financial architecture to cater to credit needs of the rural economy. “So a compression in informal loans is likely by the next Kharif,” he said.

How are farmers dealing with the situation now? A farm leader from Punjab said, on the condition of anonymity, that commission agents and traders are depositing (unaccounted) money in farmers’ accounts and taking post-dated cheques from them as guarantee. In Uttar Pradesh’s Bundelkhand region, according to a local non-profit, moneylenders are advancing interest-free loans to agricultural labourers to launder the money they did not declare to tax authorities. All this means in the immediate period following demonetisation, money is being channelled from the informal to the formal sector via the rural poor.

Also read: How demonetisation has impacted key sectors

“A lot of informal loans are stuck too as the moneylenders are not accepting payments in old notes or in cheques,” said Vijay Jawandhia, a farm activist from Shetkari Sangathana in Maharashtra. “In the next few months we may see informal loans drying up and this will hit the rural poor the most,” he said.

The fact that farm supply chains are functioning despite the cash crunch is due to the fact that many transactions are taking place based on credit and trust between people. “My hunch is that credit is getting pushed along the chain and the farm labour is the worst hit now,” said Sudha Narayanan, associate professor at the Indira Gandhi Institute of Development Research, Mumbai.

“Remittances have stopped from migrant labour and families back home in rural areas are cutting back on basic consumption,” Narayanan said, adding, “A crisis is looming in the next six months. The rural poor rely on informal loans and in many cases their first exposure to the banking system (post note ban) has been harrowing. We may even see a situation that they would want to stay away from formal banking systems in future.”

“The big question is how long will the credit lines continue,” she said.

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