The Thing About New Year Resolutions Is…

2017It is that time of the year when people are planning what to do on December 31, as well as their New Year resolutions. The New Year resolutions tend to be tricky things. Even though they are largely never implemented, many people never stop making them or continue making them over many years.

There is this inherent belief that come what may we will follow the resolution this time around. It doesn’t matter that we have abandoned many New Year resolutions over the years that have gone by. Or to put it slightly differently, there is a certain amount of optimism built into making New Year resolutions, year after year.

As Daniel Kahneman writes in Thinking, Fast and Slow: “Optimism is normal, but some fortunate people are more optimistic than the rest of us. If you are genetically endowed with an optimistic bias, you hardly need to be told that you are a lucky person—you already feel fortunate. An optimistic attitude is largely inherited, and it is part of a general disposition for well-being, which may also include a preference for seeing the bright side of everything.”

And this optimism essentially ensures that we keep making new year resolutions year and year. This general optimism about things spills over to other areas of life as well. In fact, many years back, there was a very interesting piece of research carried out by two American psychiatrists, Caroline Preston and Stanley Harris. They asked drivers to rate their skill, ability as well as alertness, the last time they were driving.

As Jason Zweig writes in Your Money and Your Brain about this research: “Just under two-thirds of drivers said they were at least competent as usual. Many described their most recent drive with terms like “extra good” or “100%.””

The trouble was all this did not make any sense. The researchers Preston and Harris had conducted all their research interviews on drivers who had started in their own cars but ended up in an ambulance, after an accident. “68% of these drivers were directly responsible for their crashes, 58% had at least two past traffic violations,… and 44% would ultimately face criminal charges,” writes Zweig. This after, only five out of the 50  drivers, admitted to the researchers for even being partially responsible for the crash.

This shows the general human tendency to be optimistic and overconfident about many things in life. In fact, a later survey with drivers who had a clean driving record, found that 93% of them felt that they were above-average drivers.

This optimism about oneself reflects in other areas of life as well. In fact, Zweig provides a very interesting example of how when he asks people about their savings while making speeches, they think that they save 1.8 times the average person. Of course, this is not possible.

On the flip side, optimism and overconfidence have positive aspects as well. It is the engine that keeps capitalism going. The larger point being that if people knew their odds of succeeding (or rather failing) while initiating a new thing, in many cases they would never do it at all.

As Kahneman writes: “More often than not, risk takers underestimate the odds they face, and do not invest sufficient effort to find out what the odds are. Because they misread the risks, optimistic entrepreneurs often believe they are prudent, even when they are not. Their confidence in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.”

Ultimately, any country goes from being a developing country to being a developed country, only if there are enough entrepreneurs out there dreaming about building a company and in the process creating jobs. Hence, optimism and overconfidence does have a role to play in everyday life.

The column originally appeared in Bangalore Mirror on December 28, 2016

Of Narendra Modi, Sunk Cost Fallacy and Demonetisation


In 2002, Daniel Kahneman won the Nobel Prize in Economics. Kahneman is not an economist but a psychologist. In fact, he won the prize for research he had carried out with another psychologist, Amos Tversky.

Tversky did not win the Nobel Prize because he died of cancer in 1996. The Nobel Prize is not awarded posthumously. One of the great stories about Tversky is about he and his wife going to the movies. On many occasions Tversky would be back home just 20 minutes later.

As author Michael Lewis writes in The Undoing Project—A Friendship That Changed the World: “Amos would have decided in the first five minutes, whether the movie was worth seeing—and if it wasn’t he’d just come home and watch Hill Street Blues(his favourite TV drama) or Saturday Night Live(he never missed it) or an NBA game(he was obsessed with basketball).”

“They’ve already taken my money,” he would explain. “Should I give them my time, too?”

Tversky was basically not becoming a victim of what is called the sunk cost fallacy. Once we have sunk money or our reputation into a deal we would rather make the best of it than go back on it. The sunk cost fallacy leads to an escalation of commitment. Let’s take a few examples. Tversky chose to walk out of a movie he did not like. But how many of us choose to do that? We choose to waste our time after having wasted our money.

Or take the case of something as simple as reading a book. Within the first 50 pages of the book it is more or less clear, whether we are liking the book or not. But even in situations when we are not liking the book we tend to complete reading it.

Escalation of commitment can go much beyond this. As Yuval Noah Harari writes in Homo Deus—A Brief History of Tomorrow: “Business corporations often sink millions into failed enterprises, while private individuals cling to dysfunctional marriages and dead-end jobs.”

Kahneman, who I mention earlier in the column, defines the sunk cost fallacy in his book Thinking, Fast and Slow, as: “The decision to invest additional resources in a losing-account.”

The sunk-cost fallacy is visible both in private businesses as well as government projects. Investments in many projects which are failing and floundering continue to be made. Good money continues to be thrown after bad money. While this does not make sense for the company and the government on the whole, it makes tremendous sense from the CEO running the firm or the head of the government.

As Kahneman writes: “The escalation of commitment to failing endeavours is a mistake from the perspective of the firm but not necessarily from the perspective of the executive who “owns” a floundering project. Cancelling the project will leave a permanent stain on the executive’s record, and his personal interests are perhaps best served by gambling further with the organisation’s resources in the hope of recouping the original investment—or at least in an attempt to postpone the day of reckoning.”

Something similar is happening in the case of demonetisation. It was more or less clear within ten days of announcing demonetisation that the government had botched up big-time. The initial goal of demonetisation was to tackle black money and fake notes. Since then the narrative has been moved to digital and cashless transactions. This in a country where 98 per cent of the consumer transactions happen in cash, internet connections outside cities can’t be relied on and a major section of the population, does not own a smart phone. On top of this, nearly one-fourth of the population is illiterate.

It would have made sense for the government to pull the plug on demonetisation very quickly. But that would have meant a stain on the record of prime minister Narendra Modi. Hence, it has continued with changing narratives.

Now the government is even planning to start a lottery in order to justify demonetisation. It’s throwing good money after bad. It has given out an email id asking citizens to mail information about people who have black money. This is Orwellian. And finally, it has launched another tax amnesty scheme.

The sunk cost fallacy is playing out real time.

The column was originally published in the Bangalore Mirror on December 22, 2016

Modi Should Close Loophole Allowing Political Parties to Launder Black Money



On December 16, 2016, the revenue secretary Hasmukh Adhia said that the political parties are free to deposit old Rs 500 and Rs 1,000 notes in their bank accounts. Adhia also said that deposits in the accounts of political parties are not to be taxed. “If it is a deposit in the account of a political party, they are exempt. But if it is deposited in individual’s account then that information will come into our radar,” he said. This basically meant that deposits made by political parties would not be up for scrutiny.

This statement created a lot of controversy. The finance minister and master spinner Arun Jaitley then took pains to explain that the political parties were not being given any favourable treatment. As he said: Under Section 13A of IT Act 1961, Political parties have to submit audited accounts, income and expenditure details and balance sheets. Post demonetisation, no political party can accept donations in 500 and 1000 rupee notes since they were rendered illegal tenders. Any party doing so would be in violation of law.

Just like anyone else, political parties can also deposit their cash held in the old currency in banks till the 30th of December provided they can satisfactorily explain the source of income and their books of accounts reflect the entries prior to 8 November,” he added.

While it may sound different, both Adhia and Jaitley were essentially saying the same thing. This is how things prevail as of now. Political parties are currently not required to publicly disclose contributions of up to Rs 20,000.

As Sandip Sukhtankar and Milan Vaishnav write in a research paper titled Corruption in India: Bridging Research Evidence and Policy Options: “This rule allows contributors to package unlimited political contributions just below this threshold value completely free of disclosure.”

This basically means that any political party having received individual donations of up to Rs 20,000 in cash can deposit it in bank accounts. This money will not be investigated simply because these donations need not be publicly disclosed. That is the law of the land. And that is precisely what Adhia said: “If it is a deposit in the account of a political party, they are exempt. But if it is deposited in individual’s account then that information will come into our radar.”

Further, the political parties can go through the audits that Jaitley talks about but they still won’t have to publicly declare the names of the individuals and institutions, who have donated amounts below Rs 20,000.

In fact, let’s look at some data from 2014-2015, put together by the Association for Democratic Reforms. As the report titled Analysis of Income & Expenditure of National Political Parties for FY- 2014-2015 and dated June 3, 2016, points out: “Only 49% of the total donations of the parties came from voluntary contributions above Rs 20,000.” This means that 51 per cent or more than half of the total donations of National Political Parties came from donors whose details are not available in the public domain. The BJP, Congress, BSP, NCP, CPI and CPM, form the six national level political parties.

As the report points out: “A total of Rs 648.66 crores (51% of total donations) of the total donations to National Parties was collected during FY 2014-15 from donors whose details are not available in the public domain.”

The report makes several other interesting points:

a) BJP… collected Rs 434.67 crores (50% of total donations) from donors whose details are unavailable.

b) BSP claims not having received any donation above Rs 20,000, hence no donations details of the party are in public domain. The BSP has been declaring this for 10 years now.

c) NCP is only party which has not received donation below Rs 20,000 during FY 2014-15. Thus all voluntary contributions are available in the public domain.

d) As far as the Congress is concerned, 32 per cent of the donations of the party came from unknown sources.

e) The unknown sources of income are essentially raised through ‘sale of coupons’, ‘relief fund’, ‘miscellaneous income’, ‘voluntary contributions’, ‘contribution from meetings/ morchas’ etc.

So as far as dealing in cash is concerned, it continues to be the order of the day for political parties. It is worth mentioning here that we are talking about only six national level political parties here.

The number of political parties operating in India is significantly more. A PTI report dated August 2015 points out: “According to the [Election] Commission, as on July 24, there are 1866 political parties which are registered with it.”

Most of these parties do not fight elections. Then why are they set up in the first place? As former Chief Election Commissioner TS Krishna Murthy recently told The Indian Express: “Many political parties are set up with the sole intention of laundering black money.”

In fact, it is safe to speculate that many of these political parties would have been laundering money in the aftermath of demonetisation as well. The law of the land does not stop them from doing that. All they need to claim while depositing demonetised Rs 500 and Rs 1,000 notes into a bank is that it was donated on or before November 8, 2016.

Having said that, it would be make tremendous sense for the government to release data on the total amount of demonetised Rs 500 and Rs 1,000 notes deposited by the political parties in banks since November 8, 2016. Is the Modi government up for that?

Further, yesterday the Reserve Bank of India (RBI) came up with another rule. An individual while depositing more than Rs 5,000 must offer an explanation to at least two bank employees as to why this could not be deposited earlier. The amount will be credited only after receiving a satisfactory explanation. The RBI wants the explanation to be kept on record to facilitate an audit trail at a later stage. Also, the citizens need to show an identity proof while depositing their old Rs 500 and Rs 1,000 notes into a bank account. On the other hand, political parties can continue to receive donations of up to Rs 20,000 in cash and need not declare who gave those donations. The political parties can deposit the old Rs 500 and Rs 1,000 notes into their bank accounts, and no questions will be asked.

In fact, as I have been saying repeatedly, the issue of black money cannot be tackled seriously, without making political funding transparent. This needs simple majority in the Parliament. The BJP has a majority in the Lok Sabha and can take the first step towards this. It is likely to be supported by some parties in the Rajya Sabha as well. Even without a majority, the party did manage to get the Goods and Services Tax passed through the Rajya Sabha. So, what is holding it back on this front?

In fact, the Election Commission has suggested thatanonymous contributions above or equal to the amount of Rs two thousand should be prohibited.” But why even allow a window of Rs 2,000? Political parties should move towards a totally cashless way of taking donations.

To conclude what are Jaitley, Narendra Modi and the BJP, doing about taking care of this anomaly? An anomaly which as of now clearly allows political parties to launder black money. Will something be done on this front or are only the citizens of this country accepted to show all the honesty?

Postscript: This is my last piece for the year. Here is wishing the readers a Merry Christmas and a Happy New Year. See you in January 2017.

The column originally appeared on on December 20,2016

Why Demonetise Without Any Estimate of Black Money?


The prime minister Narendra Modi communicated the decision to demonetise Rs 500 and Rs 1,000 notes to the nation, on the evening of November 8, 2016. The idea was to tackle black money as well as fake notes.

As the government press release accompanying the decision said: “ Use of high denomination notes for storage of unaccounted wealth[black money] has been evident from cash recoveries made by law enforcement agencies from time to time. High denomination notes are known to facilitate generation of black money.”

Between then and now, a lot of analysis has happened on how much black money the government will be able to bring back in the public domain. And once the money is back in the public domain, how much money the government will be able to earn by taxing it.

Many economists and analysts have written research reports on this. These research reports have been turned into WhatsApp forwards which have been widely shared. People have passionately argued on WhatsApp groups, Facebook, Twitter and even in personal communications, as to how successful the demonetisation decision will eventually turn out for the government and in turn, for the nation.

Often big diagrams and flow-charts have been made as to show the thousands of crore that will come into the government kitty, at the end of the day. Any analysis along these lines starts with a basic assumption around the total amount of black money that the Indian financial system has. Black money is the money which has been earned through legal as well as illegal means but on which taxes have not been paid.

As it turns out that the government has no estimation of the total amount of black money in the financial system. This is something that the finance minister Arun Jaitley told the Lok Sabha in a written reply to a question that had been asked by Anant Kumar Hegde, a BJP Lok Sabha MP from Karnataka.

As Jaitley said: “There is no official estimation of the amount of black money either before or after the Government’s decision of 8th November 2016 declaring that bank notes of denominations of the existing series of the value of five hundred rupees and one thousand rupees shall cease to be legal tender with effect from 9th November 2016.”

What does this mean? It basically means that while taking the decision to demonetise Rs 500 and Rs 1,000 notes, the Modi government did not take into account any estimate of the total amount of black money in the Indian financial system. It further means that the government has no idea of how much money it expects to gain through this entire manoeuvre.

It is amazing that such a huge decision that impacts every citizen of this country was made, even without taking a basic estimate of black money into account. Of course, all big decisions in life, require some leap of faith. The perfect data and the perfect conditions are never there. But at the same time there should be some analytical basis to them as well. There must be some expectations of a payoff for the government that will make it worth all the trouble that the people of India have been be put through.

The surprising thing is that in 2011, the Congress-led UPA government had asked three institutes, the National Institute of Public Finance and Policy (NIPFP), the National Institute of Financial Management (NIFM) and the National Council of Applied Economic Research (NCAER), to estimate the total amount of black money in India.

An October 2016 PTI newsreport points out that: “Replying to an RTI query, the Ministry said study reports of NIPFP, NCAER and NIFM were received by the government on December 30, 2013, July 18, 2014 and August 21, 2014 respectively.”

The reports from these institutes have still not been put up in the public domain. “Reports received from these institutes are under examination of the government,” Finance Minister Jaitley had told the Rajya Sabha in May 2015.

Hence, the government has access to three estimates of black money. There must be some explanation behind why it chose not to take any of these reports into account while deciding to demonetise high denomination notes.

In fact, in May 2015, Jaitley had also told the Rajya Sabha: “There is no official estimation regarding the amount of black money generated in the country. Varying estimations of the amount of black money have been reported by different persons/institutions. Such estimations are based upon different sets of facts, data, methods, assumptions, etc. leading to varying inferences. However, sectoral analysis of seizure of valuables and admission of undisclosed income in the searches conducted by the Income Tax Department in the last three financial years indicates that the main sectors in this regard are real estate, trading & manufacturing, contractors, gems & jewellery, services [emphasis added], etc.”

To conclude, the question is how did the government decide to go about to demonetise Rs 500 and Rs 1,000 notes, and put the citizens of this country through great trouble, without even having a basic estimate of black money in place. On what pretext was such a disruptive decision made? This is a question that Modi and Jaitley need to answer to this nation.

The column originally appeared in Equitymaster on December 19, 2016


Demonetisation: Can Indian Banks Handle Low Interest Rates?


One of the benefits of demonetisation that is being bandied around is lower interest rates. Suddenly, banks are flush with a huge amount of deposits. The demonetised Rs 500 and Rs 1,000 notes need to be handed over to banks as well as post offices by December 30, 2016. The total value of demonetised currency is Rs 15.44 lakh crore.

Between November 10, 2016 and December 10, 2016, Rs 12.44 lakh crore has made it back to the banks. Banks have issued new notes as well as notes which continue to be legal tender of Rs 4.61 lakh crore to the public over their counters and through their ATMs.

What this means that the deposits with the banks have gone up at a very rapid pace. Between November 11 and November 25, 2016, the aggregate deposits with banks went up by 4 per cent. This increase was within a span of just 15 days. (This is the latest figure that is available.)

Given this, huge and sudden jump in deposits, it is but natural that the banks will cut the interest rates that they offer on their deposits. At the same time, the overall lending by banks (non-food credit) during the 15-day period fell by 0.9 per cent.

Hence, a rise in deposits and a fall in loans will lead to banks cutting interest rates on their deposits and then on their loans. At lower interest rates both businesses as well as consumers will borrow and spend more. And this will help economic growth. Or so we are being now told.

This, as I have often argued in the past, is a very simplistic argument. (You can read one such argument here in the Letter that I write every Friday). Lower interest rates for borrowers are just one side of the equation. We also need to consider lower interest rates for savers, who form the other side of the equation. There can’t be any borrowers without savers. Look at Table 1.

Table 1: Financial Saving of the Household Sector.As can be seen from Table 1. Deposits form a bulk of the household financial savings. Between 2011-2012 and 2015-2016, the share of deposits in the household financial savings has come down. Nevertheless, it remains a major part of how people save. If interest rates on deposits come down, people need to save more to meet their savings goal. This means lesser consumption, which has an impact on economic growth. There is also a possibility of not saving enough and not meeting their savings goal, which again is not a good thing. This could mean not having an adequate amount of money for the education of children, among other things.

Further, in a country with very little social security, the senior citizens use fixed deposits to generate regular monthly income. A sudden fall in interest rates hurts them the most. This is another thing that needs to be kept in mind. Hence, fixed deposit interest rates at any point of time should be at least 150 to 200 basis points higher than the prevailing rate of inflation as measured by consumer price index. This is not a perfect formula, given that each one of us has our own rate of inflation, but then something is better than nothing.

Given that it is the largest borrower, it is understandable that the government keeps batting for lower interest rates. But lower interest rates are not necessarily good for everyone and mindlessly advocating lower interest rates as many experts and industrialists tend to do, is not good for anyone.

Take the case of banks. How responsibly can we expect them to lend? If we look at the recent record of the banks, they don’t inspire enough confidence. In fact, this is precisely the point made by Pallavi Chavan and Leonardo Gambacorta in the RBI Working Paper titled Bank Lending and Loan Quality: The Case of India. The paper was published on the RBI website on December 14, 2016.

The major point that Chavan and Gambacorta make is as follows: “We find that a one-percentage point increase (decrease) in loan growth is associated with an increase (decrease) of NPLs over total advances (NPL ratio) by 4.3 per cent in the long run.” What does this mean in simple English? It essentially means that for every one per cent increase in loans the bad loans ratio goes up by 4.3 per cent.

This basically means that when the times are good, Indian banks go easy on the lending and end up giving loans to even those who don’t deserve a loan. As Chavan and Gambacorta point out: “Banks tend to take on more risks during an upturn in credit growth and be more cautious whenever there is a downturn.”

So why do banks go overboard while lending while times are good? The simple reason is that when times are good there is far greater competition to lend and in this scenario, the lending conditions tend to get relaxed.

But there is another reason as well-crony capitalists. As Chavan and Gambacorta point out: “Well-capitalised banks tend to take on less credit risk”. What does this mean? It means that banks which have more capital tend to take less risk when it comes to giving out loans. Hence, banks which have less capital tend to take more risk while giving out loans. The question is which banks have less capital? Public sector banks.

The new generation private sector banks, which form a bulk of the private sector banking in India, are much better capitalised than the public sector banks. So, what is it that leads to public sector banks going easy on the lending? While Chavan and Gambacorta don’t say so, the answer perhaps lies in crony capitalism.

Politicians force public sector banks to lend to their businessman friends or crony capitalists. The projects are poorly financed with the businessmen putting very little of their own money at risk. As Raghuram Rajan said in a November 2014 speech: “The reason so many projects are in trouble today is because they were structured up front with too little equity, sometimes borrowed by the promoter from elsewhere. And some promoters find ways to take out the equity as soon as the project gets going, so there really is no cushion when bad times hit.”

To conclude, those talking about lower interest rates leading to higher lending to businesses, should also keep this in mind. Public sector banks are not adept at lending, at least not as long as they remain public sector banks, which allows politicians in power to interfere

(The column originally appeared on Equitymaster on December 16, 2016)