How Demonetisation Destroyed Indian Jobs and ‘Possibly’ Helped Create Jobs Abroad

The ill-effects of demonetisation are still coming to the fore. In this issue of the Diary, I will talk about how demonetisation destroyed Indian jobs and “possibly” helped create jobs abroad.

Before I get into explaining why I am saying what I am saying, a recap of some basic economics is necessary here.

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


C = Private Consumption Expenditure

I = Investment

G = Government Expenditure

NX = Exports minus imports

The point to remember here is that imports are a negative entry in the GDP formula. The more a country imports, its GDP falls to that extent. Having said that imports also represent consumer demand at the end of the day, even though that demand does not add to the country’s GDP. For example, every time an Indian buys an electronic good manufactured in China, he is adding to the consumer demand but not to the GDP. Of course, he is adding to the Chinese GDP because exports are a positive entry into the GDP formula.

Hence, if we remove the imports of oil, gold and silver, from the total imports number (in dollars), what remains (i.e. non-oil non-gold non-silver imports) is a good indicator of consumer demand.

Now let’s take a look at Figure 1, which basically plots the year on year growth in the monthly non-oil non-gold non-silver imports. Hence, the non-oil non-gold non-silver imports in April 2017 went up by 42.5 per cent in comparison to the imports in April 2016. And that’s how it is for all other data points in Figure 1.

Figure 1: 

What does Figure 1 tell us? It tells that non-oil non-gold non-silver imports have grown at an extremely fast rate after October 2016. They are growing at rates at which they haven’t grown for a couple of years. What is happening here?

As Jahangir Aziz, head of emerging market economic research, told Bloomberg Quint recently: “What we had also feared was the demonetisation would disrupt the supply chains that run through both the formal and the informal economies. And if those supply chains get disrupted, then the revival in demand would not get fulfilled by domestic production.”

This basically means that demonetisation destroyed domestic supply chains. Without supply chains products can’t move. This has resulted in consumer demand being fulfilled through imports.

This is clearly visible in the huge growth of non-oil non-gold non-silver imports. What this also means is that as demonetisation destroyed supply chains in India, it also led to a huge job destruction. If goods weren’t moving, there was no point in producing them either. This meant shutdown of firms and massive job losses.

Further, by importing stuff that we used to produce in India earlier, we have helped the manufacturing business in foreign countries and in the process “possibly” helped create jobs there.

The irony is that one million youth are entering the workforce in India, every month. The economist Kaushik Basu had said in November 2016 that “[The] economics [of demonetisation] is complex & the collateral damage is likely to far outstrip the benefits.”The impact of this complex economics is still playing out and along with the botched up implementation of GST, has pulled down non-government GDP growth to around 4.3 per cent.

The column was originally published on Equitymaster on September 26, 2017.

What ails the Indian economy?

indian flag

A blueprint on economic revival is to be submitted to the Indian prime minister Narendra Modi, or so reports the Business Standard newspaper. This comes on the back of the slowest economic growth since Modi took over as the prime minister in May 2014.

For the period between April and June 2017, the Indian gross domestic product (GDP, a reflection of the size of the economy) grew by just 5.7 per cent. Between January and March 2016, the GDP had grown by 9.1 per cent. The last time the economy grew by less than 6 per cent (at 5.3 per cent) was between January and March 2014, when Manmohan Singh was the prime minister.

Also, the GDP growth of 5.7 per cent was achieved with the government spending more than what it usually does. The non-government part of the GDP, which forms roughly around 90 per cent of the economy, grew by a meagre 4.3 per cent.

The industry as a whole grew by 1.6 per cent, with manufacturing and construction growing by 1.2 per cent and 2 per cent, respectively.

We live in a world where any rate of economic growth greater than 2 per cent is considered to be good. But what is true for the West, isn’t really necessarily true for India. India needs to be growing rates of GDP growth faster than 7 per cent, if it has to continue to pull its millions out of poverty.

As Vijay Joshi, an economist at the University of Oxford, writes in India’s Long Road—The Search for Prosperity: “The ‘power of compound interest’ over long periods is such that even a small change in the growth rate of per capita income makes a big difference to eventual income per head.”

And how do things look for India? Where would it end by 2040 at different rates of economic growth? As Joshi writes: “At a growth rate of 3 per cent a year, income per head would double, and reach about the same level as China’s per capita income today. At a growth rate of 6 per cent a year, income per head would quadruple to a level around that enjoyed by Chile, Malaysia and Poland today. If income per head grew at 9 per cent a year, it would increase nearly eight-fold, and India would have a per capita income comparable to an average high-income country of today.”

This explains why high economic growth is so important for India. Another factor that needs to be kept in mind is that 12 million Indian youth are entering the workforce every year. This is India’s so called demographic dividend. But with construction and manufacturing growing at the rates they are, where will the jobs for the demographic dividend come from? The services sector growth continues to remain robust, but the support from industry is necessary, especially construction, given that most of these youth are low on jobs skills.

A major reason for the same comes from the lack of a good basic education. As per the Annual Status of Education Report 2016: “The proportion of children in Std III who are able to read at least Std I level text has gone up slightly, from 40.2% in 2014 to 42.5% in 2016.” Further, “in 2014, for the country 25.4% of Std III children could do a 2-digit subtraction. This number has risen slightly to 27.7% in 2016.” This has how the situation has been since 2010, after the introduction of the Right to Education.

Given this, a large portion of the youth entering the workforce are low on skills. Hence, they need low-skilled jobs which the construction and the real estate industry can provide. Both these sectors are going through a tough phase.

What hasn’t helped are India’s convoluted labour laws and the lack of ease of doing business. This has ensured that even industries like apparel manufacturing, which have the potential to create many jobs, continue to operate on a small scale. A recent report titled Ease of Doing Business—An Enterprise Survey of Indian States, published by the Niti Aayog, a government body, found that 85 per cent of the firms operating in the apparel sector employed less than eight workers. At a broader level, 85 per cent of Indian manufacturing firms are small and employ less than 50 employees.

The government feels that it has done enough to reform the labour laws, and it is the industry’s responsibility now to respond and set up labour-intensive enterprises. But that as the data suggests isn’t really happening.

Over and above this, agriculture which contributes around 15 per cent of the GDP, continues to employ half of the workforce. Exports during the first five months of this financial year (April to August 2017) are lower than where they were in 2013 and 2014.
All these factors have ensured that India has huge underemployment. Numbers from 2015-2016, suggest that only three out of five individuals who are looking for a job all through the year, are able to find one. The situation is worse in rural India, where only one in two individuals looking for a job all through the year are able to find one.

The negative effects of demonetisation have made things worse on the jobs front with many firms operating in the informal sector, which were the real job creators, having to shutdown. The botched-up launch of the Goods and Services Tax (GST), which was supposed to be a good and simple tax and it isn’t, hasn’t helped things either.

The other big worry for India is the mess its largely government owned public sector banks continue to operate in. 17 out of the 21 public sector banks have a bad loans rate of 10 per cent or more ( as of March 31, 2017). This basically means that out of every Rs 100 of loans given by these banks, loans of Rs 10 or more have already been defaulted on. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more. One bank (the Indian Overseas Bank) has a bad loans rate of 25 per cent.

These bad loans have primarily accumulated on lending to industry (read crony capitalists) where the overall bad loans rate, stands at 22.3 per cent.

The government has pumped in close to Rs 1500 billion as capital since 2009 to keep these banks going. With the banks continuing to accumulate bad loans and the Basel III norms coming into force from 2019 onward, these banks are going to need billions of rupees as capital in the years to come, to continue to be in operation.

The government clearly does not have this money and they remain reluctant to privatise or even shutdown some of these banks. Also, a major impact of the bad loans has been that the public sector banks are now reluctant to lend to industry.

To conclude, there are way too many structural issues with the Indian economy as of now. If a long-term growth rate of 7-8 per cent per year has to be sustained, these issues need to be tackled on a war footing.

The column originally appeared on the BBC on Sep 26, 2017.

There’s No Free Lunch in Economics

free lunch

So here is a small story, which you, dear reader, should probably try and remember all through your life.

There are four mithaiwallahs (sweetshops) in a colony (You can call them cookie shops or cake shops or bakeries, if you want to. It doesn’t change the argument that I am trying to make in anyway).

A fifth mithaiwallah, who is loaded with money, decides to set up shop. Given that his mithais(sweets) are more or less same to what everyone else is offering, he needs to offer something more to attract customers. So, he offers free mithais, up to one kg, every day, for the first 2 months.

Given that we all love a good deal, soon, there is a queue in front of his shop everyday. And not surprisingly, the business of the remaining four mithaiwallahs collapses. There is only so much mithai that people can consume. (I mean they can go briefly overboard on this front, but then there are health consequences that they would have to bear).

The four mithaiwallahs decide to compete with the new kid on the block. They are not as loaded with money as the fifth one to be offering stuff for free, so they cut prices of their mithais. The hope is that at lower prices the consumers who have ditched them, will come back to them. After all, they have shared a healthy relationship over the years.

And come to think of it, it is their fault as well. For a very long time, they have operated like a cartel, and have kept prices high. Given that the four mithaiwallahs are all related, the gains have been shared all within the family.

So, not surprisingly, when the fifth mithaiwallah sets up shop, the consumers who are seeing the benefits of competition for the first time, go running to him. I mean, if someone sells you products of the same and better quality for a lower price, why wouldn’t you buy stuff from him. The money thus saved can be spent somewhere else. At the end, there is only so much money going around and that has to be judiciously spent.

Soon, the four mithaiwallahs come to the realisation that cutting prices isn’t taking them anywhere because the fifth mithaiwallah continues to offer mithais for free. He is bleeding but in the process, he is ensuring that they are bleeding as well.

The fifth mithai wallah has owned government ration shops for many years and has made pot loads of money selling cheap rice, wheat and sugar, in the open market at higher rates. Hence, he is loaded with money and can outlast the four mithailwallahs he is competing with.

In order to compete the four mithaiwallahs also start offering some mithais in a limited amount for free. They are left with no other option. If they have to compete they have to offer stuff for free.

But as a result, they have to dilute the quality of their mithais. In their line of business, quality and quantity rarely go together. The consumer realises this shift in quality. This is not to say that the fifth mithaiwallah was offering good quality mithai. It’s just that he was offering it free. The fall in quality of the four mithaiwallahs leads to a situation where the consumers who were sticking on to them because of their better quality, also decide to desert them.

Soon, because of offering free stuff, they are losing money hand over fist. The wait for the customers to turn up has become endless. Of course, with no money coming in, they find it difficult to repay the loans they had taken from the local bank to build their shops.
Very soon, one of the mithaiwallah defaults on a loan. Soon, the others join them. And the local bank has a problem.

Meanwhile, the fifth mithaiwallah, seeing that his competitors are in trouble, starts cutting down on the free stuff on offer and raises prices. He figures out that soon he will be the only one left with any cash and the market will be all his. So, best to start cashing in on it.

He is the last man standing in the market and can price mithais, any way he wants to. The people are already addicted to his free mithai, cannot do without it and hence, have to pay whatever he asks for.

With the bank tottering, the depositors start making noise, and the local government has to come to their rescue, and ends up in financial trouble as well. This basically means that the taxpayer has to bailout the bank.

Dear Reader, you will see a version of this story, play out over and over again. The point being there are no free lunches in economics. Never!

There is always a cost that the system has to pay. Hence, if something looks too good to be true, maybe it is.

The column originally appeared on EquitymasterThe column originally appeared on Equitymaster on September 25, 2017.

और फिर शुरू हुआ ममता जी का छाती वाला डांस…

साल था 1994.

श्री विष्णु सिनेमा में राजकुमार की बेताज बादशाह लगने वाली थी. और उस ज़माने जैसा के अक्सर होता था, हम भी पहुंचे वहां फर्स्ट डे फर्स्ट शो देखने.

और राजकुमार की कुछ बात ही निराली थी.

ये वो समय था, जब बच्चन बूढ़े हो चले थे, और खानों की टोली ने अभी तक हिंदी सिनेमा पर अपना दबदबा बनाया नहीं था.

तो हीरो थे राजकुमार और उनकी फिल्मों की जैसी ओपनिंग लगती थी रांची में, वैसी किसी की नहीं लगती थी.
अब हुआ यूं के फिल्म का प्रिंट आया नहीं था, पर टिकटें बेचीं जा चुकी थी और खरीदी जा चुकी थी. ११ से एक बज गया और तब हमने ये सोचा के अब टिकट बेच देनी चाहिए और वापस कॉलेज, जो की बगल में ही था, जाना चाहिए.
जैसी ही टिकट बेचने लगे, किसी ने चिलाया, प्रिंट आ गया है, प्रिंट आ गया है.

प्रिंट आ गया था. और उसकी पूजा भी हो चुकी थी. डब्बे पर किसी पंडित ने लाल तिलक भी लगा दिया था.
कुछ समय में पिक्चर शुरू हुई. और लगभग ३० में ये समझ आ गया, के फिल्म काफी बकवास है. पर अब क्यूंकि पैसे खर्च कर चुके थे, तो फिल्म देखना तो लाज़मी था.(Sunk Cost Fallacy)

और मह्त्वपूर्ण बात ये थी की ममता कुलकर्णी का गाना आया नहीं था.

कौन सा? अरे वही वाला … आपने भी सुना होगा… “चूड़ियां बजाऊंगी प्रेम धुन गाऊँगी…

और फिर शुरू हुआ ममता जी का छाती वाला डांस…

और साथ में शुरू हुई सीटियां, चिल्लम चिल्ली और गाली गलौच जो की केवल ९० के दशक में एक छोटे शहर के सिनेमा घर में सुनी जा सकती थी…

एक विशेष टिपण्णी ये रही के अगर आपने फ्रंट रौ में बैठ कर ममता कुलकर्णी को नहीं देखा, तो क्या देखा…
अब यूँ हुआ के हमारे सामने एक नव विवाहित दम्पति बैठा था. फिल्म में उनकी कोई दिलचस्पी नहीं थी. पर करे भी तो क्या, कोने की टिकेटें नहीं मिली थी.

इधर ममता गा रही उधर बेचैनी बढ़ रही की (नव विवाहित दम्पति की, मेरी नहीं)… पांच मिनट गाना चला…और फिर अचानक से सब शांत हो गया… फिल्म तो चल रही थी…. पर लोग देख नहीं रहे थे..

इस बीच, नव विवाहित दम्पति खड़ा हुआ, और दरवाज़े के तरफ चलने लगा.

और फिर पीछे से एक ज़ोर से आवाज़ आयी, लगता है आज रात को खूब चूड़ी बजेगा…

Fiscal stimulus is already on, why doesn’t the govt try lowering taxes?


Media reports suggest that the central government is planning a fiscal stimulus. In simple English, what it basically means is that it is planning to spend more than what it had budgeted for, during this financial year.

Fiscal stimulus is an idea that politicians have latched on to for nearly eight decades since the British economist John Maynard Keynes published his tour de force The General Theory of Employment, Interest and Money in 1936. What Keynes suggested in this book was that in a tight economic situation, cutting taxes, so that people would have more to spend, was one way out to revive economic growth.

But the best way was for the government to spend more money, and become the “spender of the last resort”. Also, it did not matter if the government ended up running a fiscal deficit in doing so. Fiscal deficit is the difference between what a government earns and what it spends. When Keynes wrote this book, governments budgets used to be balanced (i.e. expenditure was more or less equal to revenue).

It wasn’t fashionable for governments to run a fiscal deficit back then, as it is now. Given this Keynes suggested that in a tight economic situation (the world was going through what we now call the Great Depression) it made sense for the government to spend its way out of trouble. And if that meant running a fiscal deficit, so be it.

Since then, it has been time honoured tradition for politicians and a section of economists to talk about the government spending more, in times of economic trouble. The idea being that with the private consumption slowing down, if the government spends more, incomes will go up, and this will help in reviving private consumption expenditure, which in turn will push up economic growth.


In fact, the government has already started providing a fiscal stimulus to the economy, during the first few months of this financial year. Take a look at Figure 1.

Figure 1:

Fiscal stimulus 1

Source: and

What does Figure 1 tell us? It tells that between April and July 2017 of the current financial year, the government has already touched 92.4 per cent of the fiscal deficit target that it had set at the beginning of the year. As is obvious from Figure 1, this is way beyond what usually happens.
Now take a look at Figure 2. It plots the proportion of government expenditure carried out during the period April to July (the first four months of the financial year) against the total expenditure achieved/planned for the financial year.

Figure 2:

fiscal stimulus 2
Source: and

What does Figure 2 tell us? It tells us that during a normal year, the government spends around one-third of the total expenditure during the first four months of the year. And this is a logical thing to do, given that four months constitute one-third of a year.
This time around, the government expenditure during the first four months of the year is at 37.7 per cent of the total expenditure that the government plans to incur during the year.

What Figure 1 and Figure 2 tells us is that the fiscal stimulus is already on. If the government continues to spend at the same rate as it is currently, it will end up spending 13 per cent more than it had planned at the beginning of the financial year. This will push up the budgeted fiscal deficit by around 51 per cent (assuming government revenues remain the same).

This will push up the fiscal deficit to 4.9 per cent of the gross domestic product(GDP) against the set target of 3.2 per cent of the GDP. Now what the government needs to decide is whether it should continue spending money at the rate that it currently is.
Also, what this means is that people who are now asking for the government to unleash a fiscal stimulus, probably do not know, that a stimulus is already on.

In fact, the government spending more than the usual, helped the GDP grow by 5.7 per cent during the period April to June 2017. In fact, if we leave out the government expenditure from the GDP, the non-government part, which constitutes close to 90 per cent of the GDP, grew by just 4.3 per cent. Hence, the impact of the fiscal stimulus is clearly there to see.

The trouble is that most fiscal stimuli flatter to deceive. It does help in pushing up economic growth initially, but ends up creating more problems, which the economy has to tackle in the years to come.

India’s last experience with a fiscal stimulus was disastrous. It was unleashed in 2008-2009. It propped up economic growth for a couple of years. But it also led to high inflation and high interest rates. It also led to banks going easy on lending and in the process ended up creating a massive amount of bad loans, which the system is still trying to come out from.

Also, it is worth remembering that the state governments run fiscal deficits as well. During 2016-2017, the combined fiscal deficit of the central government as well as the state governments had stood at 6.5 per cent of the GDP, down from 7.5 per cent, in 2015-2016. During this financial year, many state governments are expected to run higher fiscal deficits because they have waived off farmer loans. With the central government also spending more, the combined fiscal deficit will cross the 7 per cent level and that is not a good thing.

People in decision making should remember these points raised above. The trouble is politicians like to look up to the next election. And the fiscal stimulus that has been unleashed now is likely to keep perking up economic growth over the next year or two and this will help the incumbent government in the next elections. Having said that, as I mentioned earlier, it creates other problems in the time to come.

Also, it needs to be clarified here, that Keynes wasn’t an advocate of a government running high budget deficits all the time. Keynes believed that, on an average, the government budget should be balanced. This meant that during years of prosperity, governments should run budget surpluses. But when the environment is recessionary, governments should spend more than what they earn, even running budget deficits.

But over the decades, politicians have only taken one part of Keynes’ argument and run with it. The idea of running deficits during bad times became permanently etched in their minds. However, they forgot that Keynes had also wanted them to run surpluses during good times.

To conclude, other than the government spending more, Keynes also talked about lowering taxes. Why doesn’t the government try and lower the GST rates to start with?

The column originally appeared on Firstpost on September 23, 2017.