How I Knew Demonetisation Was Going To Be A Disaster Right From Day 2

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The recent past has seen even the biggest supporters of prime minister Narendra Modi concede that demonetisation was a disaster that the country could have done without. A major reason for this has been the gross domestic product (GDP) data for the year 2016-2017, which was published on May 31, 2017.

As per this data, the growth for the non-government part of the economy crashed to 5.6 per cent in 2016-2017, after having grown by 8.5 per cent in 2015-2016. In fact, even the 5.6 per cent growth might be an overstatement given that the GDP data does not capture informal sector data well enough. And the informal sector has been in a large mess post demonetisation.

The trouble is that anyone who had any basic understanding of economics or had read up on some economic history, would have known this from day one. And if not from day one, at least from day two.

I wrote my first piece on demonetisation within hours of the announcement to demonetise the Rs 500 and Rs 1,000 notes. As a freelance writer, I am expected to react to things as soon as they happen. The first piece I wrote had a neutral tone to it, where I tried to explain as to why the government had done what it had done.

With the benefit of hindsight, I can say that the first piece was written too quickly and at the same time was highly influenced by the government’s press release explaining the decision. But from Day 2 onwards, I went back to basic economics to essentially say that demonetisation would turn out to be bad for the Indian economy as it eventually has.

After the first piece was published I happened to remember a story that was a part of my first book Easy Money–Evolution of Money from Robinson Crusoe to the First World War.
The story was about cigarettes being used as money in the prisoner-of-war camps that cropped up all over Europe during the Second World War. The prisoners used to receive standard food parcels from the Red Cross during the war. The parcels included biscuits, butter, cigarettes, canned beef, chocolate, jam, milk, sugar, etc.[i]

As soon as the rations arrived, prisoners used to start exchanging them. One of the earliest transactions used to be nonsmokers exchanging their cigarettes for chocolates that the smokers had got. Sikhs, who had been fighting for the British Army, used to exchange their allocation of beef for other goods like butter, jam, and margarine. But gradually cigarettes went way beyond the status of a normal commodity and became the standardized medium of exchange. A prisoner of war even recalls exchanges like “cheese for seven cigarettes” happening in the camps. He also recalls an individual who sold coffee, tea, or hot chocolate at the rate of two cigarettes a cup. This individual eventually scaled up his business but failed, making losses of a few hundred cigarettes.[ii]

Sometimes, the weekly Red Cross parcels which had cigarettes in them, did not arrive. At other times, the stress of heavy air raids near the camps made peo­ple smoke away their money, that is, cigarettes.[iii]

In such situations, there was not enough money (i.e., cigarettes) going around in the prison economy and led to a situation where prices fell. Since people did not have cigarettes to buy goods, those who were hoarding food, toiletries, and so on, had to cut prices in the hope that they are able to make a sale.

This story tells us a lot about how demonetisation has played out.

Money basically has three functions. It is a medium of exchange, a unit of account and a store of value. It’s function as a medium of exchange is its most important function. People use money to buy and sell things i.e. to carry out economic transactions, with the buyer paying money to the seller every time he sells a product or a service.

In the above example cigarettes were used as money. And when a war camp ran out of cigarettes, or there was a shortage, the economy inside the camp collapsed or slowed down considerably.

How is this relevant to demonetisation? Any economy needs a certain amount of money to function properly. Demonetisation at one go rendered 86.4 per cent of the currency useless. While currency is not the only form of money in India, it is the major form.
Like with cigarettes at prisoner-of-war camps, suddenly there wasn’t enough currency going around post demonetisation. Hence, the rupee’s function as a medium of exchange came to a standstill.

The Reserve Bank of India (RBI) has replaced this money at a very gradual pace. In fact, even now the currency in circulation is at 84 per cent of the currency in circulation that prevailed before demonetisation. This shortage of currency over the last seven months has led to a slowdown in the buying and selling of things i.e. people haven’t been able to carry out economic transactions.

The slowdown in economic transactions has ultimately led to a slowdown in economic growth. In fact, when there weren’t enough cigarettes going around, prices collapsed in the prison economy. Along, similar lines prices of agriculture produce, have collapsed since demonetisation, as cash in agriculture trade has dried up. This has led to the farmers protesting across the length and breadth of the country.

Anyone who had studied some economic history would have known from the beginning that demonetisation would turn out to be a disaster that it has. Anyone who understood the functions of money, would have argued along similar lines.

But that is not how it has turned out to be. Economists have gone on and on, about how demonetisation will prove beneficial to the nation, especially in the long run. Some have even built models to show the success of demonetisation.

But the fact of the matter is that you can keep building models to justify demonetisation but that doesn’t change the basic fact that with less money going around an economy contracts or grows at a slower pace.

Because with less money people cannot carry out economic transactions of buying and selling things. And without that economy grows slower or contracts.

Yes people can move onto digital payments. But digital payments haven’t grown fast enough to be able to bring down the influence of cash in the Indian economy. This means people still prefer cash or they are simply not confident about spending money in any form at this point of time.

[i]  C. Desan. Coins Reconsidered: The Political Alchemy of Commodity Money (The Berkeley Electronic Press, 2010).

[ii] R.A. Radford, “The Economic Organisation of a P.O.W. Camp,Economica 12 (1945): 189–201.

[iii]  Desan 2010

The column originally appeared in the Huffington Post on June 17, 2017.

Why Demonetisation Did Not Hurt Modi

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Later this week, the prime minister Narendra Modi will complete three years in office. In the recent past, there have been a spate of articles analysing the performance of the Modi government.

The general conclusion seems to be that the prime minister continues to remain politically popular. The recent wins of the Bhartiya Janata Party in the Uttar Pradesh state assembly elections and the Delhi municipal elections, is evidence of the same.

Over and above this, there has been a lot of analysis around the impact of demonetisation, as more data becomes available. Most data show that the economic impact of demonetisation has been negative. For all the trouble that people were put through, the income tax department hasn’t been able to identify much of black money.

Further, barely any fake currency was identified during the process of demonetisation. Digital transactions peaked in December 2016 and have fallen since then. Hordes of informal businesses were shut down and many people lost their jobs, in the process. And if all this wasn’t enough, on some days ATMs still run out of cash.

Nevertheless, despite all this Modi continues to be a popular prime minister. What is happening here? The negative economic environment created in the aftermath of demonetisation hasn’t impacted the prime minister.

Narendra Modi is what political scientists call a populist leader. What is the definition of a populist leader? Jan-Werner Müller, a professor of politics at Princeton University, defines this in his book What is Populism?

First and foremost “it is a necessary but not sufficient condition to be critical of elites in order to count as a populist”. Over and above this, there are other factors that go into the making of a populist leader like Modi is.

As Müller writes: “Populists claim that they, and they alone, represent people… The claim of exclusive representation is not an empirical one; it is always distinctly moral. When running for office, populists portray their political competitors as part of the immoral, corrupt elite; when ruling, they refuse to recognise any opposition as legitimate. The populist logic also implies that whoever does not support populist parties might not be a proper part of the people—always defined as righteous and morally pure.”

A populist leader also likes cutting out the middleman. This means relying as little as possible on party organisations and the media, which acts as intermediaries between party organisations and the people.

This explains why Modi chose to directly address the nation on Doordarshan while announcing demonetisation on November 8, 2016. He spoke to the nation through the mann ki baat programme on radio on November 27, 2016. He addressed the nation again on December 31, 2016.

The focus of the message delivered was on how black money of the morally corrupt elite was hurting India big time and how important it was to tackle this problem on a war footing on an immediate basis. By doing this a situation of a crisis was created.

As Müller writes: “A “crisis” is not an objective state of affairs but a matter of interpretation. Populist will often eagerly frame a situation as a crisis, calling it an existential threat, because such a crisis then serves to legitimate populist governance. Put differently, a “crisis” can be a performance, and politics can be served as a continuous stage of siege.”

And this direct talking by populists attacking the so called morally corrupt elite goes down well with the true people, something which all the data and the numbers offered against decisions made by them can’t do anything about.

As Müller writes: “Populists ultimately appeal to a certain symbolic rendering of the “true people,” the appeal of that image will not vanish automatically when voters are presented with a some set of correct statistics about a particular policy area”.

And that best explains why demonetisation was a politically popular decision though numbers clearly show that it hurt the Indian economy.

The column originally appeared in the Bangalore Mirror on May 24, 2017

Of “Shaky” Demonetisation Statistics, Arun Jaitley and Black Money

We don’t live in a perfect world. And given this, governments like to showcase the positive impact of the decisions they make, all the time. Sometimes, they get very desperate in the process.

Take the case of the economic impact of demonetisation. Most data now coming out clearly shows that the decision did not have a positive impact on the Indian economy. It might have helped the Bhartiya Janata Party to win the Uttar Pradesh assembly elections, but that doesn’t necessarily make it a right decision on the economic front.

Nevertheless, the Modi government would like us to believe that demonetisation has helped the country on the economic front. Early last week the finance minister Arun Jaitley said that “more than 91 lakh people were added to the tax base due the result of the actions taken by the income tax department.”

It was later clarified that 91 lakh people were added to the tax base in 2016-2017(i.e. between April 1, 2016 and March 31, 2017). As per Jaitley’s statement 91 lakh individuals were added to the tax base post demonetisation, which is incorrect.

Meenakshi Goswami, Income Tax Commissioner and the official spokesperson of the Central Board for Direct Taxes (CBDT), told NDTV later in the week that91 lakh was the total number of new taxpayers enrolled in the financial year 2016-2017.”

Now this makes things interesting. On the face of it, the addition of 91 lakh individuals to the income tax base sounds like a huge number. But when we are talking about any increase or decrease, a number should never be viewed in isolation.

The trouble is that we don’t have long term data on this front because of a change in the definition of “tax base” and “new tax payer added during the year”. The annual report of the ministry of finance for 2015-2016 points out that new taxpayers “added during the year 2014-15 is 76,04,154”. This basically means that 76 lakh new taxpayers were added during 2014-2015. I couldn’t find any data for 2015-2016. Now compare the 91 lakh additions in 2016-2017 to 76 lakh additions in 2014-2015, and suddenly the number doesn’t seem too high, given that no demonetisation was carried out in 2014-2015.

Even if the government doesn’t do anything, taxpayers get added every year, especially when the minimum tax slab continues to remain the same. In 2014-2015, the minimum tax slab was Rs 2,50,000, which is where it continues to be. This basically means that inflation alone would have ensured that more people came into the tax bracket and thus increased the tax base.

Over and above this, as the economy grows and people earn more, more people come into the tax bracket.

Once we take these factors into account, the addition of 91 lakh taxpayers suddenly doesn’t sound much, especially taking into account the disruption that demonetisation caused through the length and the breadth of the country.

Further, Sushil Chandra, chairman of CBDT said that between November 2016 and March 2017, the search actions of the income tax department revealed an undisclosed income of Rs 16,398 crore. On the other hand, the surveys had led to a detection of Rs 6,746 crore during the same period.

Again, if we look at these numbers in isolation, they sound like a lot of money. But that doesn’t turn out to be the case if we look at numbers over a period of time. Take a look at Table 1. It shows the undisclosed income admitted to and detected during the search operations as well as surveys conducted by the income tax department over the last few years.

Table 1: Undisclosed income

Financial Year Number of groups searched Undisclosed income admitted (in Rs Crore) Number of surveys conducted Undisclosed income detected (in Rs Crore) Total undisclosed income (in Rs Crore)
2012-2013 422 10,291.61 4630 19,337.46 29,629.07
2013-2014 569 10,791.63 5327 90,390.71 1,01,182.34
2014-2015 545 10,288.05 5035 12,820.33 23,108.38
2015-16 445 11,066.24 4422 9,654.8 20,721.04
2016-17* 222 6,304.71 977 17,62.51 8,067.22

*Up to September 2016 in case of search numbers and August 2016 in case of survey numbers
Source: Ministry of Finance Annual Reports and the Press Information Bureau
The numbers for 2016-2017 are incomplete. But there is enough detail that lets us analyse the issue. Between April and September 2016, the total undisclosed income (or black money) admitted through search operations of the income tax department stood at Rs 6,304.71 crore. The undisclosed income detected through surveys conducted between April and August 2016 had stood at Rs 1,762.51 crore. If we add these numbers we get Rs 8,067.22 crore.

Between November 2016 and March 2017, the search actions of the income tax department revealed an undisclosed income of Rs 16,398 crore, as pointed out earlier. On the other hand, the surveys had led to a detection of Rs 6,746 crore during the same period. Adding both these numbers we get Rs 23,144 crore. Adding this to the earlier Rs 8,067.22 crore, we get around Rs 31, 211 crore.

This is the total undisclosed income identified by the income tax department during the course of 2016-2017. The number is incomplete because the information for the month of October 2016 is missing in case of search operations and information for the months of September-October 2016 is missing in case of survey operations.

Nonetheless, it is a good ballpark number to work with. Hence, the total amount of undisclosed income or black money identified by the income tax department in 2016-2017 stood at more than Rs 31,211 crore.

Is it such a big deal? Look at Table 1. The total amount in 2012-2013 had stood at Rs 29,629 crore. This amount hasn’t been adjusted for inflation. It is safe to say that in inflation adjusted terms more undisclosed income was identified by the income tax department in 2012-2013 than in 2016-2017. In 2013-2014, the number stood at Rs 1,01,182 crore, which is significantly more than 2016-2017. And it is worth remembering here that these numbers happened without demonetisation. In fact, as the numbers clearly show the efficacy of the income tax department when it comes to identification of black money has come down since 2014-2015.

To conclude, the rosy picture of demonetisation that the government is trying to paint, is really not true. The more data we look at the clearer this becomes.

Postscript: I recently did a podcast with the writer Amit Varma who is currently the editor of the Pragati magazine, on the Right to Education and how it has screwed up our education system. Most of what I spoke was based on my new book India’s Big Government—The Intrusive State and How It is Hurting Us. You can listen to the podcast here.

The column originally appeared in Equitymaster on May 22, 2017.

New IIP Shows Demonetisation Slowed Down Indian Manufacturing Growth Big Time

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India has a new Index of Industrial Production (IIP). It is bigger and according to economists who track such things, it is better than the previous one. The IIP basically gives growth estimates of three sectors-manufacturing, mining and electricity. The manufacturing sector forms more than three-fourths of the IIP.

The base year for the new IIP has been changed to 2011-2012 from the earlier 2004-2005. This has been done to capture the changes in the industrial sector that have happened over a period of time and “to also align it with the base year of other macroeconomic indicators like the Gross Domestic Product (GDP), Wholesale Price Index (WPI)”.

Like any other index, the IIP tracks various items that make for the manufacturing, mining and electricity sectors. These items need to be changed or relooked at from time to time in order to ensure that the IIP continues to maintain a representativeness of the manufacturing, mining and electricity sectors in particular and the industry as a whole in general.

The new IIP has a total of 809 items in the manufacturing sector. The earlier one had 620. While, the number of items which constitute the manufacturing part of IIP have gone up, 124 items have been removed as well. These include items like gutka, calculators and colour TV picture tubes. Items like cement clinkers, medical and surgical accessories, refined palm oil etc., have been added. Along similar lines, the electricity sector now includes data from the renewable energy sector as well.

Over and above this, there has been an increase in number of factories in panel for reporting data and closed ones have been removed. All in all, these steps have been taken in order to ensure that the new IIP is a better representation of industry than the old one was.

Given that, items that constitute IIP have change majorly, it is not surprising that the growth figures of IIP have changed as well. Take a look at Figure 1. It plots both the new IIP and the old IIP growth rates over the last half decade, April 2012 onwards.

Figure 1: 

One look at Figure 1 is enough to tell us that the old IIP and new IIP are different beasts altogether, though both are very volatile. Now take at data from March 2013. As per the old IIP series, the growth was at 3.5 per cent. The new IIP series puts the growth at 15.1 per cent. That’s how different the old and the new IIP are.

In fact, as per the new IIP, the industrial growth stood at 3.3 per cent in 2014-2015, the last year of the Congress led UPA government. As per the old IIP the growth had stood at – 0.1 per cent. Hence, we can conclude that the state of the industry in the last year of the Congress government wasn’t as bad as it seemed at that point of time. It’s just that the old IIP may have no longer remained a good representation of the Indian industry.

In fact, the new IIP shows that industrial growth picked up in 2016-2017, the last financial year. The growth stood at 5.1 per cent. As per the old IIP the industrial growth was at 0.6 per cent, during the course of the year. What this also tells us is that the two IIPs are as different as chalk and cheese.

There is an interesting trend that the new IIP catches on to in the manufacturing sector. Manufacturing makes up for 77.6 per cent of the new IIP as against the 75.5 per cent in the old one. Take a look at Table 1.

Table 1: Manufacturing Growth

Period Manufacturing Growth(in %)
Dec 2012 to Mar 2013 9.4
Dec 2013 to Mar 2014 3.7
Dec 2014 to Mar 2015 3.2
Dec 2015 to Mar 2016 4.9
Dec 2016 to Mar 2017 1.6

Source: Centre for Monitoring Indian Economy.

The manufacturing growth between December 2016 and March 2017 stood at 1.6 per cent. This has been the slowest in comparison to the same period in previous years. Why is this the case? The one word answer to this is demonetisation. The Modi government announced demonetisation of Rs 500 and Rs 1,000 notes on November 8, 2016, and sent the economy into a tailspin. The interesting thing is that the average manufacturing growth between April 2016 and October 2016 had stood at 6.9 per cent. This signalled the revival of the manufacturing sector after having grown by around 3 per cent in 2015-2016 and 3.8 per cent in 2013-2014.

Demonetisation managed to scuttle that revival in this growth. Also, it is worth pointing out here that the IIP data is collected from “entities in the organised sector units registered under the Factories Act, 1948”. This means that the unorganised sector is not covered. And as I have often written in the past, the impact of demonetisation on the unorganised sector has been far greater.

Up until now, the government has refused to admit that demonetisation has had a negative impact on the economy (Subscription Required). I guess it’s time it looked at the new IIP numbers to realise the obvious.

(The column was originally published in Equitymaster on May 16, 2017)

Is Reserve Bank of India a Subordinate Department of the Finance Ministry?

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The Reserve Bank of India(RBI) released the latest monetary policy report on April 6, 2017. In this report, the RBI said that: “In Q4[January to March 2017], remonetisation progressed at an accelerated pace.” It also said: “To sum up, economic activity should recover in 2017- 18 on the back of the fast pace of remonetisation“.

Remonetisation essentially refers to the RBI printing currency and pumping it into the financial system, in order to replace the currency rendered useless by demonetisation. Notes of Rs 500 an Rs 1,000 denomination were demonetised on November 8, 2016. Since then the RBI has been replacing the demonetised notes with new notes of Rs 500, Rs 2,000 and notes of other denomination which continued to remain legal in the aftermath of demonetisation.

In the monetary policy report India’s central bank claims that the remonetisation has happened at an accelerated/fast pace between January and March 2017. The trouble is that its own data shows otherwise. Take a look at Figure 1. It shows the weekly rate of increase in currency in circulation from mid-January 2017 to mid-March 2017.

Figure 1:

As can be seen from Figure 1, the weekly increase in currency in circulation has been slowing down since early January. How is the weekly increase in currency in circulation obtained? The currency in circulation as on January 6, 2017, was at Rs 8,98,017 crore. This jumped to Rs 9,50,803 crore as on January 13, 2017. This meant an increase of Rs 52,786 crore or around 5.9 per cent (Rs 52,786 crore divided by Rs 8,98,017 crore). A similar calculation is carried out for every week since then. This is how the weekly increase in currency in circulation is calculated.

In fact, by the end of the March 2017, the weekly increase in currency in circulation was at a three-month low, since January 6, 2017. This explains why there has been a shortage in currency in the recent past, with the ATMs running out of money time and again.

In April 2017, the weekly increase in currency in circulation has recovered a little than in comparison to the past. Nevertheless, we need to remember that the total currency in circulation is still a long way away from where it was at the beginning of November 2016, before demonetisation happened.

On November 4, 2016, the total currency in circulation had stood at around Rs 17.98 lakh crore. On April 14, 2017, the latest data that is available from the RBI, the total was at Rs 13.9 lakh crore. The gap between then and now is still at 22.7 per cent. In the pieces that I wrote on demonetisation I had said that the total currency in replacement would be replaced by May 2017. But the pace at which the RBI is currently going, it seems it will take more time than that.

Also, the RBI in the monetary policy report claims that the remonetisation happened at an accelerated/fast pace. This as we can see from Figure 1 is clearly not the case. The rate of weekly increase in currency in circulation at the beginning of January was close to 6 per cent. By end of March this had dropped to 1.7 per cent.

Of course as any base gets bigger, its rate of increase is likely to fall. But in this case, it is worth remembering that we are still nearly 23 per cent down from where the currency in circulation was before demonetisation.

One argument that has been finding favour is that the government needs to bring down currency in circulation so that people move towards digital forms of payment. While there is no denying digital is good, it is not going to happen over a period of a few months. Human habits ingrained for decades don’t change that fast. And given that the government will need to maintain the currency in circulation where it was before demonetisation was carried out. Every economy needs a certain amount of money to function and given the recent currency shortage we are nowhere near that.

The question is why has the weekly rate of increase in currency in circulation slowed down. Are the RBI and the government printing presses not working three shifts a day, like they were doing earlier? Is there a shortage of paper and ink? This is something only the RBI or the government can answer. The funny thing is that the banking journalists covering the RBI as a beat, haven’t put this question to the central banker as yet.

And what explains the RBI’s statement saying that the process of remonetisation or the weekly increase in the currency in circulation, is happening at a fast/accelerated pace. Why is the RBI saying something which its own data does not bear out?

Since the beginning of demonetisation, the communication of the government has been to make it look like a success and that is understandable. A similar bug seems to have bit the RBI as well when it has used words like accelerated and fast, when the weekly increase in currency in circulation has actually slowed down.

This brings me to something that TT Krishnamachari (TTK), who was the finance minister of the country, between 1957-1958 and 1964 and 1964, once said about the RBI. As TCA Srinivasa Raghavan writes in Dialogue of the Deaf-The Government and the RBI: “TTK’s view, expressed forcefully… [was] that the RBI was no more than a ‘subordinate department of the finance ministry’.”

In the case of demonetisation, the RBI is clearly behaving like a subordinate department of the finance ministry. And that does not bear well for the Indian economy.

The column originally appeared on April 24, 2017, on Equitymaster

The Undependable GDP

On February 28, 2017, the ministry of statistics and programme implementation published the Gross Domestic Product(GDP) growth figure for the three-month period between October and December 2016.

During the period the Indian economy grew by 7 per cent. This took most economists by surprise because they were expecting demonetisation to pull down economic growth. On November 8, 2016, the Prime Minister Narendra Modi had announced that come midnight the notes of Rs 500 and Rs 1,000 denomination, would no longer be money. Hence, the GDP growth for the period October to December 2016 was expected to be lower.

In one go 86.4 per cent of the currency in circulation was rendered useless. As Alain de Botton writes in The News—A User’s Manual: “Like blood to a human, money is to the state the constantly circulating, life-giving medium.”

When money is taken out of an economy, it stops functioning given that economic transactions come to a standstill. In the Indian case, cash/currency is the major form of money given that a bulk of transactions happen in cash. As per a PwC report 98 per cent of consumer payments by volume happens in cash. The Economic Survey of 2016-2017 points out: “The Watal Committee has recently estimated that cash accounts for about 78 percent of all consumer payments.”

In this scenario where bulk of consumer transactions happen in cash, the Indian economy for the period October to December 2016, should have come to a standstill. But the government data suggests that it grew by 7 per cent.

This seems unbelievable. The private consumption expenditure has grown by 10.1 per cent, the second fastest since June 2011. This when the retail loan growth of banks during October to December 2016, grew by just 0.5 per cent. The manufacturing sector grew by 8.3 per cent when bank credit to industry contracted by 2.8 per cent. Hence, there is something that is clearly not right about India’s GDP data.

Some analysts and experts have suggested that data is being fudged to show the government in good light. I really don’t buy that given that there is no evidence of the same. Having said that, one reason why the impact of demonetisation hasn’t been seen in the GDP growth figure is because the GDP calculations do not capture the informal sector well enough.

This is primarily because small manufacturers and those in the retail trade do not maintain accounts. Hence, estimates of the informal sector need to be made using the formal sector indicators. As the Economic Survey points out: “It is clear that recorded GDP growth in the second half of financial year 2017 will understate the overall impact because the most affected parts of the economy—informal and cash based—are either not captured in the national income accounts or to the extent they are, their measurement is based on formal sector indicators.”

In simple English, this basically means that the size of the informal sector while calculating the GDP is assumed to be a certain size of the formal sector. The formal sector has not been affected much due demonetisation. Hence, to that extent the size of the informal sector has been overstated in the GDP. It is expected that more information coming in by next year will set this right. This basically means that the GDP growth is likely to be revised downwards as more data comes in.

But this lack of dependable GDP data and other economic data creates its own set of problems for policymakers in particular.

This is a point that former RBI governor D Subbarao makes in his book Who Moved my Interest Rate?. As he writes: “Our data on employment and wages, crucial to judging the health and dynamism of the economy, do not inspire confidence. Data on the index of industrial production(IIP) which gives an indication of the momentum of the industrial sector, are so volatile that no meaningful or reliable inference can be drawn. Data on the services sector activity, which has a share as high as 60 per cent in the GDP, are scanty.”

Further, this poor quality of data is frequently and significantly revised, making things even more difficult for policymakers. And this possibly led YV Reddy, Subbarao’s predecessor at the RBI, to quip: “Everywhere around the world, the future is uncertain; in India, even the past is uncertain.”

Long story short—sometime around this time next year, the GDP for October to December 2016, is likely to see a significant revision.

The column originally appeared in Daily News and Analysis (DNA) on March 9, 2017

And the Notebandi Lies Continue…

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010

One week back, the finance minister Arun Jaitley said in the Rajya Sabha: “At no point of time, not for a single day, was the currency inadequate.”

Every government needs to defend decisions it has taken. In that context Jaitley’s statement is hardly surprising. Nevertheless, it not only mocks the common man of this country but also tells us how disconnected our ruling politicians are with the realities of the day.

Jaitley was essentially talking about the situation that prevailed in the aftermath of demonetisation or notebandi, as it is more commonly referred to as.

If there was no currency shortage for even a single day, why did ATMs have such long lines for close to a month? Is Mr Jaitley saying that people just gathered there because they had nothing else to do?

If there was no currency shortage even for a day, why did the government place limits on ATM withdrawals? It was churlish of Jaitley to have said what he did, given that 86 per cent of the currency in circulation was demonetised, the midnight of November 8, 2016, onwards.

The advantage with making speeches is that nobody asks questions at the end of it. Nevertheless, the lack of empathy among the politicians does get registered.

That apart, let’s look at the currency in circulation data published by the Reserve Bank of India every week. Take a look at Figure 1.

 

Figure 1:

Figure 1 essentially shows the currency in circulation in the Indian economy in 2017. December 30, 2016, was the last date for depositing the Rs 500 and Rs 1,000 notes which had been demonetised. Hence, I have taken the currency in circulation numbers from January 6, 2017, onwards, which is a week later.

The currency under circulation has been going up since 2017. On November 4, 2016, four days before prime minister Narendra Modi, made the announcement to demonetise Rs 500 and Rs 1,000 notes, the total currency in circulation had stood at Rs 17.97 lakh crore. In comparison, on February 3, 2017, the total currency in circulation, the latest data available, stood at Rs 10.49 lakh crore.

Hence, the total currency in circulation as on February 3, 2017, was at 58.4 per cent of the level before monetisation was announced. Given this, it is not surprising that the currency shortage, even though it has eased, continues to persist. This goes against what the Economic Affairs Secretary Shaktikanta Das recently said about the remonetisation process being complete.

Take a look at Figure 2. It basically plots the total increase in currency in circulation every week since January 6, 2017.

Figure 2:For the week ending January 13, 2017, the total currency in circulation grew by Rs 52,780 crore. Thereafter, the increase in circulation has fallen quite dramatically. One explanation for this may lie in the fact that initially more Rs 2,000 notes were being printed and that has now been replaced with more Rs 500 notes being printed, which is what the financial system needs, given the shortage of change. But at the same time, it takes four Rs 500 notes to replace money worth Rs 2,000.

The larger point being that the financial system is still away from having an adequate amount of currency. This, as I have explained in the past, is primarily because of the limited currency printing capacity of the government of India and the Reserve Bank of India.

The average increase in currency between January 6 and February 3, 2017, comes to around Rs 37,778 crore. At this speed, it will take many more weeks, before the financial system gets to a level, where it has adequate currency.

The total currency in circulation had stood at Rs 17.97 lakh crore before demonetisation. As of February 3, 2017, the total currency in circulation stood at Rs 10.49 lakh crore. The difference between this and the total amount of currency in circulation before demonetisation stands at Rs 7.48 lakh crore (Rs 17.97 lakh crore minus Rs 10.49 lakh crore).

At the speed of introducing currency worth Rs 37,778 crore per week, it will take close to 20 weeks for the currency under circulation to reach the pre-demonetisation level. One logic that has been offered is that the government may choose not to replace the entire currency.

Even if the government chooses not to replace the entire currency, at Rs 37,778 crore per week, it will take many more weeks before the currency in circulation stabilises at an adequate level.

While, the economics of it, can get tricky, even if the government chooses to go up to Rs 16 lakh crore and not Rs 17.97 lakh crore, it will still take close to 15 weeks to get to the pre-demonetisation level. Of course, the time taken can come down if the speed of money printing can be increased.

Long story short—both Jaitley and Das are essentially lying to the country in saying what they are. And that is something worth remembering and talking about, dear reader.

The column was originally published on February 14, 2017, on Equitymaster