India’s informal Hundi market and how it has suffered a blow post demonetisation

The recent hoopla around declining GDP growth firmly puts blame at the door step of demonetisation. Though the move was controversial mostly among so called liberal elites, armchair economists and of course, the opposition political parties, it paid huge political dividends to Modi government. The reality is, the effects of demonetisation are still unfolding. The initial impact was obviously negative since the move was always meant to be disruptive. But whether it will be positive in long term is yet to be seen.

One sector that definitely got hurt badly was the informal money lending or the ‘Hundi’ market. There are two types of black money – The first kind of black money, the classic black money, generated through bribes. That money does not generate any economic value. It generally stays hidden or in some cases gets flown out of country to Swiss bank. This kind of black money is the worse. It is a true loot of India.

The second type of black money is different. The second type of black money is primarily hidden from the government because of taxation purposes. This money is earned legally and honestly but usually under-‘receipt’ed’. The earners are professionals like Doctors or Architects or businessmen.

- Advertisement - - Article resumes -

Some of these people don’t mind lending it out in Hundi market or the informal money lending sector. The interest rates in Hundi are quite high – 18% on an average and transactions mostly happen in cash. The borrowers usually tend to pay interest on a monthly basis. The market is quite efficient even though the potential to default is high and also it does not have much recourse potential. The lender can lend his own hidden money or pool in money from his circle and front it up to borrowers.

The word Hundi goes back to medieval India. The system can be considered as pre-cursor to formal banking sector. The Hundi is not just lending but also includes cashless remittance. From financing expeditions of Mughals during medieval times to financing grain market transaction during British era, the system lubricated commerce across length and breadth of Indian subcontinent.

Per an article in The Hindu Business Line, the Marwaris were pioneers of Hundi transactions and as the lines of communication and transportation increased during British era, so did the business empires of Marwaris. However, with introduction of formal banking infrastructure in India, Hundi and such similar financial instruments never gained official status.

Per Reserve Bank of India, Hundis are “a part of the informal system, have no legal status and are not covered under the Negotiable Instruments Act, 1881.” Researching on Hundi is not easy and statistics on size and breadth of this financial instrument are almost non-existent. Though RBI mentions about waning of Hundi transaction, the reality is the Hundi market was doing quite well prior to demonetisation.

The obvious question here is, since banking infrastructure is comparatively widely accessible today, why would anyone borrow at such a high interest rate when banks lend roughly at around 10%. The equally obvious answer is because banks literally don’t lend enough money or in lot of cases, don’t lend money at all.

Usually if one has to open a brand new business then banks won’t lend you. They usually require three years of clean and positive balance sheet. That means, the business not just has to be running for at least three years but it should be making money for three consecutive prior years! So, to begin with, the cash is raised through informal means or family money is used. And when expanding in the initial phase, again informal sector is leveraged.

The hundi market black money creates a positive impact on GDP. Businesses get established or are able to expand, generating more cash flows and more jobs. But, all is not positive here. Since formal banking sector is not lending to these businesses, anything’s that not formal and not necessarily legal has hidden costs. Remember the 18% interest? The cost of borrowing has to be recovered, right? So it gets passed on to the service requester or to the consumers indirectly. So, because government doesn’t allow banking to be free of suffocating regulations, the whole society directly or indirectly pays the price. And I am not even adding the lost opportunity costs of the entrepreneurs who couldn’t open their businesses because their business model doesn’t afford them to pay 18% interest!

Demonetisation has impacted Hundi transactions since cash suddenly dried up and became “honest black money”. The cash transactions dried up overnight, so the lending also dried up. The projects in flight or about to get started must have been severely impacted. The effect of this may not even show up directly on GDP growth considering that it’s an informal sector. Plus, projects that did not start would not have any impact on GDP since, but the imprints of it can be seen in consumption pattern.

Government needs to take concrete structural banking and taxation reforms post demonetisation. No, GST is not the answer, not yet at least. GST coupled with lower income tax and simpler income tax would be lot more efficient. (the GST rates are also way to high, but that’s for another topic) Modi government has done great job in increasing banking imprint in rural area  but banks don’t exist merely to manage accounts.

So, the next generation banking reforms should free the banks to lend more freely and yes, to take the positive risk. In India, “Mallya gets loans as much as he wants but the small entrepreneurs are made to pay hell to get even a penny. This needs to change in a structured fashion. Just as economy can not be at the whims of government policy, it shouldn’t be at the mercy of informal lending sector either. If Modi government manages to implement these key reforms, then Indian economy will reach the stratosphere it never imagined in a very short period of time. The Bank Recapitalisation plan, may just be the beginning, in that regard.

Share and Support:
Support OpIndia by paying for content

Most read articles recently

Activist opposing Akshaya Patra’s mid-day meal contract thinks ‘Brahmins obstruct India’s development’

The Akshaya Patra has come under criticism recently for not including onion and garlic in its mid-day meals for school children.

Mumbai Police teaches a lesson in humility to ‘special’ Sonam Kapoor

Actor Dulquer Salman clarified that he and Sonam were sitting inside a car that was rigged to a truck and hence were not breaking traffic rules.

Uttar Pradesh: Eight cattle smugglers arrested in Bahraich with arms and ammunition

The smugglers even tried to trample the police personnel with their vehicle.

Rafale: SC examined the pricing details closely, ‘did not rely’ on CAG report as claimed by Rahul Gandhi

Rahul Gandhi has claimed that the Supreme Court verdict on Rafale was based only on the CAG report, while it is not true

Church of South India Archbishop Dyvasirvadam arrested in church fund scam, reports Times of India

According to the report, archbishop Dyvasirvadam was allegedly involved in misappropriation of church fund for over a decade

Double whammy for Congress in court: After Rafale verdict, Rakesh Asthana’s appointment as special director gets SC approval

The Supreme Court's verdict is being seen as the second major embarrassment for both the Congress party and Prashant Bhushan, as the Supreme Court had earlier rejected a plea on the issue of a probe concerning the Rafale deal.

Here is what connects attack on Akshaya Patra, French NGO against Rafale and demonization of Amarnath Yatra

The web of foreign-funded NGOs that demonised the Amarnath Yatra, French NGO that complained against Rafale in France and the demand to remove Akshaya Patra from midday meals contract

Congress friendly journalist wishes death upon BJP Delhi spokesperson Tajinder Bagga

During the run-up to Gujarat assembly elections last year, Trivedi was caught spreading morphed images with Amit Shah's fake quotes on Patidars

Pro-Congress troll resumes fake news website, makes outlandish claims on Rafale targeting Modi

Abhishek Mishra has been associated with the website which spreads fake news and Islamist propaganda

Amidst Rafale row, PAC led by Congress leader Mallikarjun Kharge slams HAL, questions efficiency

In 2015 Dassault had also expressed its inhibition in partnering with HAL, flagging its concern about the companies technical inadequacies

Latest articles

Connect with us

125,692FansLike
98,050FollowersFollow
6,178SubscribersSubscribe

Don't miss these