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


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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

[iii]  Desan 2010

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

After Farm Loans, Will Govts Waive Off Mudra Loans Next?


A few days back I suggested on Twitter that people with outstanding home loans should organise themselves and ask the government to waive off their loans.

This idea basically came from several state governments waiving off loans given to farmers. It was started by Andhra Pradesh and Telangana, the two states to come out of the erstwhile Andhra Pradesh.

Then it was followed in Uttar Pradesh, where the newly elected government decided to waive off farm loans of around Rs 36,359 crore. It was followed by Maharashtra.

There is a clear trend here. Maharashtra chief minister Devendra Fadnavis recently explained his decision to waive off loans to farm loans by saying:Neighbouring Telangana and Andhra did it first. It created pressure and then UP announced the waiver. The demand had been there but it became very strong after UP’s decision.”

The idea also came from the fact that banks were busy treating large corporates which had defaulted on their loans, with kids gloves, by restructuring their loans and giving them a longer time to repay. This was basically happening because the corporates owed a large amount of money to banks. And any default would hit them hard.

Now as a home loan borrower, try going to a bank and ask for the postponement of payment of EMI to repay the home loan and see how a bank reacts. Obviously, different kind of borrowers get treated differently.

What has helped the cause of the farmers is that they are numerous in number and the fact that they are organised, which helps them carry out protests at a level so that the government registers it. What has helped the corporates is that their average loan amounts are very large and any default would hit the banks hard.

These factors are missing in case of individuals who have taken on home loans. They are not many in number. They are spread across the length and breadth of India. And they are not organised. In 2013, the number of outstanding home loans stood at 46.43 lakh. I couldn’t find a more recent number. Over and above this, there would be home loans given by housing finance companies, as well.

Typically, the outstanding home loans (in value) are around 60:40 (scheduled commercial banks: housing finance companies). Taking the housing finance companies into account, as well as the fact that the total outstanding home loans may have gone up from where they were in 2013, it is safe to say that the total number of outstanding home loans will be still less than 1 crore.

Also, the individuals who have taken on these home loans would be spread across the length and breadth of the country. Hence, it is difficult for them to get together and protest that the government waive off their home loans, like has been the case with farm loans. The same stands for other kinds of retail loans which have smaller average ticket value, in comparison to the home loan, which is usually the largest loan that an individual ever takes on.

Over and above this, the average loan amount owed by them is very small and that ensures that they are likely to face the full legal wrath of the bank, if they default on their home loans, which is not the case with corporates.

Having said that, there is a precedent of a government waiving off home loans as well. In December 2016, the Telangana government had announced a waiver of home loans of around Rs 3,920 crore to individuals who had benefitted from the housing schemes for economically weaker sections of the society over the years.

So, if individuals with home loans, can get themselves organised they might also be able to get a loan waive off.

But there is one particular kind of borrower, who is in a position to organise himself, protest and ask for a loan waive off.

In 2016-2017 and 2015-2016, the total amount of loans extended under the Pradhan Mantri Mudra Yojana (PMMY or better known as Mudra loans) stood at Rs 3,17,977.81 crore. The total number of borrowers over the two-year period stood at around 7.46 crore. A bulk of these loans have been made to women.

Taking cue from farmers, if these borrowers can manage to organise themselves and protest and demand a waive off of their loans, there is a good chance that they might get it. Assuming that only one individual in one household has got a loan under PMMY, we are looking at 7.46 crore households. At five members per household, we are looking at more than 37 crore individuals, on whom these loans have had some impact. And that is a large vote bank.

If these individuals can get themselves organised they are in a very good position to demand and get a waive off on their PMMY loans. Also, the governments have already set a precedent and will find it very difficult to say no.

This will be especially true for states where elections are scheduled before the Lok Sabha election of 2019. On a totally different note, they might not even need to take it up as an issue, some lazy politician might just do the job for them, by promising a waive off.
And that is the problem with these waive offs. They are unlikely to stop in a hurry.

The column originally appeared on June 19, 2017, on Equitymaster.


Narendra Modi and the Oil Lottery


Three weeks ago, the Narendra Modi government completed three years in office. On the occasion, the media went to town discussing the performance of the government. The general opinion among analysts, television anchors and economists, who have a thing or two to say on such matters, was that the government had done well on the economic front, given that that the Indian economy grew by 7.5 per cent per year over the last three years. In coming to this conclusion, these individuals did not take one thing into account: the falling price of crude oil.

When Narendra Modi was sworn in as prime minister in late May 2014, the price of the Indian basket of crude oil was a little over $108 per barrel. As of June 8, 2017, a little over three years later, the price of the Indian basket of crude oil stood at $48 per barrel, around 56 per cent lower.

Lest I be accused of making only a point to point to comparison, take a look at the following figure.

Source: Petroleum Planning and Analysis Cell.

In May 2014, the average daily price of the Indian basket of crude oil was $106.85 per barrel. It rose in June 2014 to $109.05 per barrel. And then the price of oil started to fall. Since June 2014, the overall trend in oil prices, has been on its way down (as can be seen by the red arrow). Even though prices have gone up in the recent past, they are well below where they were between mid-2011 and mid-2014.

This can be best described as the luck of Narendra Modi. At least on the economic front, lower oil prices have made the Modi government look good.

I first made this point in the weekly Letter that I write. The foremost impact of lower oil prices has been on the rate of economic growth. Let’s try and create a counterfactual situation here by trying to figure out how economic growth would have turned out to be if the oil prices in the last three years, were as high as they were during the time when Manmohan Singh was the prime minister.

At its most basic level, the gross domestic product (GDP) is expressed as Y = C + I + G + NX, where:

C = Private Consumption Expenditure
I = Investment
G = Government Expenditure
NX = Exports minus imports

India imports around four-fifths of the oil that it consumes. To be very precise, in 2016-2017, the actual import dependency or the proportion of crude oil consumed that is imported stood at 82.1 per cent.

Given this, net exports (or NX) in the GDP tends to be a negative number. Higher oil prices essentially ensure that oil imports go up. Oil imports going up leads to the net exports number becoming a larger negative entry. In the process, the GDP number comes down and the GDP growth comes down as well.

The reverse is also true. Hence, when oil prices come down, the NX number comes down, the GDP goes up, and in the process the GDP growth goes up as well. This is precisely what has happened over the last three years.

As per the latest GDP numbers declared on May 31, 2017, the economic growth during the last three years stood at 7.5 per cent per year. This was primarily because the average price of Indian crude oil between April 2014 and March 2017, stood at $59.3 per barrel. In comparison, the average price of crude oil between April 2011 and March 2014 had been $108.5 per barrel.

Now, let’s assume that the average net exports figures were at the same level during the Narendra Modi years as they had been when Manmohan Singh was the prime minister between 2011-2012 and 2013-2014. We are basically trying to figure out as to what would have happened if the price of oil had continued to be at a high level even after 2014.

What impact would have this had on the economic growth? The economic growth during the three-year period that Modi has governed would have been 6.5 per cent per year, and not the 7.5 per cent that it has come to. This is nearly 100 basis points lower.

Let’s compare this to the economic growth during the last two years of Manmohan Singh’s government. (I am using the last two years because in case of the new GDP series launched in January 2015, data starts only from 2011-2012.) The economic growth stood at 5.9 per cent.

While this is lower than the three-year economic growth during Modi’s era, it is not as low as it initially seemed. And that is primarily because of lower oil prices during Modi’s time as the prime minister.

So, lower oil prices have bumped up the economic growth figure. They have also benefited the government in another way. The benefit of lower oil prices hasn’t been passed on to consumers in the form of lower petrol and diesel prices.

As mentioned earlier, between May 2014 and now, the price of the Indian basket of crude oil has fallen by 56 per cent. During the same period, the petrol price in Mumbai has fallen by a mere 1.9 per cent. In case of diesel, the price has fallen by only 3.6 per cent.

Hence, the central government and the state governments have totally managed to capture the fall in oil prices. If we look at the central government, the net excise duty collections of the central government stood at around Rs 1,76,535 crore in 2013-2014. This has jumped by more than 100 per cent to Rs 3,87,369 crore by 2016-2017, primarily because the government chose to capture a bulk of the fall in price of oil by increasing excise duty on petrol as well as diesel.

This helped the government to keep increasing its expenditure without having to bother about a large fiscal deficit.

It is interesting to speculate what would have happened if the government had passed on the fall in the price of crude oil to consumers in the form of lower petrol as well as diesel prices. Consumers would have had more money to spend. And robust consumer spending is always a better way to create economic growth than a terribly leaky government spending.

To conclude, while the Modi government has done better in the last three years than the Manmohan Singh government did in its last two years, the fall in the price of crude oil has been a major reason behind it. Modi has been terribly lucky, and it’s time that analysts and economists acknowledged this reality.

The interesting thing here is that people have a hard time distinguishing between luck and skill. As Michael Mauboussin writes in The Success Equation: “Our minds have an amazing ability to create a narrative that explains the world around us, an ability that works particularly well when we already know the answer.” In Modi’s case, this has meant attributing India’s good official economic growth rate to his skill rather than to the fact that he got lucky.

The column originally appeared on on June 14, 2017.

Farm loan waive offs are really not a solution, only temporary relief


On June 11, 2017, Devendra Fadnavis, the chief minister of Maharasthra, decided to follow his Uttar Pradesh counterpart, Yogi Adityanath, in waiving-off loans to farmers in Maharashtra. The loans of small and marginal farmers have been waived off with immediate effect.

As far as other farmers are concerned, a committee has been set up to decide on a criteria for a further waive off. Initial estimates being made in the media suggest that this loan waiver will cost the Maharashtra government anywhere between Rs 25,000 crore to Rs 30,000 crore.

The union finance minister Arun Jaitley has refused to finance farm loan waive offs of the state governments. Given this, the government of Maharashtra will have to finance this waive off on its own, in order to repay the banks which have given these loans.
How will this impact the finances of the government of Maharashtra? In 2017-2018, the government of Maharashtra was expected to run a fiscal deficit of Rs 37,789 crore or 1.53 per cent of the GDP. Fiscal deficit is the difference between what a government earns and what it spends. (The source of all the numbers reflecting the financials of the Maharashtra government is

The loan waive offs to the farmers is expected to cost the farmers Rs 25,000 crore to Rs 30,000 crore. The state will have to finance this through borrowing more and this will add to the fiscal deficit of the state. At the upper level of Rs 30,000 crore, this would mean that the fiscal deficit would jump to Rs 67,789 crore or 2.74 per cent of the state gross domestic product (GDP), if everything else remains the same.

Even with the farm loan waiver the state’s fiscal deficit will be well within the 3 per cent limit that had been prescribed by the 14th Finance Commission. Having said that this borrowing will not do any good to the overall borrowings of Maharashtra.

In 2017-2018, the total debt of the government of Maharashtra is expected to be a little over Rs 4.13 lakh crore. The farm loan waiver will add another Rs 30,000 crore to this. In absolute terms, Maharashtra is the most indebted among all states in the country.

Though when expressed as a percentage of the state’s GDP, this comes to around 18 per cent of the state’s GDP, which is not very high in comparison to other states.

While the finance minister Arun Jaitley has stayed away from financing the farm loan waive offs of state governments, the question is does it really matter? The central government actually guarantees the debt taken on by the state government. Hence, in effect, the borrowings of the state governments are also effectively liabilities of the central government.

The only thing that Jaitley’s stance does is that it keeps the fiscal deficit of the central government under control. But the overall fiscal deficit of the central government and the state governments does go up, and that is the figure that matters.

The overall fiscal deficit of states has been a reason for worry in the recent past. In 2013-2014, the overall fiscal deficit of the state governments stood at 2.2 per cent of the GDP. This jumped to 3.6 per cent of the GDP in 2015-2016 before falling to 2.9 per cent of the GDP in 2016-2017.

With states like Maharashtra and Uttar Pradesh before it, waiving off loans to farmers, the overall fiscal deficit of the states, will go up again in 2017-2018. More states are expected to follow suit. Demands are already being made in states like Punjab and Tamil Nadu for farm loan waivers. Given that several states have already waived off loans to farmers, other states will find it difficult not to waive off loans, as and when the demands start coming in.

This will push up the overall fiscal deficit of the nation.

When governments borrow more, they crowd out private borrowing and in the process, push up interest rates. While, the likelihood of something like this happening immediately are low because the growth in private borrowing remains slow. But as and when the economy picks up, there will be a problem.

Also, newsreports suggest that farmers have now started defaulting on their loans in expectation of the government of the state that they live in, waiving off their loan. In economics, this is termed as a moral hazard.

The economist and former Vice-Chairman of the Federal Reserve of the United States, Alan Blinder, writing in After the Music Stopped, says that “the central idea behind moral hazard is that people who are well insured against some risk are less likely to take pains (and incur costs) to avoid it”. In this context, it means farmers defaulting on their loans in expectation of them being waived off. It also leads to a deterioration in the credit culture, with farmers being expected their debts to be waived off even in the future.

Also, waive offs do not solve any of the structural problems of Indian agriculture. The biggest problem of Indian agriculture is that it employs many more people than it should. Agriculture employs close to half of India’s workforce and contributes around 14 per cent of the GDP. Clearly, people need to be moved away from agriculture. But for that low-skill jobs need to be created elsewhere, which is not happening.

Further, the average plot size on which agriculture is carried out over the years, has fallen dramatically over the years, making agriculture unviable in many cases. But it’s not easy to buy or sell agri land, given the change in land usage norms, or even otherwise. This makes it difficult for farmers to unlock some value of their land and raise the capital for doing something else.

Also, it does not help that infrastructure to sell and store agriculture produce in the country remains pathetic. Take the case of pulses. 2016-2017 was a year of bumper production in pulses, with the production going up by more than 35 per cent. But with very little storage facilities, farmers have had to make distress sales and the price of pulses has fallen by 19.5 per cent in May 2017, in comparison to the same period last year.

Unless, these wrongs are set right, waive offs of loans to farmers are only going to offer temporary relief to the farmers, and things will be soon back to as they were earlier.

The column appeared in on June 14, 2017

When Media Covers Economics, Simple Becomes Simplistic


If front pages of the so-called national newspapers published out of Delhi are to be believed, all is not well between the Reserve Bank of India (RBI) and the ministry of finance. The ministry of finance wants the RBI to cut interest rates and the RBI is not in the mood to do so.

The impression that is created by such newsreports is that interest rates are holding back economic growth. If interest rates were to be cut, consumers would borrow and spend more, and at the same time corporates would borrow more and expand their businesses.
This sounds very simple and straightforward. As Julia Shaw writes in The Memory Illusion: “For our work to carry significance, we must be able to explain it simply.”

Nowhere, does this apply more than in the media, be it newspapers, websites or television. The effort is always to make things as readable and as understandable as possible for the audience.

In doing so, the nuances get lost. While the idea is to make things simple, they end up becoming simplistic. As Shaw writes: “When I explain concepts by using analogies, stories or simplifications, I always risk losing some of the nuances of the inherently complex issues under discussion.”

Lower interest rates leading to greater lending and in turn economic growth is one such thing. Since the beginning of January 2015, interest rates have been on their way down, but that hasn’t led to increased lending, as theoretically it should have.

In 2016-2017, the total fresh lending carried out by banks stood at 44 per cent of the total fresh lending carried out by banks in 2015-2016. This, even though interest rates at which banks lent in 2016-2017 were lower than the interest rates in 2015-2016.
So, what happened here? Bank lending to corporates contracted in 2016-2017.

This basically means that overall, banks did not make any fresh loans to corporates in 2016-2017. Corporates have defaulted on a significant portion of the bank loans they had taken on in the past. Given this, banks are not in the mood to lend to corporates.

Over and above this, the good corporates who have not defaulted on loans and are in a position to repay, are not in a mood to borrow from banks. In some cases, this is because there are other cheaper modes of finance available. And in some other cases, this is because of the simple fact that the current operations of the corporates are producing enough to meet the market demand. Hence, lower interest rates do not help. Corporates borrow when there is a need to borrow.

Now take the case of home loans. Between 2014-2015 and 2015-2016, fresh home loans given by banks fell by around 10 per cent. This jumped up by more than 25 per cent between 2015-2016 and 2016-2017. What happened here? Of course, lower interest rates helped to some extent. But what also helped where the government sops on home loan interest rates, as well as falling real estate prices in large parts of the country.

All this nuance goes missing, when an impression is created that lower interest rates lead to greater borrowing, which in turn leads to higher economic growth. As we have seen here that is clearly is not the case. As John Kenneth Galbraith points out in The Economics of Innocent Fraud: “Business firms borrow when they can make money and not because interest rates are low.”

Along similar lines, individuals borrow when they feel confident of being able to repay the EMI. This is not to say that lower interest rates do not lead to increased borrowing, but the truth is not as simple as that.

Also, none of these newsreports, bother to take into account the fact that people save a lot of their money using fixed deposits. And if interest rates on fixed deposits go down, it impacts the savings plans of many people. What about that?

The piece originally appeared in the Bangalore Mirror on June 14, 2017