Has demonetisation harmed non-farm employment generation in the medium term?

Prime Minister Narendra Modi promised to create 10 million jobs in five years while campaigning in the 2014 general election. After completing more than three years in office, has the government been able to deliver? We do not know for sure. Findings of a large-sample survey on employment, conducted by the National Sample Survey Office (NSSO), will only be available around 2019. However, there is no debate about one thing. For the employment situation to improve, more non-farm jobs have to be created.

In the post-reform period, the construction sector has been the most dynamic from the perspective of non-farm job generation. In 1993-94, 74.4% of India’s employment was in the primary sector. This includes agriculture and mining and quarrying. Manufacturing, construction and services had a share of 7.3%, 3.3% and 14.8%, respectively. In 2011-12, the share of manufacturing, construction and services had increased to 8.5%, 13.1% and 18.7%, respectively. Construction alone added more non-farm jobs than manufacturing and services put together during this period. These figures are based on the principal status method, which takes into account the economic activity status for the major part of the past year.

Given its huge absorption capacity for manual labour, dynamism in the construction sector is crucial from the perspective of employment generation. Things started deteriorating at the beginning of this decade itself. According to the old GDP series, construction grew at 9.3% in the last decade. After 2011-12, annual growth figures have not crossed 5% even once. A deceleration in construction sector growth might have been one of the important reasons for the relatively slower growth in rural wages in recent years.

Why did this slowdown happen? Infrastructure has been one of the sectors hit hard by the so-called twin-balance sheet problem. Companies have failed to pay back their debts. As a result, new credit flow has been affected. In contrast, credit to infrastructure projects had increased at a much faster pace during the last years of the previous decade.

As shown in Chart 2 above, growth in the construction sector did not suffer a continuous decline like credit growth to the infrastructure sector. Resilience of the personal housing sector seems to be the explanation. After declining in the beginning of the present decade, credit growth for personal housing recovered and braved the downward trends in credit to industry and infrastructure.

This changed after demonetisation. Growth in personal housing credit has been largely falling after November, 2016. Gross value added in the construction sector contracted 3.67% in the last quarter of 2016-17. There has been some recovery in the first quarter of this fiscal year. But the 2% growth that quarter is the second lowest since the Modi government took over.

How accurate is it to take personal housing credit growth as a proxy for demand in the construction sector? We look at the trend in year-on-year growth for personal housing credit and cement production (from the Index of Industrial Production) to check this. The two indicators broadly move together. On a cumulative basis, year-on-year growth in cement production between April and July is in negative territory for the first time since 2013-14.

Demonetisation disrupted economic activity in all major sectors due to the liquidity squeeze which followed. Its impact might have been much more severe in the housing market due to two reasons.

Use of unaccounted cash is much higher in the real estate sector than in other areas. Post-demonetisation, unavailability of cash or hesitation to engage in such transactions might have driven down demand. Illegal cash might have been the lubricant in the engine of the housing market in India. Then, there is the fact that many people, especially those in rural areas, depend on the informal rather than formal credit market for building houses. This sector too was badly affected by demonetisation due to scarcity of circulating capital.

In the long-run, purging unaccounted cash from real-estate transactions is one of the most promising measures to increase tax-compliance in India. And moving people into the formal-credit ecosystem has long-term benefits. Still, demonetisation’s sudden shock has dealt a body-blow to the housing sector. This could affect employment generation in the non-farm sector in the medium term. The golden goose of mass-employment generation seems to have become collateral damage in the government’s zeal to purge black money.