India’s small businesses hit by cash squeeze

Inside the small Jai Ma Ambe Metalworks, owner Omkar Sharma, 60, looks forlornly at the eight, ancient-looking metalworking machines in his primitive workshop. Until last month, his tiny enterprise had 12 workers making bolts and other door fittings for larger hardware makers. Today, most of Mr Sharma’s workers have disappeared along with the work — casualties of New Delhi’s decision to ban the use of 86 per cent of India’s circulating currency. 

 “Everything has come to a stop,” says the metalworker, whose business — it operated out of a bare-bones cement room in an industrial estate on Delhi’s outskirts — was run entirely on cash. “We don’t know what is going to happen next.” 

Prime Minister Narendra Modi’s government claims that purging most of India’s old cash supply, and replacing it with a smaller quantity of new banknotes, will bring long-term economic benefits, including catching small, informal enterprises like Mr Sharma’s in the tax net. But at the Wazirpur Industrial estate, a hub for the kind of small and medium enterprises at the heart of India’s fragmented manufacturing sector, hard-hit entrepreneurs are wondering whether they can survive the currency shock, or even resume production. 

A month after the overnight ban, many have simply pulled down their shutters, paralysed by their inability to secure raw material, sell their wares or pay workers without cash. “At least 50 factories have closed down because of this,” says Mr Sharma. 

Mohan Jain, a broker who supplied steel sheets to small workshops that then turned it into hardware, confirms that trade has collapsed. “The guy who has the material says he will only take new notes. The guy who wants to buy says he only has old notes. No business is happening,” he gripes. Workers, mostly rural migrants, have returned to their villages. 

“For the SMEs, it’s a death knell,” Saurabh Mukherjea, chief executive of Ambit Capital, said of the demonetisation. “The notion that one day cash is going to come back is wrong. Those days are not going to come back. This is a forced economic revolution with major structural implications.” 

Ever since independence, India has deliberately nurtured small enterprises, a policy born out of Mahatma Gandhi’s romantic ideal of small village industries meeting local needs and a deep-rooted distrust of big business. Banks in India are required to extend a set amount of credit to small and medium-size industries and government regulations discourage businesses from growing above a certain threshold. 

The result is a highly fragmented, inefficient manufacturing sector that is barely regulated and operates mostly in cash to evade taxes and other mandatory payments. It is these tiny, informal enterprises — many supply parts or products used by larger, more tightly regulated formal sector companies — that have been hardest hit by the cash crunch. 

The transition to carrying out business through the banking system that Mr Modi’s government is advocating would be tough for many, as they would have to pay taxes, the legal minimum wage, and other mandatory fees, which Mr Mukherjea estimates would raise their costs by an estimated 30 to 40 per cent. 

That suggests many working-class Indians and the businesses they patronise could face hard times ahead. According to the economic census released in March, about 30m Indians work in manufacturing; of those, 10m are self-employed with no hired workers, just family. Manufacturers with hired labour have an average workforce of less than seven people, according to the survey. 

Small businesses’ woes could also put additional strain on India’s already stressed banking system. According to Mr Mukherjea, 17 per cent of bank lending is to small and medium enterprises, while another 5 per cent is to non-banking finance companies and housing finance companies, which also indirectly lend to such entities. 

It is not just small businesses that are feeling the pinch.

Gaurav Daga, owner of Oswal Cable Products, imports plastic polymers used to manufacture everything from industrial cables to shoes to automobile components. His clients run across the gamut of India’s manufacturing sector, from large national brands and their big suppliers to small industries. 

His sales have dropped by half since Mr Modi announced the ban on the use of high denomination banknotes, and imposed cash rationing. Several of his big customers — large, national shoe companies with bank accounts and big workforces — have been forced to suspend production, due to their inability to pay their workforce — rural migrants, with neither bank accounts nor smartphones. 

“They don’t have money to give to their labourers,” Mr Daga said. “They have it in a bank but they don’t have currency. And you cannot open banks accounts for everyone overnight.” 

Mr Daga fears worse lies ahead. His large customers have deferred future orders as they wait to see whether domestic demand recovers.   He also expects the liquidity squeeze to worsen as the deadline for depositing old Rs500 and Rs1,000 notes draws closer. “They have made a very fundamental mistake,” Mr Daga says of the Modi government. “They had an issue with black money, but they banned the currency. But the currency was neither white nor black. Things won’t return to normal very soon.” 

Additional reporting by Jyotsna Singh