IMF says demonetisation a big dampener, cuts India's growth to 6.6% from 7.6% 01-18

The IMF today cut India's growth rate for the current fiscal year to 6.6 per cent from its previous estimate of 7.6 per cent due to the "temporary negative consumption shock" of demonetisation, days after the World Bank also decelerated India's growth estimates.

"In India, the growth forecast for the current (2016-17) and next fiscal year were trimmed by one percentage point and 0.4 percentage point, respectively, primarily due to the temporary negative consumption shock induced by cash shortages and payment disruptions associated with the recent currency note withdrawal and exchange initiative," the International Monetary Fund (IMF) said in its latest World Economic Outlook (WEO) update released today.

The IMF said that after a lacklustre outturn in 2016, economic activity is projected to pick up pace in 2017 and 2018, especially in emerging market and developing economies.

The global growth for 2016 is now estimated at 3.1 per cent, in line with the October 2016 forecast.
Economic activity in both advanced economies and emerging market and developing economies (EMDEs) is forecast to accelerate in 2017-18, with global growth projected to be 3.4 per cent and 3.6 per cent, respectively, again unchanged from the October forecasts, it said.

As per new IMF projections, India's growth in 2016 is now estimated to be 6.6 per cent as against 7.6 per cent earlier forecast.

In 2017, IMF has projected a growth rate of 7.2 per cent as against its previous forecast of 7.6 per cent.

The Indian economy is likely to revive to go back to its previously estimated growth rate of 7.7 per cent in 2018, according to the WEO update.

The cut in India's growth rates comes days after the World Bank decelerated India's GDP growth for 2016-17 fiscal to 7 per cent from its previous estimate of 7.6 per cent citing the impact of demonetisation. But forecast issued on January 11 said that India would regain momentum in the following years with a growth of 7.6 per cent and 7.8 per cent due to a reform initiatives.
Despite IMF's downward revision of India's growth rate and a slight upward revision of China's growth projections, India continues to be the fastest growing countries among emerging economies.
But in 2016, China with 6.7 per cent has edged past India (6.6) with 0.1 percentage point.
The growth forecast for 2017 was revised up for China (to 6.5 per cent, 0.3 percentage point above the October forecast) on expectations of continued policy support, the IMF said. India's growth rate in 2017 as per the latest IMG projections is 7.2 per cent.

In 2018, China's growth rate is projected to be 6 per cent against India's 7.7 per cent.
IMF said, in China, continued reliance on policy stimulus measures, with rapid expansion of credit and slow progress in addressing corporate debt, especially in hardening the budget constraints of state-owned enterprises, raises the risk of a sharper slowdown or a disruptive adjustment.

These risks can be exacerbated by capital outflow pressures especially in a more unsettled external environment, the IMF said.

IMF said global activity could accelerate more strongly if policy stimulus turns out to be larger than currently projected in the US or China.

Notable negative risks to activity include a possible shift toward inward-looking policy platforms and protectionism, a sharper than expected tightening in global financial conditions that could interact with balance sheet weaknesses in parts of the euro area and in some emerging market economies, increased geopolitical tensions, and a more severe slowdown in China, it said.

Maurice Obstfeld, Economic Counsellor and IMF Research Department Director, at a news conference here, said among emerging economies, China remains a major driver of world economic developments.

"Our China growth upgrade for 2017 is a key factor underpinning the coming year's expected faster global recovery. This change reflects an expectation of continuing policy support; but a sharp or disruptive slowdown in the future remains a risk given continuing rapid credit expansion, impaired corporate debts, and persistent government support for inefficient state-owned firms," he said.

In light of the US economy's momentum coming into 2017 and the likely shift in policy mix, IMF has moderately raised its two-year projections for US growth.

"At this early stage, however, the specifics of future fiscal legislation remain unclear, as do the degree of net increase in government spending and the resulting impacts on aggregate demand, potential output, the Federal deficit, and the dollar," Obstfeld said.



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"Humiliated" by post-note ban events, RBI staff write to Urjit Patel 01-14

Feeling "humiliated" by events since demonetisation, RBI employees today wrote to Governor Urjit Patel protesting against operational "mismanagement" in the exercise and Government impinging its autonomy by appointing an official for currency coordination.

In a letter, they said autonomy and image of RBI has been "dented beyond repair" due to mismanagement and termed appointment of a senior Finance Ministry official as a "blatant encroachment" of its exclusive turf of currency management.

"An image of efficiency and independence that RBI assiduously built up over decades by the strenuous efforts of its staff and judicious policy making has gone into smithereens in no time. We feel extremely pained," the United Forum of Reserve Bank Officers and Employees said in the letter addressed to Patel.

Commenting on "mismanagement" since November 8, when note ban was announced, and the criticism from different quarters, the letter said, "It's (RBI's) autonomy and image have been dented beyond repair."

At least two of the four signatories --- Samir Ghosh of All India Reserve Bank Employees Association and Suryakant Mahadik of All India Reserve Bank Workers Federation --- confirmed the letter. The other signatories are C M Paulsil of All India Reserve Bank Officers Association and R N Vatsa of RBI Officers Association.

The forum represents over 18,000 employees of the RBI across the ranks, Ghosh said.

The letter said appointment of an officer to coordinate currency management is a "blatant encroachment" on the exclusive jurisdiction of the RBI on currency and accused the Government of "impinging on RBI autonomy".

"May we request that as the Governor of RBI, its highest functionary and protector of its autonomy and prestige, you will please do the needful urgently to do away with this unwarranted interference from the Ministry of Finance, and assure the staff accordingly, as the staff feel humiliated," it said, soliciting "urgent action".

The RBI has been discharging the role of currency management for over eight decades since 1935, it said, adding the central bank does not need "any assistance" and the interference from FinMin is "absolutely unacceptable and deplorable".

The letter comes days after concerns about RBI's functioning being raised by at least three former Governors -- Manmohan Singh (former PM), Y V Reddy and Bimal Jalan. Former Deputy Governors, including Usha Thorat and K C Chakrabarty, have also voiced their concerns.

The letter said the RBI staff has carried out its job excellently following the move to ban 87 per cent of the outstanding currency by the government.

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How Will Demonetization Affect Business in India in 2017? Knowledge @ wharton 01-08

It’s work in progress. Three events dominated India’s economic landscape last year, but whether they can be described as “progress” is debatable. One definitely isn’t: the unseemly brawl that broke out over control of the Tata group with Ratan Tata returning as interim chairman after ousting incumbent Cyrus Mistry. A lot of dirty linen is being washed in public, putting partly in the shade the political charges being traded elsewhere.

The second is the goods and services tax (GST), whose objective is to replace all taxes levied by the federal government and the states with one central tax. The GST is scheduled to come into effect by April or — at the latest — by September. Although both houses of Parliament have approved the bill and the President has signed off on it, a GST Council is now squabbling over the details, which could delay implementation.

“The timing is not right for implementation,” says West Bengal finance minister Amit Mitra, who is also chairman of the empowered committee of state finance ministers. He lays the blame squarely on the center’s move to demonetize Rs500 ($7.4) and Rs1,000 notes. “We all supported the GST under the premise that this would be the only destabilization factor,” Mitra told a TV channel. “We did not know that there would be a much bigger destabilization in the form of demonetization that would be let loose on the country.”

According to Wharton emeritus professor of management

, while it is too early to assess the impact of demonetization, the move raises long-term questions. “What will have been gained from this step, and at what cost and mostly borne by whom?” he asks. He notes that rival political parties that have protested against demonetization could “broaden their tactical agenda to harm or even derail the GST implementation.” It also remains to be seen how the negative sentiment against demonetization could hurt the BJP and its allies in assembly elections in Uttar Pradesh in February-March, he adds.

“What will have been gained from [demonetization], and at what cost, and mostly borne by whom?” –Jitendra Singh

Demonetization represents much more than destabilization; critics argue that it has struck a body blow on economic activity in India. The decision – which was entirely unsuspected – was announced on 8 November 2016. While the pros and cons of the measure still continue to be debated, the consensus of opinion appears to be that while the proponents of demonetization may have had good intentions, the suffering it has caused to millions of Indians is unwarranted. Since Rs500 and Rs1000 notes make up some 86% of the total currency in circulation in India, especially in the vast rural areas, one economist compared the pain to what individuals might experience if 86% of their blood was removed from their bodies.

To be sure, demonetization has its supporters. While industrialists and corporate chiefs (Ratan Tata, Mukesh Ambani, K.V. Kamath and Deepak Parekh, to mention a few) favor the move, economists (including Nobel laureates Amaryta Sen and Paul Krugman, among others) are critical. “The clan of economists has spoiled the party [with] their estimates of how output will be affected as spending has stopped, manufacturing hit and several workers laid off. The net result can be a fall of between 0.5% and 2% in GDP,” says online news channel Firstpost. “The debate still goes on.”
According to Singh, Modi took “a bold, even visionary, step” with demonetization in attempting to combat the black economy and counterfeiting, and cutting financial support to terrorism. “What was always key, however, was how well the implementation process would unfold,” he notes.

“Even supporters of the decision would say that the implementation was far from perfect.”

Kartik Hosanagar, a professor in Wharton’s department of operations, information and decisions, views demonetization against the backdrop of other economic gains. The year 2016 has overall been “a good year” for India, he notes, listing the highlights:

⦁ The GDP growth rate has held up at more than 7%.

⦁ Foreign direct investment went up significantly during the year. (It rose 30% on a year-on-year basis to $21.6 billion between April and September 2016, according to public ⦁ data published by the India Brand Equity Foundation, a government-sponsored trust.)

⦁ Initiatives such as the ‘⦁ Make in India’ program “have borne early fruits.” Many MNCs including Panasonic and Pepsi set up manufacturing facilities in India during the year.

⦁ “The startup world has seen ⦁ a drop in investment activity, but I see that as a return to sanity
rather than a worrisome contraction,” Hosanagar adds.

“The biggest wild card in all of this, of course, is demonetization,” notes Hosanagar. “It’s unclear how it will all play out.” He hopes that “any impact on economic activity and GDP will be temporary, and the long-term benefits such as an increase in cashless activity will be more permanent.” He adds that “this is the India optimist in me speaking.”

“The biggest wild card in all of this, of course, is demonetization.” –Kartik Hosanagar

Part of the problem with demonetization was that it came as a bolt from the blue; the government claimed giving advance notice would have the defeated its purpose. But not everyone agrees with that view. “There was no need for secrecy,” counters Jayati Ghosh, a professor of social sciences at Jawaharlal Nehru University. “All demonetizations through history have been done with some advance warning. This reduces the damage to innocent people. The government could monitor suspicious transactions after the announcement, just as it is doing now. In any case, I would not have demonetized Rs500 notes. If high-value notes like Rs1,000 are the problem, why replace them with even higher value notes?” (A Rs2,000 note has been introduced as part of the package.)
Moving Goalposts

The government, meanwhile, seems to have moved the goalposts: The claimed objective of the exercise has apparently changed from rooting out black money to promoting cashless transactions. Several measures have been introduced, among them a 0.75% discount on digital payments made for buying petrol and diesel and a 0.5% cut in the price of railway season tickets bought using digital technology.

In another twist, the government appears to be no longer pushing demonetization as a “cashless” plan. It has now become a “less-cash” strategy. That is as it should be; the world doesn’t have a cashless economy so far. In India, Bloomberg data shows the share of cash in the volume of consumer transactions is 98% (against 55% in the U.S. and 48% in the U.K.). It is 90% in China and 86% in Japan. Much of the cash transactions are in rural India. So, expectedly, life came to a near standstill and much misery ensued when people found themselves unable to use their own money. Even when the money was in a bank account, limits on ATM withdrawals compounded the problem further.

But India is also a country where finding novel, workable solutions to problems – commonly known as jugaad — is par for the course. While long lines multiplied in front of banks and ATMs (several people claimed to have had heart attacks while standing in them), ways were found to deal with the situation. By December 31, the visible impact was a Parliament at near paralysis as politicians took potshots at each other, a plethora of banking riches coming back into the system (some 90% of the Rs500 and Rs1,000 notes were returned), and a host of new scams to convert black money into white with the connivance of bankers and politicians.

Nobody is denying a short-term setback. The Reserve Bank of India (RBI) has reduced the GDP growth rate forecast for 2016-17 from 7.6% to 7.1%, the Asian Development Bank from 7.4% to 7%, Fitch from 7.4% to 6.9% and Bank of America-Merrill Lynch from 7.7% to 7.4% (for calendar 2016). All believe, however, that growth will recover the next year.

Modinomics to the Defense

Modi defended the demonetization exercise in a televised speech on New Year’s Eve, arguing that it had to be done. “It seemed at times that the evils and corruptions of society, knowingly or unknowingly, intentionally or unintentionally, had become a part of our daily lives,” he said. “Crores of Indians were looking for an escape from this suffocation.”

Modi said in his speech that after demonetization, only 24 lakh (2.4 million) Indians acknowledge an annual income of Rs. 10 lakh each (Rs. 1 million). “Can we digest this? Look at the big bungalows and big cars around you,” he said. “If we look at any big city, it would have lakhs of people with annual income of more than [Rs.] 10 lakh. Do you not feel, that for the good of the country, this movement for honesty needs to be further strengthened?” The upshot of that is his government would now try to bring hundreds of thousands of tax evaders into the net.

But Modi will find it tough to strengthen the tax machinery sufficiently to force those people to start paying taxes, according to critics. “If he doesn’t, then what was the point of subjecting the whole country to so much disruption and pain?” writes Siddharth Varadarajan, former editor of The Hindu newspaper, in The Wire, a nonprofit publication.

Modi also said in his speech that over the last 10-12 years, the demonetized currency was being used in the black economy, and that excess cash in the system caused inflation to spike and fueled corruption. “Lack of cash causes difficulty, but excess of cash is even more troublesome,” he said. Critics have attacked those remarks as being unsound in economic theory.

Demonetization could have potentially derailed the GST, which was practically a done deal, according to experts interviewed by Knowledge@Wharton. The impact of demonetization will pass in a couple of quarters, but the GST delay will have more far-reaching effects. “Undoubtedly, the GST is a bigger reform. It would be the most fundamental reform initiated since 1991,” says Dharmakirti Joshi, chief economist at Crisil, a global S&P company.

“There was no need for secrecy. All demonetizations through history have been done with some advance warning.” –Jayati Ghosh 

Commenting on demonetization, Joshi says: “Any disruption in the flow of money, verily the economy’s lifeblood, impacts business cycles quickly. There is no precedent to the scale of demonetization that has taken place in India. That is why quantifying its impact is so difficult. A few countries that replaced their old currency with new did it in a gradual manner — the introduction of the euro in the Eurozone, or in Zimbabwe where the old currency was gradually phased out.”

The GST Impasse

The government has only itself to blame for the GST impasse. The proposal has been around for a dozen years. Its origins lie even further in the past: In 2000, the BJP-led government of A.B. Vajpayee started a discussion on the GST. Prime Minister Narendra Modi had opposed it when he was chief minister of Gujarat; now, it is the pivot of his reforms. Experts agree that the GST could increase India’s GDP by 1.5% to 2%. It has received, in its time, the backing of former finance ministers Pranab Mukherjee (now president of the country) and P. Chidambaram. Yet it still gets held up.

One reason is that implementing the GST requires a constitutional amendment. The GST Constitutional Act has already been passed by the Lok Sabha and the Rajya Sabha (the two houses of Parliament) and, on 8 September, the President of India signed off on it. The states – in the form of the GST Council – are reading from the same book. But it may take some time to get to the same page.

According to Singh, while the GST has the potential to boost GDP growth and foreign investment flows, the opposition to it could cost the country dearly. “There is the very real possibility that some actors will take the low road, and try to delay or even derail the GST implementation,” he notes. “If that were to occur, it will not be the first time in post-1947 Indian history when key leaders would snatch defeat from the jaws of victory.”

Singh hopes that the political parties involved, including state level parties, “put the collective long-term interests of India and all Indians above apparently enticing short-term partisan gains, and get the GST bill implemented at the earliest.”

Viewed in isolation, demonetization and GST could be promising for India, according to Singh. “Absent some of these spillovers, the long-term impact of the demonetization could be quite positive for the Indian economy,” he says. “If the GST gets implemented soon, and if there is further rationalization of the tax structure, and if opposition parties cooperate, there may be a couple of quarters of somewhat lower growth, and then the economy would return to its positive trajectory. But there are several ‘ifs’ in between.”

Tata, Cyrus Mistry

The end of the year also saw a high-profile family split. The 149-year-old Tata group, the largest in the country and the most respected, with a global turnover of more than $100 billion, sent shockwaves through corporate India with the ouster of chairman Cyrus Mistry.

Mistry took charge four years ago after a search panel was appointed to find a replacement for Ratan Tata, who was turning 75. The 50-year-old Mistry was a surprise choice. And problems were apparently building for a long time under the surface.

“Any disruption in the flow of money, verily the economy’s lifeblood, impacts business cycles quickly. There is no precedent to the scale of demonetization that has taken place in India.” –Dharmakirti Joshi

Mistry is now being ousted from all the Tata group companies. Says a letter to shareholders by Ratan Tata: “Since Mistry was appointed as a director of various Tata group companies only as a corollary to his being the chairman of Tata Sons, the right step would have been for him to resign as director. Unfortunately, he has not yet done so, and his continued presence as a director is a serious disruptive influence on these company boards, which can make the company dysfunctional, particularly given his open hostility towards the primary promoter, Tata Sons.”

Responded Mistry: “I have to say that the board of directors [of Tata Sons] has not covered itself with glory. To ‘replace’ your chairman without so much as a word of explanation and without affording him an opportunity of defending himself in a summary manner must be unique in the annals of corporate history. The suddenness of the action and the lack of explanation have led to all manner of speculation and has done my reputation and the reputation of the Tata group immeasurable harm.”

Most of the Tata group is owned by the Tata trusts, of which Ratan Tata is chairman. So there are no two ways about how the ouster move will go. But Mistry has his supporters. His family has a stake of some 20% in Tata Sons; the trusts hold about 66%. Besides, he is not without friends, who include some independent directors. Nusli Wadia, a board member of Tata Motors, has entered the fray (with yet another letter). “[JRD Tata, Tata Group chairman before Ratan Tata] never expected anyone to toe his or the Tata line,” he told the board of Tata Motors (where he has been an independent director). “It is both sad and unfortunate that Tata Sons and its interim chairman Ratan Tata are not only not practicing this great tradition but effectively destroying it.” Wadia has sued Tata Sons for defamation.

Singh suggests that the problems at the Tata Group run beyond those related to Mistry’s ouster. He describes the group as “a structurally complex entity, with multiple interests at play, all of which may not always be naturally aligned.” As Mistry’s family owns a significant minority shareholding in Tata Sons, “it is natural to think that interpersonal issues are paramount here,” he noted. “This is a mistake. There are difficult structural issues embedded in the context, some of which will not go away with Mistry’s departure as chairman of Tata Sons.”

According to Singh, the Tata-Mistry controversy could have wider, deleterious effects if it is not resolved soon. “At a minimum, it is a distraction from the effective governance and operations of the group; it could damage the Tata brand; and it also has the potential to raise questions in the international community about the attractiveness of India as an investment destination.”

As matters stand, Mistry has resigned from the boards of the major Tata companies (except for Tata Sons). “The fight goes onto another platform,” he told the Business Standard newspaper after he quit. “[I] will pursue it further. This move gives me an opportunity to concentrate my efforts…. I will be moving legally.” Won’t the battle be long and arduous? “I have a lifetime ahead of me,” he replied.

In a statement to the shareholders announcing his resignation, Mistry states: “Bringing to the fore these ethical issues can have a short-term adverse impact… I feel strongly that such short-term pain is necessary for long-term interests.”

Is that Cyrus Mistry talking or Narendra Modi?

Note ban most disruptive policy innovation since 1991: Former RBI Governer D. subba Rao. 01-07

Image credit : Shyam's Imagination Library

Former Reserve Bank governor D Subbarao today termed demonetisation as "creative destruction and the most disruptive policy innovation since 1991 reforms" that has helped destroy blackmoney.
"On November 8, the Prime Minister (Narendra Modi) and the Reserve Bank have demonetised 86 per cent of currency in circulation overnight, which is what is arguably the most disruptive policy innovation in India since the 1991 reforms," he said.

"Demonetisation, in that sense, is creative destruction.

But it is a very special type of creative destruction. Because what it has destroyed is a destructive creation -- blackmoney.

So, you can understand that demonetisation is creative destruction of a destructive creation," Subbarao said.

He was addressing an international conference organised by the Institute for Development and Research in Banking Technologies (IDRBT) here.

He further said demonetisation is "arguably" leading to a flurry of innovations in Indian financial sector by way of digitisation of payments.

"There are two perspectives. Extension of a global trend of financial technology which is upending the finance industry and discontinuous change in a low-income country from cash incentive economy to a less-cash economy. Either way, we will have disruptive innovations in India's financial sector," he explained.

Subbarao said that though cost and benefit of this demonetisation exercise is a very contentious debate, the subject of policy innovation is not contentious.


According to him, the country witnesses a lot of disruptive innovations in finance in payment system.
The model of traditional banking has access to low-cost deposits and has an advantage over other financial institutions, including fintech companies, according to the former governor.

"That advantage is going to be neutralised by the business model of these fintech companies which will beat onefficiency, service and trust," Subbarao remarked. 

He suggested the traditional banks should look into otheravenues to compete by tying up with these companies orpayments banks that are coming up.

He urged regulators to promote innovation and protectconsumers and preserve financial stability.

"On the one hand, they have to make sure the stabilityis preserved and on the other hand, they should regulatetightly that innovation is not scorched. This balance is avery difficult judgement call," he added.

On microfinance, he said the model has benefited millionsof low-income families in India, particularly in AndhraPradesh (before the state bifurcation).

He recalled that RBI was in a dilemma at the time of 2010crisis on whether to regulate the interest rates of MFIs andif so, what figure would be justified.

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Demonetisation Day 50: Black money kingdom has been shaken from its roots Sukumar Mukhopadhyay 01-01

I went about asking many people in bank queues and markets about what they had to say on demonetisation. They all agreed there was some inconvenience but they largely supported it. The logic behind this was that they were willing to suffer in order to get back at the hoarders of black money.

Writers and economists are all divided on party lines. The best and worst example being that of former Prime Minister and noted economist Dr Manmohan Singh calling demonetisation an "organised loot and a legalised plunder."

Opinions it seems depends also on personal dislike. Even Amartya Sen called demonetisation a despotic act. Sen also alleged that it is a breach of promise but little efforts did he take to clarify his position. P N Bhagwati has refuted Amartya Sen on this ground.

So we shall take a plunge into the matter and analyse each issue purely on the basis of its merit.

Rabi crop row- Some economists cried foul that the Rabi crop has been ruined. But actually when demonetisation started on Nov 8, this crop was already three inches high since the season starts from October.

Woes of the rural folk- Again, some critics are shedding tears for the village folk, saying that 80 % of the country's villages do not have banks. The percentage is possibly correct. But the conclusion that 80% of the nation's people do not have access to banking facilities is wrong. Look at what the Prime Minister said in his speech during Independence Day in 2012. Manmohan Singh, who was then the Prime Minister of India, had said that 50% of households have bank accounts.

Four years since then and after Jan Dhan Yojana, the percentage of households having bank accounts is likely to be much higher than 50%. It may be 70%. Economists trying to deride Modi do not realise that banks in small towns serve all villages around the small town. If the villagers can come to the town to go to school, college, market and see cinema, can they not go to the banks as well?

Black money and black economy- Black economy is different from black money, which is just a part of the larger economy. The total value of 500 and 1000 rupee notes is Rs 15.5 lakh crore.There is no reliable estimate of black economy which consists of land, real estate, jewellery and cash. Only the cash portion is black money.  Demonetisation is only against black money and not black economy. The criticism that demonetisation will not tackle black economy is, therefore, misplaced.

Unexplained cash deposits- This is the crux of the issue. Government had expected that Rs 4-5 lakh crore of cash in circulation would not come back. But this amount may not be more than Rs 1 lakh crore. How much of it will come back is not definite. Even if most of it comes, all of that will not become white. Income tax department will investigate and if the depositors are not able to explain, they can impose high tax and penalty which will, in turn, yield a high revenue. Apart from this, the department will get higher income tax on higher interest. So benefits from these will definitely accrue from next year onwards. The economy too will have more white money than black money. That itself is a transformation.

Fake money- An estimated amount of Rs 400 crore of fake money will be eliminated.

Property prices- Real estate prices have fallen and so the middle class has benefited. Mispricing of real estate had earlier stood on the way to entrepreneurship, global competitiveness and job creation.

Recession- Some economic activity which depended on payment by black money may slow down but soon they will resume momentum with white money.

Gold rush- Assumption that people will buy more gold is wrong as the gold or ornament merchants will not accept old Rs 500 and Rs 1,000 notes.

GST– Kaushik Basu's remark that GST is a better alternative than demonetisation is based on a complete misunderstanding of what the Goods and Service Tax is. GST deals with indirect tax. Most black money is generated in direct tax. And even in the developed countries like UK, Germany or Canada where GST exists, there is substantial evasion. 

Digitisation- A higher level of digitisation has taken place following demonetisation and it will improve the ease of business.

Therefore, the impact of demonetisation cannot be judged by merely how much black money has been rendered useless. We have also to take into account how much amount the income tax department can recover in raids, tax returns, penalties and other channels.

Even if black has got converted into white, there has been a transformation from black economy to white economy to that extent. The prosecution of the money launderers will send shivers in the spine of the black prospective operators. The corrupt operators will now be dreading. Corruption has been brought to the centre-stage for launching an attack aginst it, while all along black money and corruption had been taken for granted.  Demonetisation has had a transformational value on the psyche of people.

It is a fundamental reform in India. After decades of rhetoric, some real action has been taken. Demonetisation along with all other policies such as the Jan Dhan Yojana, Aadhar-linked payments, mobile banking, GST, the Income Declaration Scheme and the Benami Property Act will have a real impact on black money.

The kingdom of black money will be shaken from its roots.

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Why demonetisation is greatest blunder by a govt in 69 years of free India Prem Sankar Jha 01-01

December 30, the deadline Prime Minister Modi set for completing his exercise in demonetisation has come and gone, and there is now no room to doubt that it was the single greatest blunder that any government has made in the 69 years that India has been free. On November 8, Mr Modi demonetised 20 billion bank notes, accounting for 86 per cent of the cash in circulation in the Indian economy. But only a fraction of the new currency notes needed to replace them had been printed. As if this was not inept enough ‘somebody’, that is to say everybody from the prime minister to the head of the Reserve Bank, ‘forgot’ that if the new notes were of a different size from the old, the ATMs would not work.  The result was that, like a car engine run without lubricating oil, the economy simply seized up.

The impact on the economy has not only been catastrophic but highly unequal. Those with bank accounts and credit cards were merely inconvenienced. Those who earn and spend mostly, or entirely in cash, found themselves rendered penniless overnight. These were the poor of India. Banks still account for only a little over 30 percent of total credit extended in the country. The balance comes from moneylenders who deal in cash. That credit collapsed.   In terms of value the proportion of transactions that has been digitized is also about the same. But this figure is deceptive because in numbers around 90 percent of transactions still take place in cash. This entire segment – the lion’s share—of the economy is now paralysed.

The fewer are the transactions in the economy, the lower is the income they generate. There is now a consensus among economists and bankers, therefore, that the GDP will shrink in the second half of this fiscal year. Shortly after the demonetisation Goldman Sachs slashed its growth estimate for the second half of the year by 1.6 percent and predicted that the GDP would grow by 6.8 percent. This was 0.8 per cent below its original estimate.  Deutsche bank similarly estimated that the annual growth would be around 6.5 percent. But the most pessimistic estimate was that of Ambit Capital which forecast that the economy would actually shrink in the remainder of the year, and bring the annual growth rate down to only 3.5 percent for the year.

Anecdotal evidence suggests that Ambit’s estimate is likely to prove closest to the mark. 90 percent of India’s more than 300 million non-agricultural unorganized labour is paid daily or weekly in cash. To pay them their employers have to have that cash first. The government’s severe weekly withdrawal limits have made it virtually impossible to pay these workers in the new legal tender. So far employers were paying them in old notes and asking them to convert these into the new money. But this loophole has been shrinking and will shut on December 30.

As a result, Mazdoor Nakas—casual labour markets-- where many of these workers congregate every morning in the search for work, now receive a trickle of hopeful aspirants, as the news has spread that their employers, mostly in the construction, do not have the cash with which to pay them. There is a swelling reverse stream of migrant workers returning to their home villages, where the cash they have managed to save before the calamity will last longer than in the city. Sectoral information from organized industry for the month of November was bleak: a 20 percent fall in auto sales, 35 to 40 per cent in two wheelers, 63 per cent in tractors.

But the most severe crunch has taken place in the rural areas, where nearly all transactions are in cash and there are far fewer banks. The demonetisation occurred just as farmers in north India in particular were selling their Kharif crop and making their purchases for the Rabi. There is some preliminary which suggest that the area sown with Rabi crops has therefore shrunk but the full impact upon the Rabi will only be known as the crop ripens. What is certain is that farmers all over India have minimized their purchases of non-essential goods. This will killthe fillip that the bumper Kharif harvest would have given to the consumer goods industries.

Mr Modi has sought to reassure the people that this is only a short term, and necessary pain that the people have to suffer, to cleanse the black money of corruption and black money. Once it is over the economy will not only revive, but emerge stronger than ever.  This is wishful thinking. For the sharp cut in spending that has taken place will last for the entire time, now estimated at up to six months more, that it will take for all the old notes to be replaced. During all this time spending will remain constrained so income growth will fall too. This means that the decline in consumer spending will persist.

This will force manufacturers to cut production in order to clear their unsold stocks. That will cause a second round of reduction of orders and retrenchment of employees, so another contraction in income and expenditure.  The economy will therefore continue to glide downwards till it bottoms out. Left on its own the economy is likely to take another two years to recover. By hen 2019 will have come and gone, and so will the Modi government.

If Mr Modi wishes to revive the economy quickly enough to recoup his party’s political fortunes, he will have to give it a huge jolt, not unlike the electric shock given to patients suffering a cardiac arrest. The only way in which he can do that is through a huge cut in interest rates. By this I do not mean a cut of 50 or even 100 basis points in policy rates. I mean a slew of changes in various policy rates that will bring the lending rates of the commercial banks lend to investors of five to seven percent below the banks down to at most five per cent; that is six to seven percent below that rates that had prevailed before demonetisation.

A cut of this magnitude will enable India’s dying infrastructure and real estate companies to refinance their debt and thereby halve their interest costs. This alone will enable a large proportion of these companies to pull out of the red and take up many of the Rs 8,80,000 crore worth of ‘stalled’ projects that they abandoned when interest rates began to rise, and industrial growth to sink, six years ago.

A halving of bank lending rates will also revive the real estate sector as millions of home buyers will once more be able to meet their monthly installment payments, and  give a huge fillip to the sale of consumer durables that account for more than a quarter of manufacturing output.

But how will Mr Modi bring interest rates down so sharply now , when neither he nor his predecessor were able to persuade the RBI to do so earlier, and when he has formally  ceded the entire power to set them to the RBI and its newly created monetary policy committee? The latter contains economists who, one presumes , are more sensitive to economic growth issues than the bankers of the RBI, but even they will be bound by the now official diktat of ‘inflation targeting’.

Inflation targeting requires central banks to keep lending rates in the economy above the rate of inflation at all times. Its purpose is not economic growth but financial stability, because doing so reassures all Indian, and particularly foreign, holders of Indian money that the government will not allow the value of their savings and investment to depreciate. Advocates of inflation targeting claim that growth will automatically pick up when prices and exchange rates stabilize, but they are unable to describe the chain of cause and effect that will make this happen. There is also very little evidence in the experience of other countries that had adopted inflation targeting, to buttress this claim. On the contrary, South Korea’s two-decade long surge to prosperity took place in the midst of a 21percent annual rate of inflation and a continuous devaluation of the won to counteract its impact upon external competitiveness.

In India inflation targeting, which has been the informal mantra of the RBI since 2006, has bestowed the kiss of death on industry, infrastructure, construction, and therefore  employment. This is because it does not distinguish between inflation caused by an excess of demand in the economy, which high rates can bring down, and one cause by shortages of supply, whether of food grains, industrial  raw materials ( usually a  reflection of rising global commodity prices) , or labour which, by curbing production, they can only intensify.

India’s cost of living index is sticky, and has diverged further and further from the wholesale price index of inflation that the government used earlier, because ever since 2007, its CPI inflation has reflected local and global shortages, and not the state of domestic demand. Judged by the latter, which is reflected both by the wholesale price index and the GDP deflator, the true rate of demand inflation in the country was zero or negative even before Mr Modi exploded his demonetisation bombshell.

In India inflation targeting will play a useful role if it keeps interest rates two to three percent above the rate of demand inflation. By that yardstick today even a five percent long term rate of interest would be on the high side. So bringing commercial bank lending rates down to this level is the minimum that Mr Modi should do.


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Demonetisation, Not a tragedy, A Remedy S. Gurumurthy 12-14

Narendra Modi is correcting the monumental mismanagement of the economy by the economist Dr. Manmohan Singh


In his article (“Making of a mammoth tragedy”, The Hindu, December 9), Dr. Manmohan Singh attacked the demonetisation of high denomination notes (HDNs) by the National Democratic Alliance (NDA) government as the “making of a mammoth tragedy”. In his prose, Dr. Singh speaks less as an economist in which capacity he is respected more than as the former Prime Minister, the role which has actually dented his image. Yet it is best to respond to him on economic issues which he has kept away from, not to his political verses. Undisputed facts, not alluring rhetoric, should decide whether demonetisation is a tragedy or a remedy. Is it a monumental mismanagement of the economy as Dr. Singh charges? Or is it a remedy for the accumulated filth as Prime Minister Narendra Modi claims? To know the answer, the story of the Indian economy from 1999 to 2004 under the NDA and from 2004 to 2014 under the United Progressive Alliance (UPA) needs to be recalled.

Real versus statistic

During the NDA rule (1999-2004), real GDP grew by 27.8 per cent, annually 5.5 percentage points. Annual money supply, that fuels inflation, by 15.3 per cent. Prices by 23 per cent, annually 4.6 per cent. Asset prices rose only moderately in those five years. Stocks rose by 32 per cent; gold by 38 per cent. Taking Chennai as an illustration, land prices by 32 per cent. Jobs rose phenomenally, by almost 60 million. The NDA also turned in a surplus of $20 billion in 2002-04 in the external sector, after decades of unending deficits, save in two years in the late 1970s.

Now come to the UPA rule under Dr. Singh, the economist Prime Minister. In the first and best six years of the UPA (2004-05 to 2009-10), before it was hit by scams, real GDP grew by 50.8 per cent, annually 8.4 percentage points — one-and-a-half times NDA’s. The world celebrated Dr. Singh. The UPA was intoxicated by the “high growth” story. But how many jobs did UPA’s high growth produce? Believe it or not, just 27 lakhs against 600 lakhs during NDA’s five years, according to NSSO data. UPA achieved one-and-a-half times NDA’s GDP growth, but just 5 per cent of its job growth. Dr. Singh now bemoans that Mr. Modi’s demonetisation will stifle jobs!

Move on. In the six years, prices rose by 6.5 per cent (4.6 per cent under NDA). The external sector deficit was $100 billion (against NDA’s $20 billion surplus). Did high petroleum prices force it? No. Zero-rated customs duty-led capital goods imports which topped petroleum imports was the culprit.

Asset inflation

Why was the UPA’s high growth jobless? The well-kept secret is that huge asset price inflation, not production, passed off as high growth. In the first six years of the UPA, stock and gold prices jumped by three times — annually by 60 per cent. Property prices doubled every two-three years. In Gurgaon, not on the property map in 1999, land prices rose by 10-20 times. Asset inflation in six years was three times the annual nominal GDP growth. The asset inflation not the result but the cause of the UPA’s “high growth”! How? Modern economics deducts the non-asset price inflation from nominal growth to know the real growth. But it sees asset price rise as wealth and prosperity and adds it to GDP. See how this economics worked for the UPA.

Unmonitored Rs.500/1,000 notes

Economics says money, growth, prices and jobs are inter-related. Apply this rule to the NDA and UPA periods. During 2004-10, average money supply grew annually 18 per cent (15.3 per cent under the NDA). But asset prices rose by several multiples of it. The moderate rise in money supply over the NDA’s number does not explain the huge asset inflation. The clue hides in the rising unmonitored HDN cash stock with the public which made black money deals easy. In 1999, the cash with the public was 9.4 per cent of nominal GDP. By 2007-08, instead of falling due to rising bank and digital payments, it jumped to 13 per cent of nominal GDP. Later it began hovering around 12 per cent.

More critically, the HDNs with the public more than doubled from 34 per cent in 2004 to 79 per cent in 2010. On November 8, 2016, it was 87 per cent. The average annual rise in HDNs was 51 per cent between 2004 and 2010 and the annual rise was 63 per cent by 2013-14. The Reserve Bank of India noted that two-thirds of the Rs.1,000 notes and one-third of the Rs.500 notes — that is over Rs. 6 lakh crore now — never returned to banks after they were issued. The unmonitored HDNs roaming outside banks began driving up the gold and land prices by black cash and the stock prices through Participatory Notes (PNs) — which are largely hawala transfers out of India — that came back pretending as foreign investment in stocks. The PNs rose from Rs.68,000 crore in 2004 to Rs.3.81 lakh crore in 2007.

How did the asset inflation lead to the UPA’s “high growth”? Inflated asset prices to the extent realised by sale got accounted as part of income and included in GDP. Large part of the gains on stock sale got added to GDP with very little tax under Securities Transaction Tax. The spurious wealth effect also led to high-end consumption. The annual private consumption growth averaged 18 per cent till six years to 2009-10 — 80 per cent over the NDA average. The fake wealth effect, powered by HDN cash, scripted the UPA’s “high growth” story. HDNs outside banks took refuge in stocks, gold and land, produced capital gains-led growth and consumption. Had the HDNs circulated through the banking system, it would have multiplied through the fractional reserve model, reduced the inflation and interest, and funded the small-and-medium enterprises starved of organised funding.

Catch-22 situation

The curse — asset inflation inspired jobless growth — seems irreversible till unmonitored HDNs roam and fuel fake growth. Dr. Singh had had enough wake-up calls when the share of HDN cash was escalating year after year from 2004. He could have de-escalated the hugely growing cash economy had he remonetised the HDNs by lesser denominations without demonetisation — sparing the people of discomfort and economy of short-term damage. Of course, he would have lost the “high growth” brand that made UPA rule an economic success. To unmask this deception and revive job productive growth, the unmonitored HDNs needed to be brought to account forcibly. By his inaction, undeniably, Dr. Singh had landed the economy in a Catch-22 situation. The Modi government could either opt to continue the status quo of jobless growth or force temporary decline in growth to reinstate real growth and jobs. It opted for the latter. Even an undergraduate student in economics will tell you that it will cause hardship and hit growth in the short run. A Cambridge economist is not needed to write a column on that. It is already late. If the status quo of unmonitored HDNs were to last for another five-six years, the size of HDNs would have become so huge that no government may have been able to act against it — inevitably inviting a huge crisis, both internal and external. Prime Minister Modi has rightly called the demonetisation as “kadak chai” (bitter pill). That HDNs promoted high bribery and helped terror funding through fake HDNs cannot be disputed at all. Far from doing a monumental misappropriation or making a “mammoth tragedy”, Mr. Modi is correcting the monumental mismanagement of the economy by the economist Dr. Singh.

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Notes ban will hurt economy: former chief economist of World Bank 12-10

“Demonetisation will cause the economy to run into great difficulties in the future. Declaring the old Rs500 notes legal again might minimise the damage majorly,” said Kaushik Basu, former chief economist, World Bank. Basu was delivering a lecture at the Indian Institute of Technology-Bombay (IIT-B) on Friday as part of the N R Kamath Chair Colloquium.

Talking about ‘the economics of corruption, black money and demonetisation’, Basu examined the statement made public by the finance ministry, a day after demonetisation was announced.
“The ministry said this move will help control the printing of fake currency in our country. However, what is happening instead is that people are exchanging their notes, fake or not, for fresh new notes. This is not solving the problem,” he said. He added that the government should focus on producing better quality currency. He said that instead of helping control inflation, this move might damage the economy further.

“Even the idea of walking towards a cashless society is a long stretch for India. Currently, close to 98% transactions take place through cash. Even the US would take 10-12 years to achieve this goal,” he said.

The total value of Rs500 and Rs1,000 notes stands at Rs 15 lakh crores, said Basu. He added that only Rs12 lakh crores has been deposited in banks so far. “New notes worth only Rs4 lakh crores have been circulated in the market and the Reserve Bank of India said this figure will reach Rs6 lakh crores by the end of December. The shortfall is a lot. The government needs to take serious steps to save the economy during the next financial year,” he said.

Comparing the current situation to a similar move orchestrated by the Indian government in 1978, when it banned Rs1,000 notes, Basu highlighted how the move damaged the country’s economy in 1979-80. He said the only way to save prevent intensive damage this time around was to scale back. “The government must accept its mistake and take responsibility. It must take a step back and reverse part of the decision. People will be angry, but this will help minimise the problem,” concluded Basu.


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Currency Press Capacity: Around 6 Months Needed To Replenish Rs. 500 Notes. 11-17

New Delhi:  Will new notes which replace the demonetised currency find itself in circulation soon? Unlikely, if the capacity of all the currency printing presses in the country is taken into account.

The latest calculation, based on capacities of the currency printing presses, shows that replenishment would take around six months.

This is particularly true for the new Rs. 500 notes, whose printing, presumably, started after November 10. Till those are replenished in adequate numbers, the "currency pain" would not go away since Rs. 2,000 notes are difficult to exchange for lower denominations.

However, enough of the new Rs. 2,000 notes may already have been printed, calculations show.

The central government had demonetised Rs. 500 and Rs. 1,000 currency notes on November 8, sending the whole nation into a tizzy. Long queues outside banks have been a daily occurrence since then because enough currency notes are not available with them.

New information gleaned from public sources show that the government may be too optimistic in claiming that "adequate amount" of money would soon be in circulation.

That's because of the limited capacity of the printing presses in the country for such a sudden, huge job.

There are four currency presses -- one each in Nashik (Maharashtra), Dewas (Madhya Pradesh), Salboni (West Bengal) and Mysuru (Karnataka).

The first two are owned by the central government through the Security Printing and Minting Corporation of India Ltd. According to information available in the Finance Ministry's latest annual report, the yearly currency printing capacity of these two presses is around 40 per cent of the total in the country.

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The other two presses -- in Nashik and Dewas -- are part of the Bharatiya Reserve Bank Note Mudran Pvt. Ltd. (BRBNMPL), a wholly-owned subsidiary of the Reserve Bank of India (RBI). These two, comprising 60 per cent of the total capacity, can print 16 billion notes in two shifts per year, according to information available on BRBNMPL's website.

In essence, it means that total capacity in the country would be 26.66 billion notes in two shifts. If all three shifts run, as the government says is happening now, the four presses would be able to print 40 billion notes a year, irrespective of the denomination.

Now, according to the government, the total money in circulation -- before Rs. 500 and Rs. 1,000 notes were declared illegal -- was Rs. 17.54 lakh crore or Rs. 17,540 billion. Of this, 45 per cent was in Rs. 500 denomination -- equivalent to Rs. 7.89 lakh crore or Rs. 7,890 billion and 39 per cent in Rs. 1,000 notes amounting to Rs. 6.84 lakh crore or Rs. 6,840 billion.

In other words, there were 15.78 billion notes of Rs. 500 denomination in circulation and 6.84 billion notes of Rs. 1,000.

But if they are going to print Rs. 2,000 notes equivalent to value of the Rs. 1,000 notes declared illegal, that is, worth Rs. 6.84 lakh crore, they would have to print only half, or 3.42 billion notes.

If the printing started in early September, as has been claimed by some printing press officials, they would need only a little over two months to meet the full requirement, even at 50 per cent capacity. In other words, they should have printed all the replacement needs of Rs. 2,000 notes till now.

Further, how long will they need to print Rs. 500 notes, now that the machines would not be printing Rs. 2,000 notes? Assuming an 80 per cent run (remember Rs. 500 and Rs. 1,000 comprised 84 per cent of all currencies), the time taken for the new Rs. 500 notes, which began printing, presumably, on November 10, would be: 5.9 months.

The rest of the 20 per cent capacity could be used for the lower denomination notes from Rs. 5 to Rs. 100.

So, by April-end, one would presume, all the new notes would be in circulation. And, of course, the pain would be longer than the 50 days that Prime Minister Narendra Modi has mentioned.

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