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)

Mr Subramanian, Lower Interest Rates Do Not Always Lead to More Bank Loans

Arvind_Subrahmaniyam

“Lower interest rates lead to higher lending,” is something that most economists firmly believe in. The beliefs of Arvind Subramanian, the chief economic adviser to the ministry of finance, are not an exception to this rule.

Hence, not surprisingly in a lecture a few days back he came out all guns blazing against the Reserve Bank of India(RBI) for not cutting the repo rate. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loan. We say sort of a benchmark here because there are other factors which go into deciding what rate of interest that banks charge on their loans.

Subramanian wants the RBI to cut the repo rate further from its current level of 6.25 per cent. As he said: “Inflation pressures are easing considerably… the inflation outlook is benign because of a number of economic developments… Against this background, most reasonable economists would say that the economy needs all the macroeconomic policy support it can get: instead, both fiscal policy and monetary policy remain tight.

The point here being that current inflation is under control and from the looks of it, future inflation should also be under control. And given this, the RBI must cut its repo rate. The RBI last cut the repo rate in October 2016. And as and when it cuts the rate further, the hope is that the banks will cut their lending rates. Only then will people and industries both borrow and spend more. This will give a flip to the economy. QED.
Subramanian’s point is well taken. Nevertheless, does it make sense? We will deviate a little here before we arrive at the answer.

The RBI Monetary Policy Report released in early April 2017 points out that the decline in the one-year marginal cost of funds based lending rates (MCLRs) of banks between April and October 2016 was just 15 basis points. This when the repo rate was cut by 50 basis points. Hence, even though the RBI cut its repo rate by 50 basis points, the banks cut their lending rates by just 15 basis points, a little under a one-third. One basis point is one hundredth of a percentage.

Post demonetisation “27 public sector banks have reduced their one-year median MCLR in the range of 50 to 105 bps, and 19 private sector banks have done so in the range of 25 to 148 bps.” This when the repo rate has not been cut at all. On an average the one year MCLRs of banks fell by 70 basis points to 8.6 per cent.

What has happened here? A cut in the repo rate barely makes any difference to the cost at which banks have already borrowed money to fund their loans. But demonetisation did. The share of the “low cost current account and savings account (CASA) deposits in aggregate deposits with the SCBs went up to 39.2 per cent (as on March 17, 2017) – an increase of 4.0 percentage points relative to the predemonetisation period”. This is because people deposited the demonetised notes into the banks and this money was credited against their accounts.

This basically meant that banks suddenly had access to cheaper deposits because of demonetisation. And this in turn led them to cut interest rates on their loans, despite no cut in the repo rate. The RBI’s repo rate continued to be at 6.25 per cent during the period.

A cut in lending rates is only one part of the equation. The bigger question has it led to higher borrowings? Are people and businesses borrowing more because lending rates are now lower than they were in the past? And this is where things become interesting.
The total deposits of banks between October 28, 2016 (before demonetisation) and December 30, 2016 (the last date to deposit demonetised currency into banks) went up by 6.41 per cent to Rs 10,568,17 crore. This was a huge jump during a period of two months. This sudden increase in liquidity led to banks cutting their deposit rates and then their lending rates.

Interestingly, the total deposits of banks have continued to remain stable and as of April 30, 2017, were at Rs 10,509,337 crore. This is a minor fall of 0.6 per cent since December 2016.

Between end October 2016 and end April 2017, only around 36 per cent of the incremental deposits raised by banks were loaned out. (We are looking at non-food credit here. The total bank loans that remain after we adjust for the loans that have been given to the Food Corporation of India and other state procurement agencies for the procurement of rice and wheat produced by farmers).

This means for every new deposit worth Rs 100, the bank loaned out just Rs 36, despite a cut in interest rates.

If we were to look the same ratio between end October 2015 and end April 2016, it projects a totally different picture. 116 per cent of the incremental deposits during the period were lent out. This means for every new deposit worth Rs 100, the bank loaned out Rs 116.  This means that deposits raised before the start of this period were also lent out.

Hence, a greater amount of lending happened at higher interest rates between October 2015 and April 2016. And this goes totally against Subramanian’s idea of the RBI needing to cut the repo rate. It also goes against the idea of banks lending more at lower interest rates.

Given this, low interest rates are only a part of the story. If that is not leading to higher lending, it doesn’t help in anyway. Lending isn’t happening due to various reasons, which we keep discussing. Demonetisation has only added to this issue.

Also, a fall in interest rates hurts those who depend on a regular income from fixed deposits to meet their expenditure. It also hurts those who are saving for their long-term goals. In both the cases, expenditure has to be cut down. In one case because enough regular income is not being generated and in another case in order to be able to save more to reach the investment goal. And this cut in spending hurts the overall economy. Interest rates are also about the saver and depositor.

We are yet to see a professional economist talk from this angle. To them it is always a case of garbage in garbage out i.e. lower interest rates lead to increased lending. This is simply because most professional economists these days get trained in the United States where the system is totally different and lower interest rates do lead to a higher borrowing by businesses and people.

But that doesn’t necessarily work in India. It is a totally different proposition here.

The column originally appeared in Equitymaster on May 15, 2017.

The State of Real Estate, Six Months After Demonetisation: Falling Prices, Desperate Builders & Return of Black Money

250px-Underconstruction_Building

Housing and real estate is one area in India where writing anything is very difficult given the lack of data. Nevertheless, a few inferences can be made from the little data that is available.

In the last edition of the Letter we unveiled the Indian Economic Thermometer (IET). One of the inputs into the IET was retail loan growth. A major constituent of retail loans are housing loans. As of March 2017, housing loans formed around 53 per cent of the total retail loans given by banks.

By tracking the total amount of housing loans given by banks, we can make a few inferences regarding the state of the real estate sector in India. So, let’s take a look at Table 1. It shows the total amount of home loans given by banks during the course of a year, over the last few years.

Table 1:

Total Home Loans (in Rs crore) Increase/Decrease with respect to the previous year
2012-13 59,647
2013-14 81,900 37.3%
2014-15 89,935 9.8%
2015-16 1,18,245 31.5%
2016-17 1,13,323 -4.2%

Source: Centre for Monitoring Indian Economy.

Table 1 makes for a very interesting reading. For the first time in five years, the total amount of home loans given by banks during the course of a year, has fallen. The total amount of home loans given out in 2016-2017 was around 4.2 per cent lower than the total amount of loans given out in 2015-2016. This is another data point that shows the largely moribund state of the real estate sector in India.

One point that needs to be kept in mind is the fact that home loans are also given out by housing finance companies. The trouble is that regular data on the home loans given by housing finance companies is not available. And this is ironical because housing finance companies are regulated by the National Housing Bank(NHB), which is a 100 per cent subsidiary of the Reserve Bank of India(RBI). It is worth asking that when the RBI can put out month on month data on loans given by banks, what is stopping the NHB?

The latest data I could find on this front was as of March 31, 2015 and that is really not of much help more than two years later, given that we are trying to look at the current state of home loans. In 2014-2015, housing finance companies gave out home loans worth Rs 75,488 crore. During the same year, banks gave out home loans amounting to Rs 89,935 crore. This means that in 2014-2015, housing finance companies gave out around 45.6 per cent of the total home loans. In an ideal world, this data should not be ignored. But given that we don’t have access to it, there is nothing really that we can do about it.

Getting back to the point. Let’s get into a little more detail into the home loans given by scheduled commercial banks during 2016-2017. Let’s look at March 2017. During the course of the month, banks gave out total home loans of Rs 39,952 crore. This basically means that 35.3 per cent of the total home loans given out during the course of the year, got disbursed during one month, which happens to be the last month of the financial year.

What is happening here? Before March 2017, Rs 18,900 crore worth of home loans were disbursed in September 2016. This amounted to 17 per cent of the total home loans disbursed during the course of the year. Hence, between the two months, more than half of the home loans disbursed during the year, were disbursed.

It is well known that builders have got a huge amount of unsold inventory with them. This inventory has been in various stages of construction. At the same time, the builders have been trying to sell this inventory for a while now, by offering a better price as well as goodies on the side.

As some of this inventory has achieved completion stage, it has become slightly attractive for homebuyers given that people prefer buying finished homes these days in comparison to under-construction ones. Also, with builders wanting to show good year end numbers they have gone easy on the price in the month of March 2017, is what bankers tell me.

There is another phenomenon at work. These days people don’t apply for a home loan just at the point of time short-listing and buying a home. They apply for it in advance and get the loan sanctioned but not disbursed. The moment they get a good price for a home, they get the loan disbursed. That is another explanation for a jump in home loan numbers in March 2017.

Also, once people buy a ready to move in new home, there is activity in the secondary home market as well. They may want to sell the homes they were living in, and that also leads to more people taking on home loans. This phenomenon is likely to play out more in the coming months, if the basic assertion I am making turns out to be correct.

Another point mentioning here is that between November 2016 and February 2017, banks barely gave out any home loans. During the period, the banks gave out home loans worth Rs 8,851 crore. In March 2017, they gave out total home loans of Rs 39,952 crore, which was 4.5 times the home loans given out in the previous four months.

A major reason why people weren’t taking on home loans between November 2016 and February 2017 was demonetisation. There simply wasn’t enough currency going around. With this, the real estate transactions came to a standstill because without currency it wasn’t possible to fulfil the black part of the real estate transaction. Those who owned homes(builders and investors) were not ready to sell homes, without being paid for a certain part of the price, in black.

By March 2017, nearly three-fourths of the demonetised currency was replaced.

This basically means that by March 2017, there was enough currency in the financial system for the black part of the real estate transactions to start happening all over again. Also, the Rs 2,000 note makes this even more convenient.

This availability of currency ensured that the black part of any real estate transaction could be easily paid, which had become difficult between November 2016 and January 2017. Once the black transactions became possible, real estate started getting bought and sold again, and this in turn ensured that home loans started to be disbursed again.

Between builders desperate to end the financial year on a good note and currency finding its way back to the financial system, people started taking on home loans again. The interesting question is whether this revival in home loans will continue. For that we will have to wait for the home loan data of April 2017.

The big question here is that are real estate prices falling? If you listen to what the real estate industry has been saying you would feel that real estate prices have either not been falling or will not fall more.

Ashutosh Limaye, Head-Research & REIS, JLL India, told ET Now thatprices have come down but by and large prices are holding.” Or as Getamber Anand told Moneycontrol.com:  “I feel prices in most markets have bottomed out and stabilised with little or no margin for further reduction.”

Let’s look at some data to see if this is true. As I mentioned earlier, real estate data is not easy to get. The simple way to figure out whether prices are going up or down or are flat, would be to look at the prices at which deals are happening. But given that there is no such data at an agglomerated level, one has to try and look at this in a slightly different way.

Every bank has to carry out what the RBI calls priority sector lending. What kind of lending gets categorised as priority sector lending in case of home loans? As per a RBI circular dated April 23, 2015, a priority sector housing loan is defined as: “Loans to individuals up to Rs 28 lakh in metropolitan centres (with population of ten lakh and above) and loans up to Rs 20 lakh in other centres for purchase/construction of a dwelling unit per family provided the overall cost of the dwelling unit in the metropolitan centre and at other centres should not exceed Rs 35 lakh and Rs 25 lakh respectively.”

This is how priority sector home loans continue to be defined. Hence, housing loans of up to Rs 28 lakh in a city with a population of Rs 10 lakh or more, and financing the purchase of a home with a price of up to Rs 35 lakh, is categorised as a priority sector housing loan. In other centres, a priority sector housing loan is a loan of up to Rs 20 lakh used to finance the purchase of a house with a price of up to Rs 25 lakh.

Let’s look at Table 2. It shows the priority sector loans as a proportion of total home loans given by banks.

Table 2:

Total Home Loans (in Rs Crore) Priority Sector Home Loans (in Rs Crore) Proportion
2012-13 59,647 1,349 2.3%
2013-14 81,900 34,800 42.5%
2014-15 89,935 20,386 22.7%
2015-16 1,18,245 19,890 16.8%
2016-17 1,13,323 26,082 23.0%

Source: Centre for Monitoring Indian Economy.

What does Table 2 tell us? We are interested only in the years 2015-2016 and 2016-2017, when the definition of priority sector housing loans was the same. What we can see is that in 2016-2017, nearly 23 per cent of the loans given out were priority sector home loans. In 2015-2016, this figure was at just 16.8 per cent. In absolute terms, 31.1 per cent more priority sector home loans were disbursed in 2016-2017 than in 2015-2016.

What does this mean? It means that banks have financed more homes with an official registered price of Rs 35 lakh or lower in metropolitan cities and Rs 25 lakh or lower in other centres. We use the term official registered price, simply because a black component always gets paid in cash, over and above the official price.

With banks financing more homes of Rs 35 lakh or lower in metropolitan cities and Rs 25 lakh or lower in other centres, it basically means that either prices have come down or more homes have been built in that segment (which builders like to call affordable housing). Hence, more homes have become available in the sub-Rs 35 lakh segment in the metropolitan centres and in the sub-Rs 25 lakh segment, in other centres.

In fact, in the month of March 2017, when the maximum amount of home loans were given out in comparison to any other month during the last financial year, 28 per cent of the loans were priority sector home loans.

Given this, home loan data does suggest that home prices have fallen. Of course, there is no way of figuring out to what extent have the prices fallen. The answer would be different for different parts of the country.

But how does all this work at a personal level? One technique of driving down the price is to keep talking to the representative of the builder over a period of time, keep him interested and keep driving down the price. Of course, this needs a lot of patience and depends on how desperate the builder is to sell what he has already built.

The column originally appeared on Equitymaster on May 10, 2017

Six Months After Demonetisation Cash is King Again and Questions Still Remain

narendra_modi

On November 8, 2016, the prime minister Narendra Modi announced his government’s decision to demonetise Rs 500 and Rs 1,000 notes, to an unsuspecting nation. The decision came into effect from the midnight between November 8 and November 9, 2016, and suddenly rendered 86.4 per cent of the nation’s currency in circulation, useless.

It’s been six months since then and more than four months since December 30, 2016, the last date for depositing the demonetised Rs 500 an Rs 1,000 notes, into bank accounts. But even after this period as far as the government is concerned, a few basic points remain.

a) How much demonetised money finally made it into bank accounts? When demonetisation was first announced, this number was shared regularly. Nevertheless, the last announcement on this front from the Reserve Bank of India(RBI) came on December 13, 2016. As of December 10, 2016, Rs 12.44 lakh crore of demonetised currency had made it back into the banks.
Given that Rs 15.44 lakh crore worth of currency notes had been demonetised, nearly 80.6 per cent of the currency had found its way back into banks, nearly three weeks before the last date to deposit demonetised notes into bank accounts.
Neither the Reserve Bank nor the government has told the nation how much money eventually made it back into the banks. This is an important question and needs to be answered.

b) The initial idea behind demonetisation was to curb fake currency notes and eliminate black money.
As far as fake currency goes the minister of state for finance Arjun Ram Meghwal told the Lok Sabha in early February 2017 that the total number of fake notes deducted in the currency deposited into banks after demonetisation stood at 2.46 lakhs. This amounted to a total value of Rs 19.5 crore.
As mentioned earlier, the total value of demonetised notes had stood at Rs 15.44 lakh crore. Given this, the proportion of fake notes deducted is almost zero and can be ignored. Hence, as far as detecting and eliminating fake notes was concerned, demonetisation was a total flop.
How did it do as far as eliminating black money is concerned? The hope was that the black money held in the form of cash will not make it back into the banks, as people wouldn’t want to get caught by declaring it. But by December 10, 2016, more than four-fifth of the demonetised notes had already made it back into the banks. Since then the government and the RBI have not given out any fresh numbers. It’s surprising that it has been more than four months since December 30, 2016, and this number is still not out in the public domain.
Also, it is important to point out here: “High denomination notes are known to facilitate generation of black money. In this connection, it may be noted that while the total number of bank notes in circulation rose by 40% between 2011 and 2016, the increase in number of notes of Rs.500/- denomination was 76% and for Rs.1,000/- denomination was 109% during this period.”
If high denomination notes facilitate generation of black money, then why replace Rs 1,000 notes with Rs 2,000 notes. Given that a Rs 2,000 note is twice the value of a Rs 1,000 note, it makes black market transactions even more easier. It also makes storage of black money in the form of cash easier, given that it takes less space to hide the same amount of money.
Again, this is a basic disconnect in what the government planned to achieve through demonetisation and what it eventually did. No effort has been made to correct this disconnect.

c) The government has still not offered a good explanation of what prompted it to demonetise. There has been no similar decision taken by any other country in a stable financial situation like India currently is, in the modern era. The best that the government has done is blamed it on the RBI. As Meghwal told the Lok Sabha in early February 2017: “RBI held a meeting of its Central Board on November 8, 2016. The agenda of the meeting, inter-alia, included the item: “Memorandum on existing banknotes in the denomination of Rs 500 and Rs 1000 – Legal Tender Status.””
Anybody who has studied the history of the RBI would know that the RBI would never take such an extreme step without extreme pressure from the government.

d) Other than eliminating black money and fake currency notes through demonetisation, in the aftermath of demonetisation, the government wanted to promote cashless transactions. As Modi said in the November 2016 edition of themann ki baat radio programme: “The great task that the country wants to accomplish today is the realisation of our dream of a ‘Cashless Society’. It is true that a hundred percent cashless society is not possible. But why should India not make a beginning in creating a ‘less-cash society’? Once we embark on our journey to create a ‘less-cash society’, the goal of ‘cashless society’ will not remain very far.”

How are things looking on that front? Look at the following table. It shows the volume of digital transactions over the last few months.

Month Volume of digital transactions (in million)
Nov-16 671.5
Dec-16 957.5
Jan-17 870.4
Feb-17 763.0
Mar-17 893.9
Apr-17 843.5

Source: Reserve Bank of India

While digital transactions picked up in December, they have fallen since then. The total number of digital transactions in April 2017 is higher than it was in November 2016. Nevertheless, it is worth asking, whether this jump of 25 per cent was really worth the trouble of demonetisation.

e) Falling digital transactions since December 2016 tell us that cash as a mode of payment is back in the system. There is another way this can be shown. Between November 2016 and February 2017, banks barely gave out any home loans. During the period, the banks gave out home loans worth Rs 8,851 crore. In March 2017, they gave out total home loans of Rs 39,952 crore, which was 4.5 times the home loans given out in the previous four months. It also amounted to 35 per cent of the home loans given out during the course of 2016-2017.

A major reason why people weren’t taking on home loans between November 2016 and February 2017 was demonetisation. There simply wasn’t enough currency going around. With this, the real estate transactions came to a standstill because without currency it wasn’t possible to fulfil the black part of the real estate transaction. Those who owned homes (builders and investors) were not ready to sell homes, without being paid for a certain part of the price, in black.

By March 2017, nearly three-fourths of the demonetised currency was replaced. This basically means that by March 2017, there was enough currency in the financial system for the black part of the real estate transactions to start happening all over again. Also, the Rs 2,000 note makes this even more convenient.

To conclude, six months after the declaration of demonetisation it is safe to say that demonetisation has failed to achieve what it set out to achieve i.e. if it set out to achieve anything on the economic front.

The column originally appeared on Firstpost on May 9, 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

Digital Payments Go Up in March, But a Large Part is Seasonal

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I have been closely tracking the increase in currency in circulation and the volume of digital payments being made by Indians, for some time now.

The idea is to check if people are “increasingly” moving towards digital modes of payment in the aftermath of demonetisation. Having more and more people go digital has emerged as one of the motives for demonetisation.

I use the word increasingly because even without demonetisation, people have been moving towards digital modes of payment over the years at a pretty good rate.

Look at Table 1. It shows the volume of digital transactions happening in India over the last few months. This table has been reproduced from a report titled Macroeconomic Impact of Demonetisation: A Preliminary Assessment, authored by the Reserve Bank of India and published on March 10, 2017. The table had data until February 2017, I have updated it for March 2017 as well.

Table 1: Number of digital transactions.

Volume (in Crore) Nov-16 Dec-16 Jan-17 Feb-17 Mar-17
National Electronic Funds Transfer 12.3 16.6 16.4 14.8 18.7
Cheque Truncation System 8.7 13 11.8 10 11.9
Immediate Payment Service 3.6 5.3 6.2 6 6.7
Unified Payment Interface 0.03 0.2 0.42 0.42 0.62
Unstructured Supplementary Service Data 0 0.01 0.03 0.02 0.02
Debit and Credit Card Usage at Point of Sales 20.6 31.1 26.6 21.2 23
Prepaid Payment Instrument 5.9 8.8 8.7 7.8 9
Total 51.1 75.0 70.2 60.2 69.9

Source: Reserve Bank of IndiaBetween February 2017 and March 2017, the total number of digital transactions has jumped by around 16 per cent to 69.9 crore. There are two reasons for it. One is the fact that the rate of increase in currency circulation has gone down dramatically during the month of March 2017.

This is something I had discussed last week. Take a look at Figure 1. It plots the rate at which currency circulation has been increasing week on week since January 6, 2017.

Figure 1: 

Due to reasons which only the government or the RBI can explain, the rate of increase in currency circulation has been slowing during the course of March. What does this mean? The currency in circulation as on March 3, 2017, was at Rs 11,98,412 crore. This increased to Rs 12,45,819 crore as on March 10, 2017. This meant a jump of Rs 47,407 crore or around 4 per cent (Rs 47,407 crore crore divided by Rs 11,98,412 crore). This jump of 4 per cent is referred to as the rate of increase in currency circulation.

For the week ending March 30, 2017, the currency in circulation increased by just 1.7 per cent. Hence, even though the currency in circulation is going up, the rate at which it is going up has slowed down dramatically. For the week ending January 13, 2017, it had grown by 5.9 per cent.

This slow growth of currency in circulation wasn’t enough to satiate the demand of the public and to a large extent explains why ATMs have generally been running dry. And this to some extent explains the increase in digital transactions.

Take a look at debit and credit card usage at point of sale terminals in Table 1. After falling dramatically in between January and February 2017, they have jumped up again by 8.5 per cent during the course of March. This is a good indicator of the fact that the shortage of currency forced people to use digital money.

Over and above this, there is a seasonality factor as well. March is the last month of the financial year and digital payments seem to go up during the course of the month, as people pay their taxes (advance income tax and service tax) as well as settle business payments between them.

Take a look at Table 2. It shows the digital payments made between November 2015 and April 2016. It shows that the digital payments showed a jump between February 2016 and March 2016.

Table 2:

Volume (in Crore) Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16
National Electronic Funds Transfer 10 12 11.9 11 12.9 11.2
Cheque Truncation System 7.1 8.2 7.8 8.4 8.8 7.9
Immediate Payment Service 1.9 2.1 2.3 2.4 2.6 2.7
Debit and Credit Card Usage at Point of Sales 16.6 17.8 18 17.2 18.5 19.1
Prepaid Payment Instrument 6.3 6.9 6.5 6.5 7.2 6.9
Total 41.9 47 46.5 45.5 50 47.8

Source: Reserve Bank of IndiaIn Table 2, I have ignored Unified Payment Interface as well as Unstructured Supplementary Service Data, given that the numbers are very small and do not have any overall impact. As can be seen from Table 2, the total number of digital transactions in March 2016, went up by around 9.9 per cent to 50 crore, in comparison to February 2016.

Between February 2017 and March 2017, the jump was at 15 per cent (ignoring Unified Payment Interface as well as Unstructured Supplementary Service Data). As explained earlier, a part of this jump is because of shortage of cash, something that the government wants and a part of this jump is simple seasonality as people make their tax payments and settle their year-end business payments.

As can be seen from Table 2, in April 2016, the total number of digital transactions fell by around 4.4 per cent. Given this, once April 2017, data comes out, we will get a much clearer trend on the impact of demonetisation and shortage of cash on digital payments.

Dear Reader, keep watching this space.

The column originally appeared on Equitymaster on April 19, 2017