India: A Web of Real Estate, Banks, Unemployment and Politicians. And how each is linked to the other.

indian flag

In the Letters that I have written till date, I have tried to build a logical argument on the basis of data. Given this context, this Letter is different from the usual. The idea for this Letter came from a random conversation with a dear friend who works as a writer in the Mumbai film industry.

Typically, when I write to you, dear reader, I get into a lot of detail with numbers, graphs and tables, in order to explain a single issue. While it is important to have a good understanding of individual issues that plague the Indian economy, at the same time it is important to have a Big Picture understanding as well.

As they say, getting into too much detail about any issue leads to a situation where you can miss the wood for the trees. To set this right, in this piece I will try and explain what I see are the biggest problems which are likely to hold the Indian economy back in the years to come and how they are linked with each other, the 7-8 per cent official economic growth rate notwithstanding.

I have written this Letter in the form of a conversation I had with my friend. Of course, this is not the real conversation I had. Real conversations cannot be as well-structured as any writeup can be. Nevertheless, in an ideal world this is the conversation I should have had, if the idea was to explain to my friend India’s economic situation, the way I see it.

So here we go.

It has been many years since I walked the lanes of Versova, a quaint suburb of Mumbai, where the rich strugglers of the Indian film industry also stay along with the stars. (The poorer ones stay in Oshiwara). A 15-minute walk from a coffee shop and I am at my friend’s place.

As soon as he opens the door, one of the two cats he has, jumps on me. Funnily, I don’t recall the name of the cat. “He is just trying to be friendly, Sir!” my friend says. Once upon a time I had a morbid fear of cats. But living in a building which is full of cats, this fear has gone away.

I went in and made myself comfortable on the sofa and had a cup of black coffee, which my friend had made. Like any normal Indian I like a dash of sugar in my coffee (though I am perfectly fine with sugarless tea). This is something my friend finds a little odd. “Who puts sugar in black coffee?” he asks rather animatedly. And I ended up with sugarless black coffee, which as they say is an acquired taste. Now that is something that you say when you don’t like something and are trying to fit in.

After an hour of talking about films and politics, we somehow end up talking about the Indian economy, of all things. This, even though I make it a point not to talk shop when I am with friends.

And honestly, I don’t recall how I ended up talking about one million Indians entering the workforce every month, India’s so called demographic dividend. “So, you know one million Indians are entering the workforce every month,” I said. “This means 1.2 crore during the year, which is half of Australia’s population.”

“What is the big deal asked my friend?” asked my friend. “As people age, at some point of time they need to start making a living and enter the workforce.”

“True. But as they enter the workforce, they need to find jobs, which they currently aren’t.”

“Ah. Jobs. Yes. I once had a job, you know, with a newspaper,” my friend said, getting a tad melodramatic.

“Yes. You did,” I said. “So, there are 1.2 crore individuals Indians entering the workforce every year and there are very few jobs being created for them. And that is a huge problem.”

“But I remember reading somewhere last year that India’s rate of unemployment was just 5 per cent.”

“Yes,” I replied.

“How do you reconcile this with the fact that those entering the workforce are not finding jobs?” my friend asked.

“Oh, that is because of the way unemployment is calculated. There are two methods. In one method, anyone who has been employed for 183 days is considered employed. As per this method the rate of unemployment is 5 per cent. In another method, anyone who has been employed for the last 30 days is considered employed. As per this method, the rate of unemployment is even lower at 3.7 per cent. Hence, you could be unemployed for a major part of the year and still be considered employed.”

“Ah, this is that classic statistics are like bikinis point…”

“Yes. Interestingly, only 60 per cent of Indians who are looking for a job through the year are able to find one. The figure is close to 52 per cent in rural India. This tells you the real state of India’s unemployment scenario rather than the rate of unemployment, which clearly doesn’t.”

“Yeah, it does. So, what is the real state of India’s unemployment. Are there any estimates for that?”

“A recent report titled OECD Economic Surveys India puts the rate of unemployment among India’s youth between the ages of 15 and 29 at more than 30 per cent. These youths are neither employed nor in education or training,” I replied.

“But tell me something what’s wrong with people working in agriculture after all bharat ek krishi pradhan desh hai (India is a country where the main activity of people is farming),” said my friend, coming up with a cliché.

“In agriculture, across the generations the plot sizes of land have become smaller and smaller. You know, the average size of the plot was around 2.82 hectares in 1970-1971 and by 2010-2011 this had fallen to 1.16 hectares. The 2010-2011 data point is the latest data point that is available, and since then the plot sizes for agriculture would have fallen even more,” I explained. (one hectare = 2.5 acres).

“How do you remember so many data points,” my friend asked.

“You forget this is a quasi-fictional conversation my friend,” I replied. “And we are both characters in the hands of the writer, who also happens to be me.”

“Ah. So, agriculture is no longer as viable as it used to be,” said my friend, getting back to the point.

“Yes. Hence, people need other kinds of jobs.”

“Yes, that is clear.”

“Interestingly that explains why several land-owning castes across the country which includes Jats in Haryana, Patels in Gujarat, Marathas in Maharashtra and Kapus in Andhra Pradesh want reservations in government jobs. With size of agriculture plots falling across generations, agriculture is no longer as viable as it used to be. Hence, they want government jobs.”

“So, what kind of jobs are a majority of this individuals entering the workforce good for?” my friend asked.

“If I were to talk like an economist, India’s natural comparative advantage is in low-skilled jobs.”

“Come on. I know you never went anywhere near an Economics text book. Try talking in simple English.”

“Our school education system has been totally screwed up over the years, with the learning outcomes coming down dramatically,” I said, speaking in simple English. “Madhav Chavan, of the Pratham Education Foundation estimates that in the period of the ten years up to 2015, 10 crore children completed primary school without the ability to do some basic reading and mathematics. This makes it very difficult for a lot of people to get into any kind of an office job or even a semi-skilled job, which requires the ability to read, write or do some basic maths,” I explained.

“Oh, that doesn’t leave much scope for anything but low-end labour jobs.”

“Yes. When move people move from agriculture they first move towards low-end construction jobs.”

“So why isn’t the same happening in India?”

“Because there isn’t as much construction happening as there should.”

“Meaning?”

“Companies aren’t expanding because they have borrowed a lot of money and are finding it difficult to repay the bank loans they have taken on. That means less construction. In fact, all the large borrowing by corporates has also left India’s government owned public sector banks in a mess. They are also not in a mood to lend to corporates.”

“But what about the government, construction isn’t just about corporates. India has an extremely poor physical infrastructure, which only the government can build and improve.”

“Yes, you are right. The government has been spending money on developing physical infrastructure and that does create jobs in construction. But there is only so much that the government can spend every year without ruining its finances.”

“What about real estate?” asked my friend, a question that I was waiting for. “Construction happens there as well.”

“Yes, real estate is one sector that can actually create jobs for the low-skilled workers who are entering the workforce or moving away from agriculture.”

“So, what is the problem?”

“The eight biggest cities form the largest part of the real estate market in the country. And the price rise in real estate in these 8 cities has made most homes being built very expensive and beyond what most people can afford. In fact, this has now reached a stage where the real estate builders aren’t building new stuff and at the same time they are having a difficult time trying to sell off what they had built. Hence, things have more or less come to a standstill.”

“Basically, the real estate sector is in a moribund state,” my friend stated.

“Yes, that is the right word to be used.”

“What can revive the sector?”

“A fall in prices and a massive one. But that hasn’t happened for a while even though prices have not gone anywhere in the last few years.”

“Why is that not happening?”

“There are multiple reasons for the same,” I replied. “Most Indian real estate companies are fronts for the ill-gotten wealth of politicians. The builders who operate as fronts have promised a certain rate of return to politicians, and hence, are not able to cut prices. This is one possible explanation. Another explanation that keeps getting offered is the fact that the builders and politicians have made a lot of money over the years, and hence, are in no hurry to cut prices to sell the real estate inventory of homes that has been built up.”

“That’s too generic,” my friend replied. “You need to be a little more specific than just that.”

“We need to understand the influx of black money in real estate in a little more detail. The question is why does a builder take a portion of the payment when he sells a flat or a house, in black, i.e., in cash? I think it is very important to understand this. He takes a payment in cash because he needs to make payments in cash. He needs to pay his suppliers in cash. But more importantly he needs to pay politicians and bureaucrats in cash.”

“Now that is getting interesting.”

“Unless a builder has politicians and bureaucrats in his pocket, it is very difficult for him or her to be in the business of real estate, given how complicated the regulations governing the sector are in state after state, in India. The speed money paid to politicians and bureaucrats essentially helps builders stay in the game. And this speed money cannot be paid in cheque or through NEFT/RTGS/IMPS and so on. It has to be paid in cash.”

“Yes.”

“And this cash can only come from the buyer who is buying the flat or the homes that the builder has built. Hence, genuine buyers turn their white money into black, every time they buy a house to live in. And then there are investors who are looking to put their black money to some use. For them real estate remains the best mode of investment. And this black money also ensures that prices don’t fall.”

“Yes. This makes sense.”

“The politician other than seeking a bribe in the form of cash needs cash to fight elections. Fighting elections in India has become a very expensive proposition over the years. Even in a municipal election in a big city, a serious candidate has to spend a crore or two, with the risk of not getting elected. Where does a lot of this money come from? From real estate. This also explains why the rules and regulations governing real estate in states across India remain so convoluted. This allows state level politicians to demand their cut every time a new real estate project is proposed. It also explains why real estate has not been brought under the ambit of Goods and Services Tax.”

“Hmmm.”

“So, the point is that unless electoral financing in India is cleaned up, the real estate sector won’t get cleaned up. Unless real estate sector gets cleaned up, construction in the sector won’t pick up. And unless construction picks up, the sector won’t be able to create any jobs. And unless there are jobs in this sector, many of the one million Indians entering the workforce every month will continue to remain unemployed. India’s so called demographic dividend might turn into a demographic disaster.”

“Now that was very interesting,” my friend said.

“Interesting. But a tad simplistic as big picture conversations are.”

“And how do I get into the details?”

“You can read my new book India’s Big Government—The Intrusive State and How It is Hurting Us,” I replied.

By then the kebabs had come and it was time to eat.

The column originally appeared on Equitymaster on April 27, 2017.

One Letter That Explains Most of India’s Economic Problems

indian flag

In the Letters that I have written till date, I have tried to build a logical argument on the basis of data. Given this context, this Letter is different from the usual. The idea for this Letter came from a random conversation with a dear friend who works as a writer in the Mumbai film industry.

Typically, when I write to you, dear reader, I get into a lot of detail with numbers, graphs and tables, in order to explain a single issue. While it is important to have a good understanding of individual issues that plague the Indian economy, at the same time it is important to have a Big Picture understanding as well.

As they say, getting into too much detail about any issue leads to a situation where you can miss the wood for the trees. To set this right, in this piece I will try and explain what I see are the biggest problems which are likely to hold the Indian economy back in the years to come and how they are linked with each other, the 7-8 per cent official economic growth rate notwithstanding.

I have written this Letter in the form of a conversation I had with my friend. Of course, this is not the real conversation I had. Real conversations cannot be as well-structured as any writeup can be. Nevertheless, in an ideal world this is the conversation I should have had, if the idea was to explain to my friend India’s economic situation, the way I see it.

So here we go.

It has been many years since I walked the lanes of Versova, a quaint suburb of Mumbai, where the rich strugglers of the Indian film industry also stay along with the stars. (The poorer ones stay in Oshiwara). A 15-minute walk from a coffee shop and I am at my friend’s place.

As soon as he opens the door, one of the two cats he has, jumps on me. Funnily, I don’t recall the name of the cat. “He is just trying to be friendly, Sir!” my friend says. Once upon a time I had a morbid fear of cats. But living in a building which is full of cats, this fear has gone away.

I went in and made myself comfortable on the sofa and had a cup of black coffee, which my friend had made. Like any normal Indian I like a dash of sugar in my coffee (though I am perfectly fine with sugarless tea). This is something my friend finds a little odd. “Who puts sugar in black coffee?” he asks rather animatedly. And I ended up with sugarless black coffee, which as they say is an acquired taste. Now that is something that you say when you don’t like something and are trying to fit in.

After an hour of talking about films and politics, we somehow end up talking about the Indian economy, of all things. This, even though I make it a point not to talk shop when I am with friends.

And honestly, I don’t recall how I ended up talking about one million Indians entering the workforce every month, India’s so called demographic dividend. “So, you know one million Indians are entering the workforce every month,” I said. “This means 1.2 crore during the year, which is half of Australia’s population.”

“What is the big deal asked my friend?” asked my friend. “As people age, at some point of time they need to start making a living and enter the workforce.”

“True. But as they enter the workforce, they need to find jobs, which they currently aren’t.”

“Ah. Jobs. Yes. I once had a job, you know, with a newspaper,” my friend said, getting a tad melodramatic.

“Yes. You did,” I said. “So, there are 1.2 crore individuals Indians entering the workforce every year and there are very few jobs being created for them. And that is a huge problem.”

“But I remember reading somewhere last year that India’s rate of unemployment was just 5 per cent.”

“Yes,” I replied.

“How do you reconcile this with the fact that those entering the workforce are not finding jobs?” my friend asked.

“Oh, that is because of the way unemployment is calculated. There are two methods. In one method, anyone who has been employed for 183 days is considered employed. As per this method the rate of unemployment is 5 per cent. In another method, anyone who has been employed for the last 30 days is considered employed. As per this method, the rate of unemployment is even lower at 3.7 per cent. Hence, you could be unemployed for a major part of the year and still be considered employed.”

“Ah, this is that classic statistics are like bikinis point…”

“Yes. Interestingly, only 60 per cent of Indians who are looking for a job through the year are able to find one. The figure is close to 52 per cent in rural India. This tells you the real state of India’s unemployment scenario rather than the rate of unemployment, which clearly doesn’t.”

“Yeah, it does. So, what is the real state of India’s unemployment. Are there any estimates for that?”

“A recent report titled OECD Economic Surveys India puts the rate of unemployment among India’s youth between the ages of 15 and 29 at more than 30 per cent. These youths are neither employed nor in education or training,” I replied.

“But tell me something what’s wrong with people working in agriculture after all bharat ek krishi pradhan desh hai (India is a country where the main activity of people is farming),” said my friend, coming up with a cliché.

“In agriculture, across the generations the plot sizes of land have become smaller and smaller. You know, the average size of the plot was around 2.82 hectares in 1970-1971 and by 2010-2011 this had fallen to 1.16 hectares. The 2010-2011 data point is the latest data point that is available, and since then the plot sizes for agriculture would have fallen even more,” I explained. (one hectare = 2.5 acres).

“How do you remember so many data points,” my friend asked.

“You forget this is a quasi-fictional conversation my friend,” I replied. “And we are both characters in the hands of the writer, who also happens to be me.”

“Ah. So, agriculture is no longer as viable as it used to be,” said my friend, getting back to the point.

“Yes. Hence, people need other kinds of jobs.”

“Yes, that is clear.”

“Interestingly that explains why several land-owning castes across the country which includes Jats in Haryana, Patels in Gujarat, Marathas in Maharashtra and Kapus in Andhra Pradesh want reservations in government jobs. With size of agriculture plots falling across generations, agriculture is no longer as viable as it used to be. Hence, they want government jobs.”

“So, what kind of jobs are a majority of this individuals entering the workforce good for?” my friend asked.

“If I were to talk like an economist, India’s natural comparative advantage is in low-skilled jobs.”

“Come on. I know you never went anywhere near an Economics text book. Try talking in simple English.”

“Our school education system has been totally screwed up over the years, with the learning outcomes coming down dramatically,” I said, speaking in simple English. “Madhav Chavan, of the Pratham Education Foundation estimates that in the period of the ten years up to 2015, 10 crore children completed primary school without the ability to do some basic reading and mathematics. This makes it very difficult for a lot of people to get into any kind of an office job or even a semi-skilled job, which requires the ability to read, write or do some basic maths,” I explained.

“Oh, that doesn’t leave much scope for anything but low-end labour jobs.”

“Yes. When move people move from agriculture they first move towards low-end construction jobs.”

“So why isn’t the same happening in India?”

“Because there isn’t as much construction happening as there should.”

“Meaning?”

“Companies aren’t expanding because they have borrowed a lot of money and are finding it difficult to repay the bank loans they have taken on. That means less construction. In fact, all the large borrowing by corporates has also left India’s government owned public sector banks in a mess. They are also not in a mood to lend to corporates.”

“But what about the government, construction isn’t just about corporates. India has an extremely poor physical infrastructure, which only the government can build and improve.”

“Yes, you are right. The government has been spending money on developing physical infrastructure and that does create jobs in construction. But there is only so much that the government can spend every year without ruining its finances.”

“What about real estate?” asked my friend, a question that I was waiting for. “Construction happens there as well.”

“Yes, real estate is one sector that can actually create jobs for the low-skilled workers who are entering the workforce or moving away from agriculture.”

“So, what is the problem?”

“The eight biggest cities form the largest part of the real estate market in the country. And the price rise in real estate in these 8 cities has made most homes being built very expensive and beyond what most people can afford. In fact, this has now reached a stage where the real estate builders aren’t building new stuff and at the same time they are having a difficult time trying to sell off what they had built. Hence, things have more or less come to a standstill.”

“Basically, the real estate sector is in a moribund state,” my friend stated.

“Yes, that is the right word to be used.”

“What can revive the sector?”

“A fall in prices and a massive one. But that hasn’t happened for a while even though prices have not gone anywhere in the last few years.”

“Why is that not happening?”

“There are multiple reasons for the same,” I replied. “Most Indian real estate companies are fronts for the ill-gotten wealth of politicians. The builders who operate as fronts have promised a certain rate of return to politicians, and hence, are not able to cut prices. This is one possible explanation. Another explanation that keeps getting offered is the fact that the builders and politicians have made a lot of money over the years, and hence, are in no hurry to cut prices to sell the real estate inventory of homes that has been built up.”

“That’s too generic,” my friend replied. “You need to be a little more specific than just that.”

“We need to understand the influx of black money in real estate in a little more detail. The question is why does a builder take a portion of the payment when he sells a flat or a house, in black, i.e., in cash? I think it is very important to understand this. He takes a payment in cash because he needs to make payments in cash. He needs to pay his suppliers in cash. But more importantly he needs to pay politicians and bureaucrats in cash.”

“Now that is getting interesting.”

“Unless a builder has politicians and bureaucrats in his pocket, it is very difficult for him or her to be in the business of real estate, given how complicated the regulations governing the sector are in state after state, in India. The speed money paid to politicians and bureaucrats essentially helps builders stay in the game. And this speed money cannot be paid in cheque or through NEFT/RTGS/IMPS and so on. It has to be paid in cash.”

“Yes.”

“And this cash can only come from the buyer who is buying the flat or the homes that the builder has built. Hence, genuine buyers turn their white money into black, every time they buy a house to live in. And then there are investors who are looking to put their black money to some use. For them real estate remains the best mode of investment. And this black money also ensures that prices don’t fall.”

“Yes. This makes sense.”

“The politician other than seeking a bribe in the form of cash needs cash to fight elections. Fighting elections in India has become a very expensive proposition over the years. Even in a municipal election in a big city, a serious candidate has to spend a crore or two, with the risk of not getting elected. Where does a lot of this money come from? From real estate. This also explains why the rules and regulations governing real estate in states across India remain so convoluted. This allows state level politicians to demand their cut every time a new real estate project is proposed. It also explains why real estate has not been brought under the ambit of Goods and Services Tax.”

“Hmmm.”

“So, the point is that unless electoral financing in India is cleaned up, the real estate sector won’t get cleaned up. Unless real estate sector gets cleaned up, construction in the sector won’t pick up. And unless construction picks up, the sector won’t be able to create any jobs. And unless there are jobs in this sector, many of the one million Indians entering the workforce every month will continue to remain unemployed. India’s so called demographic dividend might turn into a demographic disaster.”

“Now that was very interesting,” my friend said.

“Interesting. But a tad simplistic as big picture conversations are.”

“And how do I get into the details?”

“You can read my new book India’s Big Government—The Intrusive State and How It is Hurting Us,” I replied.

By then the kebabs had come and it was time to eat.

The column originally appeared on Equitymaster on April 27, 2017.

Bank Lending Down by Half in 2016-2017

RBI-Logo_8

On April 6, 2017, the Reserve Bank of India(RBI) published the latest Monetary Policy Report. Buried on page 40 of the report is a very interesting data point which rather surprisingly hasn’t been splashed on the front pages of the pink papers as yet.

In 2016-2017, Indian banks gave out total non-food credit worth Rs 3,65,500 crore. Banks give working-capital loans to the Food Corporation of India(FCI) to carry out its procurement actions. FCI primarily buys rice and wheat directly from Indian farmers using the loans it takes from banks. When these loans are subtracted from overall loans given out by banks, we arrive at non-food credit.

In 2015-2016, the total non-food credit of banks had amounted to Rs 7,02,400 crore. What this means that non-food credit came crashing down by close to 48 per cent during the course of 2016-2017, the last financial year. To put it simply, this basically means that in 2016-2017, banks lent around half of what they had lent out in 2015-2016.

The important question is why has this happened? A major reason for this is that the total outstanding loans to industry has actually shrunk in 2016-2017(between April 2016 and February 2017, which is the latest data available) by Rs 60,064 crore. This basically means that Indian banks on the whole, did not give a single new rupee to industry as a loan during the course of 2016-2017.

And the reason for that is very straightforward. Over the years many corporates have defaulted on the loans they had taken on from banks, in particular public sector banks. And this explains why banks are not in the mood to lend to corporates anymore. As they say, one bitten twice shy.

In fact, as on December 31, 2016, the gross non-performing assets or bad loans of public sector banks had stood at Rs 6,46,199 crore, having jumped by 137 per cent over a period of two years. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. The bad loans of private banks as on December 31, 2016, stood at Rs 86,124 crore.

A major chunk of these defaults has come from corporates. As of March 31, 2016, the total corporate bad loans of public sector banks had stood at Rs 3,36,124 crore or 11.95 per cent of the total loans given out to corporates. It formed a little more than 62 per cent of the total bad loans. This is the latest number I could find in this context. There is enough anecdotal evidence to suggest that the situation has worsened since then.

Given this, as I said earlier, banks are not in the mood to lend to corporates. Hence, their overall lending for 2016-2017 has shrunk by half in comparison to 2015-2016.

The interesting thing is that while Indian banks may not be lending as much, the other sources of funding haven’t really dried up. Private placements of debt jumped up majorly in 2016-2017 in comparison to 2015-2016 and so did issuance of commercial paper by non-financial entities. Over and above this, the foreign direct investment into the country continued to remain strong. During 2016-2017, FDI worth Rs 2,53,500 crore came into the country. This was more or less similar to the amount that came in 2015-2016.

In total, the flow of financial resources to the commercial sector stood at Rs 1,262,000 crore, the RBI estimate suggests. This is around 12.1 per cent lower than the last year. Hence, the overall availability of money has shrunk but the situation is not as bad as bank lending data makes it out to be.

Basically, while banks may not want to lend to corporates, there are other sources of funding that do remain strong. Having said that, a fall of more than 12 per cent in total flow of financial resources to the commercial sector, is not a good sign on the economic front. This can only be corrected only after banks come back into the mood to lend to corporates. And that will only happen when banks get into a position where they are able to recover back from corporates a significant chunk of their bad loans. As of now no such signs are visible.

 

The column originally appeared in the Daily News and Analysis on April 25, 2017

The Unseen Effects of Banning Alcohol Along Highways

Bastiat

Sometime back the Supreme Court prohibited the sale of liquor within 500 metres of state highways and national highways. As it said in its second judgement on the issue: “India has a high rate of road accidents and fatal road accidents – one of the advisories states that it is the highest in the world with an accident occurring every four minutes.”

It further pointed out: “There is a high incidence of road accidents due to driving under the influence of alcohol… The existence of liquor vends on national highways is in the considered view of…expert authorities with domain knowledge—a cause for road accidents on national highways.”

The point being that people get drunk at shops and restaurants around highways, drive under the influence of alcohol and then cause accidents.

It is important to try and understand why people in India drink in shops and restaurants around highways. It’s not considered a good thing in India to be seen drinking with friends, colleagues and acquaintances. Hence, people like to drink outside the city near highways, so that they don’t get seen by the people whom they happen to know.

The question is will this banning of the sale of alcohol lead to a fewer accidents. Before I try and answer this question I will have to take a brief detour in order to introduce a 19th century French economist called Frédéric Bastiat.

In an essay titled That Which is Seen, and That Which is Not Seen, he wrote: “In the department of economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously—it is seen. The other unfold in succession—they are not seen: it is well for us if they are foreseen.”

In the case of the Supreme Court’s decision to ban alcohol along highways what is seen is that once shops and restaurants selling alcohol shutdown, it would lead to a major loss of taxes for the state governments. State governments earn taxes on the manufacture and sales of alcohol. If shops shutdown, then these earnings will fall.

This is something that the Supreme Court judgement has foreseen: “The states are free to realise revenues from liquor licences in the overwhelmingly large swathe of territories that lie outside the national and state highways and the buffer distance of 500 metres.”

Hence, the Supreme Court does not think that its decision would lead to lower taxes because the government could offer more licenses away from the highway. This is something that the government will eventually do. Meanwhile, what state governments have started to do in order to get around the decision is to denotify highways and have turned them into local, municipal or district roads, so that the sale of alcohol can continue. In many cases this is justified because highways are a part of the city and not outside it.

This has been done in order to ensure that the taxes from alcohol keep coming in. This is the unseen effect which Bastiat talked about and the Supreme Court decision did not foresee. In fact, the government of Maharashtra recently hiked the drought cess on petrol from Rs 6 to Rs 9, even when there is no drought in sight. This has been done to make up for the loss of revenue from shutting down of alcohol shops around highways.

Another unseen effect lies in the fact that those who used to go out of the city to drink in shops and restaurants along the highway, will now have to drink in the city. And if they drive after drinking, accidents will continue to happen. Given that they may not have to drive as long as they had to do in the past, the rate might fall.

Hence, the basic issue in this case is not drinking, but driving after drinking. And that cannot be solved by banning alcohol along highways. It can only be solved by better policing, in the city as well as on the highways.

 

The column originally appeared in the Bangalore Mirror on April 26, 2017

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

RBI-Logo_8

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