Viewpoint: Why Modi’s currency gamble was ‘epic failure’

narendra modi
The Prime Minister, Shri Narendra Modi addressing the Nation on the occasion of 71st Independence Day from the ramparts of Red Fort, in Delhi on August 15, 2017.

The devil, as they say, is in the detail.

On Page 195 of the Reserve Bank of India’s latest annual report released on August 30, 2017, lies the answer to the question, a large part of India has been asking for close to ten months.

Has demonetisation been a success or a failure? As per the RBI data released in the annual report, it is safe to say that demonetisation has been a failure of epic proportions.

On November 8, last year, the Narendra Modi government decided to demonetise Rs 500 and Rs 1,000 notes, which were worth Rs 15.44 trillion notes in total. The idea was to attack both fake currency as well as black money or unaccounted wealth. The prime minister said so in his address to the nation announcing the demonetisation decision.
This was backed up by the government press release accompanying the decision. Black money is essentially money that has been earned but on which taxes haven’t been paid.

From the midnight between November 8 and November 9, 2016, the Rs 500 and Rs 1,000 notes, were not worth anything. The people holding these notes had to deposit them in their bank accounts. This money could later be withdrawn, though there were restrictions on the amount of the money that could be withdrawn immediately.

The hope was that black money held in the form of cash wouldn’t be deposited into banks, given that people holding this money wouldn’t want to be identified. In the process, a humongous amount of black money would be destroyed.

The RBI Annual Report on Page 195 says that demonetised notes worth Rs 15.28 trillion were deposited into banks, up to June 30, 2017. This basically means that almost 99 per cent of the demonetised money was deposited into banks. Hence, almost all the black money held in the form of cash, also made it back into the banks and wasn’t really destroyed, as had been hoped.

The conventional explanation for this is that most people who had black money found other people, who did not have black money, to deposit money into the banking system.

As far as detecting fake currency is concerned, nothing much seems to have happened on this front. Data from the RBI annual report tells us that the number of fake Rs 500 (old series) and Rs 1,000 notes detected between April 2016 to March 2017 was 5,73,891. The total number of demonetised notes stood at 24.02 billion. This basically means that as a proportion the fake notes identified between April 2016 to March 2017 stands close to 0 per cent of the demonetised notes.

The total number of Rs 500 and Rs 1,000 fake notes detected between April 2015 and March 2016, stood at 4,04,794. And this happened without any demonetisation. Hence, demonetisation has failed on its two major objectives.

The funny thing is that there were no estimates of how much of black money was held in the form of cash. The government admitted to the same as well, after having made the decision to demonetise. The finance minister Arun Jaitley said so in a written reply to a question in the Lok Sabha (one of the Houses of the Indian Parliament) on December 16, 2016, where he 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.”

The search and seize operations carried out by the Income Tax Department (popularly referred to as Income Tax raids) suggested that people tend to hold around 5 per cent of their black money in the form of cash.

But even this lack of data in public, did not stop economists from coming up with their own set of numbers, trying to defend this decision of the Modi government. Leading this charge was Columbia University economist Jagdish Bhagwati (along with two co-authors), who in a column in the Mint newspaper on December 27, 2016,  wrote: “Suppose we accept the estimate that one-third of the approximately Rs15 trillion in demonetised notes is black money.” These economists did not bother to explain, what logic did they base their assumption on.

Demonetisation has badly hit India’s large cash economy. As per the Bharatiya Mazdoor Sangh (the labour wing of the Bharatiya Janata Party, which currently governs the country): “As many as 2.5 lakh units in unorganised sector were closed and the real estate sector was badly affected where a large number of workers got unemployed.”

Agriculture trade, a sector which largely operates on cash, has been badly impacted as well, with farmers not getting adequate compensation primarily for vegetables and pulses, they had grown. This has led to farmers protests across the country, which has in turn led to several state governments waiving off farm loans.

Over and above this, demonetisation caused a huge cash shortage with people having to spend many days standing in ATM lines trying to withdraw their own money. Many people even died in the process.

As far as the Modi government is concerned they are unlikely to admit that demonetisation was a big mistake and will continue to put a positive spin around it, as they have from November 2016. Things will not change on that front.

To conclude, no relatively healthy economy in the past, has carried out demonetistaion. As the latest Economic Survey of the government of India points out: “India’s demonetisation is unprecedented in international economic history, in that it combined secrecy and suddenness amidst normal economic and political conditions. All other sudden demonetisations have occurred in the context of hyperinflation, wars, political upheavals, or other extreme circumstances.”

And the real costs of this unprecedented event are only just starting to come out.

A slightly shorter version of this column appeared on


The Final Nail in the Demonetisation Coffin.


99 percent of demonetised notes were deposited into banks. So, points out the RBI Annual Report of 2016-2017.

It says that as of June 30, 2017, Rs 15.28 lakh crore of the demonetised Rs 15.44 lakh crore notes, were deposited in banks.

This basically means almost all the demonetised notes were deposited into banks.
Jagdish Bhagwati and his co-authors owe this nation a huge apology for writing the stuff they did, suggesting that a lot of this money was black money and won’t come back into banks. In the process, black money would be destroyed.

“Suppose we accept the estimate that one-third of the approximately Rs15 trillion in demonetised notes is black money,” they wrote in the Dec 27, 2017 edition of the Mint.
This when Arun Jaitley said that the government did not have any estimate of black money.

The Income Tax Dept’s search and seize operations data suggested that around 5 percent of black money typically gets held in form of cash.

But Bhagwati and company wanted us to believe that 33 percent of the demonetised notes were black money.

How did they arrive at this figure? Or in the era of post truth, they simply made up the figure?

And given this, what is the basic difference between American economists and American politicians? At least, I can’t see one.

So, Rs 16,000 crore is what ultimately did not come back. A little over 1 percent of the demonetised currency.

All of this money may not be black money given that some people simply were not in a position to exchange. And some forgot.

As far as detecting fake currency is concerned, nothing much seems to have happened on this front. Data from the RBI annual report tells us that the number of fake Rs 500 (old series) and Rs 1,000 notes detected between April 2016 to March 2017 was 5,73,891.

The total number of demonetised notes stood at 24.02 billion. This basically means that as a proportion the fake notes identified between April 2016 to March 2017 stands close to 0 per cent of the demonetised notes.

The total number of Rs 500 and Rs 1,000 fake notes detected between April 2015 and March 2016, had stood at 4,04,794. And this happened without any demonetisation.

Hence, demonetisation has failed on its two major objectives.

This is the final nail in the coffin of Demonetisation.

The only question now that needs to be answered is, who came up with this stupid idea.
And how did he manage to sell it to the prime minister…


The Mystery of Agatha Christie

agatha christie

In my free time, I am a crime fiction junkie i.e. all I do is read crime fiction. Over the years Scandinavian authors (in particular Swedish) writing crime fiction have become my favourites. The irony is that there is very little crime in Scandinavia in comparison to many other developed countries.

One reason why Scandinavian crime fiction works for me is simply because it is much more than just a murder mystery. Along with being a murder mystery, most Scandinavian crime fiction is also a reflection of the Scandinavian society as it has evolved. In many cases, history plays a very important role in resolving the mystery.
Having said that, when it comes to a good old simple murder mystery no one can beat the magic of the British writer Agatha Christie.

Dear Reader, you must be wondering why am I going on and on about crime fiction, in a column which is supposed to be on economics. Allow me to explain.

The kind of crime fiction Agatha Christie specialised in has its origin in economics and in a French financial security called the tontine. Tontine was basically an annuity. And what is an annuity? As K Geert Rouwenhorst writes in a research paper titled The History of Financial Evolution: “[In the 18th century] Governments would mostly borrow in the form of annuities: investors would lend the government say $100 and in return the government would pay investors an interest rate for the remainder of the life of the nominee; the principal was never returned.”

In the British case there was something known as the consol. The consols were perpetual bonds and like annuities they did not end with death. They went on forever and paid an interest of 3 per cent or 5 per cent.

And what were tontines? As Mihir A Desai writes in The Wisdom of Finance—Discovering Humanity in the World of Risk and Return: “Just to make things more interesting, the French government allowed individuals to buy annuities in groups, and then each individual’s payout would go up as other members in the group died. So, the government would pay a fixed amount to the group until the last member died, and, as individuals died, the survivors would get larger and larger shares of that amount. The last survivor would get very large payments until they too passed. These schemes were tontines.”

The tontines led to the basic idea behind a Christie crime novel. As Rouwenhorst writes: “If you “google” the word tontine, you’ll see a long list of references to crime novels… Each member of a group would invest… and the interest on the entire capital would to be divided among the surviving members of the group. As members would eventually decease from a group, the payout to the remaining people would go up. So now you understand why this becomes a topic for crime novels – as the number of participants in a tontine dwindles and they learn about each other’s whereabouts, it wouldn’t exactly provide the right incentive from a social point of view.”

Tontines basically set the idea of a crime novel based around a largish group in a closed setting, where people keep getting killed. In a group, in which someone has done something wrong and no one knows who, trust between the members of the group is bound to come down. Speculation on who the wrong doer is, will be rife. Agatha Christie wrote many novels around this dynamic.

The most famous of the lot, which was also made into a memorable feature film, was And There Were None. Then there were other superb novels like The Murder of Roger Ackroyd, Murder on the Orient Express, Death on the Nile and The Murder at the Vicarage, based on the same dynamic.

All these novels had their root around a group, a murder (or murders) and the speculation that followed. This became possible because the French government in the 18th century came up with a financial security called the tontine. And people say economics and finance are boring.

The column originally appeared in the Bangalore Mirror on August 30, 2017.




Why Basic Economics is Not Working in Indian Real Estate


Over the weekend I appeared on the CNBC Awaaz’s Pehredar show, discussing what else but the ‘sad’ state of India’s real estate.

At some point of time we started discussing the unsold inventories of builders. I have always been of the view that the builders won’t be able to sell these homes unless they cut prices. The representative of the builders on the show took offense at what I said and was of the opinion that they had already cut prices by as much as they could, and a further cut in prices wasn’t possible.

I said what I did on the logic that if prospective buyers are not interested in buying at the current prices, they might see value once builders lower prices. The question is whether the builder wants to unload his inventory or not. If he wants to unload his inventory then he has to cut prices irrespective of the fact whether he is making money on the deal or not.

The market doesn’t care about that simply because the buyers are not interested in buying at current prices. Also, it is worth remembering that builders are not the only ones carrying a huge unsold inventory of homes.

There are huge number of investors (both professionals as well as amateurs) who have bought homes over the years, in the hope that prices will continue to rise at the same pace as in the past. Hence, the real unsold inventory of homes is many times the unsold inventory of builders. And if this inventory has to be cleared, then prices need to fall.
When the supply of any product is higher than its demand, then prices need to fall, that is how the demand will go up, and the supply will match demand. But for that to happen in the context of Indian real estate, the builders need to be willing to cut prices, which they aren’t. Why?

The first reason on offer is that they are already selling homes at almost the cost price (in some parts of the country). Any further cut in price, would mean selling at a loss, which they aren’t willing to do. I am neither a civil engineer nor an architect to be able to verify this claim. So, I really don’t know how valid this claim is.

But there is another reason why the builders (and their bankers) may not want to cut prices. And this is something the builders are not saying. At least, not in public. Hence, this seems to be the more likely reason. Builders have raised loans from banks and other sources. Against these loans the unsold inventory of homes has been offered as a collateral. If the prices of these homes are cut, then builders may have to offer more collateral to their lenders, which is something they are either not in a position to do or don’t want to do.

In fact, if you look at the total lending by banks to commercial real estate, it stood at Rs 1,77,064 crore. It was down by 3.8 per cent from April 2016 and it forms around 2.6 per cent of total non-food lending of banks.

Given this, builders are likely to stick to their current prices, even if they are not making any sales. As I said earlier, there is much more unsold inventory in the market than just with builders.

So, what about the investors, why are they not ready to cut prices? Some of them are anchored on to the prices at which their friends, relatives and acquaintances, had sold homes in the past. They want similar prices for their homes as well and haven’t adjusted to what is the new normal. There are still others who can’t get themselves to sell at a price which is lower than the price at which they had bought. So, they are waiting for the price to recover.

This is something that varies from buyer to buyer and how desperate he or she is to sell out.

Then there is another lot, which is simply waiting for enough indexed long-term capital losses to accumulate, before they think of selling. This will turn out to be the case given that real estate prices haven’t really gone anywhere over the last few years, especially once inflation is factored in.

Another major factor hampering sales is the lack of ‘enough’ cash in the market, given that sellers still want a part of the payment to be made in black. While the process of black money generation and accumulation has re-started post-demonetisation, it will take some time before it reaches pre-demonetisation levels.

Investors who bought real estate over the years, carried out a certain portion of the transaction in black i.e. they paid in cash. Hence, now even if they want to sell what they own, they can’t carry out an all-white transaction. A certain portion of the transaction needs to be carried out in black. And as I said earlier, there isn’t enough cash going around in the financial system.

Further, even those who are in a position to sell out, don’t know what they could possibly do with the money that they get. There is a huge reinvestment risk. Real estate is down in the dumps. The stock market is at an all-time high level. Gold hasn’t gone anywhere in years. And bank interest rates are at extremely low levels. Hence, the tendency is to hold on to the homes, not sell them at lower prices.

The larger point is that home prices have to fall till they interest the prospective buyers. Whether that price is viable for a builder or the investor, is not the question here.
We are beyond that stage now. The market will only clear once the prospective buyers become interested. Currently, they aren’t.

Builders who need to make massive debt repayments and do not have enough money going around are the ones who are more likely to cut prices than others. A Pune based developer DS Kulkarni has been defaulting on fixed deposit interest for a while now. He is likely to pulldown prices in the Pune market.

Many people bought homes assuming that the future will be similar to the past. Given the huge inventory of homes in the market, there is no way the prices are going to rise at the same pace as they had in the past. I will be surprised if anyone makes any return out of real state after adjusting for all the expenses, over the next few years. This is without getting into factoring inflation and the risk of owning real estate.

If builders don’t cut prices, we will see the deadlock continuing for a few years more till prices become viable in inflation adjusted terms. This is assuming that salaries and bonuses start to recover soon.

So, if this continues, I guess anyone looking at real estate as a viable investment option, will have to wait for a few years more, perhaps till 2022 (Don’t ask me why 2022. It’s just that it is not too near like 2019 and not too far like 2027).

The column originally appeared on Equitymaster on August 28, 2017.

The DeMon is in the details


The Narendra Modi government has unleashed a whole host of numbers on us, the citizens of this country, to prove how demonetisation has led to a huge increase in the number of returns filed. Different numbers have been offered by the prime minister, the finance minister, the finance ministry and the chief economic adviser to the finance ministry. Recently, there was even a clarification put out by the finance ministry regarding how to read these numbers.

This piece is not about how to read the different numbers put out by the government. For that you can read this excellent piece by James Wilson. I try and answer a different question here: Has this increase in the number of tax returns being filed ultimately led to a substantial difference in the total amount of direct taxes being collected by the central government as a proportion of the size of the Indian economy?

If it hasn’t, then the increase in the total number of returns being filed has basically meant more work and more money for the chartered accountants, and nothing else.

So, let’s take a look at Figure 1, which maps the direct taxes collected by the central government as a proportion of size of the Indian economy — that is, its gross domestic product or GDP. Direct taxes essentially consist of corporation tax, personal income tax, income tax paid by firms other than companies, security transaction tax, hotel receipts tax, etc. Corporation tax and personal income tax form a bulk of direct taxes.

The exercise has been carried out for the financial years between 2011-2012 and 2016-2017. This has been done because the GDP data is available only from 2011-2012 onwards. Also, while carrying out the calculations wealth tax has been ignored because it was abolished in the budget speech the finance minister Arun Jaitley gave on February 28, 2015. (To be honest, the collections were so small that even if they had been included, it wouldn’t have made any difference to the overall result.)

Figure 1:

(Source for Direct Taxes data: Source: Press Information Bureau, April 4, 2017. Source for GDP data: Reserve Bank of India)

Now what does Figure 1 tell us? There has been a slight improvement in the direct taxes to GDP ratio between 2015-2016 and 2016-2017. But at 5.58 per cent of the GDP, it is still trying to play catch up with the earlier years.

Also, it is worth reminding the readers here that in 2016-2017, the government got a declaration of  Rs 65,250 crore through the Income Declaration Scheme, a voluntary income disclosure scheme. If we adjust for the taxes collected under this scheme, the direct taxes to GDP ratio falls to 5.48 per cent. This scheme was launched before demonetisation happened. This changes things. And this is how the real scenario looks like (See Figure 2).

Figure 2:

What Figure 2 tells us is that demonetisation basically led to a slowdown in the economy where lesser tax was paid than in the past. The direct taxes to GDP ratio of 5.63 per cent was achieved in 2013-2014 without demonetisation.

Also, how do things look if we ignore corporation tax (i.e. corporate income tax) and look at the remaining direct taxes. This primarily comprises of personal income tax. Let’s take a look at Figure 3, which plots the ratio of direct taxes other than corporation tax as a proportion of the GDP.

Figure 3:

(Source for Direct Taxes data: Source for GDP data: Reserve Bank of India)

Figure 3 tells us that the direct taxes other than corporation tax as a proportion of GDP has jumped by 23 basis points to 2.33 per cent in 2016-2017, in comparison to 2015-2016. One basis point is one hundredth of a percentage.

Again, the question to ask here is: Has this jump happened because of demonetisation? It has happened primarily because of the money collected as taxes and fines under the Income Disclosure Scheme. Once the tax collected under the Income Declaration Scheme is adjusted for, the ratio falls to 2.23 per cent of the GDP. And this is how Figure 3 now looks like (See Figure 4).

Figure 4:

How do things look if we were to simply look at the corporation tax to GDP ratio? Take a look at Figure 5.

Figure 5:

As can be seen from Figure 5, the corporation tax to GDP ratio has been falling for a while, and it continued to fall in 2016-2017 as well.

All this analysis was for 2016-2017. How do things look in the current financial year i.e. 2017-2018? We do not have the GDP data for that, so calculating the direct taxes to GDP ratio is not possible. Nevertheless, there are other ways to analyse this issue.

A press release put out by the ministry of finance on August 9, 2017, states the following:

The Direct Tax collections up to July,2017 [i.e. between April 2017 and July 2017] in the Current Financial Year 2017-18 continue to register steady growth. Direct Tax collection during the said period, net of refunds, stands at Rs. 1.90 lakh crore which is 19.1% higher than the net collections for the corresponding period of last year.

Basically, direct tax collections have grown by 19.1 per cent during the first four months of this financial year in comparison to the same period in the last financial year. Hence, has demonetisation led to an increase in collection of direct taxes?

A press release put out by the ministry of finance on August 9, 2016, had this to say:

The figures for direct tax collections up to July, 2016 show that net revenue collections are at Rs.1.59 lakh crore which is 24.01% more than the net collections for the corresponding period last year.

Hence, in the period between April to July 2016, the direct tax collections had grown by 24 per cent, without the demonetisation of currency which was carried out in November 2016. What this tells us is that direct tax collections grew faster before demonetisation than they are growing after demonetisation.

Personal income tax collections have grown by 15.7 per cent during the first four months of this financial year. They had grown by 46.6 per cent during the first four months of the previous financial year.

So the point is that as far as the actual direct tax collections are concerned, demonetisation has clearly had a negative impact. This also explains why the government media releases tend to focus on the number of returns filed and not the tax that is being collected. More returns being filed without any increase in taxes collected simply means more work and more money for chartered accountants — and nothing else.

One argument that can be made here is that as the income earned by those who are filing returns now (but not paying taxes) goes up, they will pay taxes as well. But this argument rests on the assumption that the minimum taxable limit to pay income tax will continue to remain where it is and will not be increased in the years to come. If one looks at the history of income tax, this has clearly not been the case. The minimum taxable limit keeps going up every few years and at a rate faster than the growth in per capita income.

Of course, given that we live in an era of post-truth, all this data and analysis doesn’t really matter. What matters is who is presenting the data, even if it is incomplete and leads to wrong inferences being made. As Evan Davis writes in Post Truth—Why We Have Reached Peak Bullshit and What We Can Do About It:

[The] argument that who you are matters more than the substantive point you are making is especially true about politicians. Voters focus on character rather than policy partly because they are better able to judge character and are relatively uninformed on policy… So, for a politician, having a good reputation is worth a hundred quick victories in specific arguments.

The moral of the story is that it doesn’t matter if the right data is not being presented, because people will believe what is being presented.

The column originally appeared on on August 24, 2017.