If PM Modi could sell Notebandi why not Bankbandi? Many banks do not deserve fresh capital


One of the examples of Big Government I have in my book India’s Big Government is that of government owned public sector banks. (The good news is that the book is available at a huge discount on Amazon till Friday, 27th October. The Kindle version is going at Rs 199, against a maximum retail price of Rs 749, and the paperback is going at Rs 499, against a maximum retail price of Rs 999).

When I wrote the book, the Indian government owned 27 public sector banks. As of April 1, 2017, the Bhartiya Mahila Bank and the five associate banks of State Bank of India, were merged with the State Bank of India. Due to this merger, the number of government owned banks fell to 21. This merger has pulled down the overall performance of the State Bank of India and is just a way of sweeping problems under the carpet. Over the years, the government plans to use mergers to reduce the number of banks it owns to anywhere between ten to fifteen. This as I have said in the past is a bad idea.

Yesterday afternoon, the finance ministry announced a plan to invest more capital in public sector banks, which are saddled with a massive amount of bad loans and restructured loans. The government plans to put in Rs 2,11,000 crore over the next two years, “with maximum allocation in the current year”.

Where will this money come from? Rs 18,139 crore has been allocated from the current financial year’s budget. Banks are expected to raise capital by issuing new shares. This is expected to raise around Rs 58,000 crore.

This leaves us with around Rs 1,35,000 crore. Where will this money come from? This money is expected to come in through recapitalisation bonds. How will this work? The government hasn’t specified the details of how these bonds will be issued. (This makes me wonder as to why have a press conference in the first place, when the most important part of the plan, has not been decided on).

From what I could gather speaking to people who understand such things, this is how it is supposed to work. The banks have a lot of liquidity because of all the money that has come in because of demonetisation. A part of these deposits will be used by public sector banks to buy recapitalisation bonds issued by the government.

The money that the government thus gets will be used to buy fresh shares that the banks will issue. Thus, the banks will be recapitalised.

Now on the face of it, this sounds like a brilliant plan, where money is moved from one part of the balance sheet to another and a huge problem is solved. But is it as simple as that?

a) By issuing recapitalisation bonds the debt of the government will go up. Over and above this, interest will have to be paid on these bonds. Both the debt and the interest will add to the fiscal deficit of the government.

b) Given that the debt of the government will go up, this would mean that the taxpayers will ultimately pick up the tab because the debt will have to be repaid. It makes sense to always remember that there is no free lunch in economics. The corollary to this is that there is no free lunch especially when something feels like a free lunch. Of course, the taxpayers aren’t organised and hence, they are unlikely to protest. And given that they finance all bailouts.

c) It remains to be seen what the banks do with this extra capital. Will they use it to write off restructured loans of corporates? Will this dull their enthusiasm (not that they had enough of it in the first place) to recover bad loans? As the situation changes, so will the behaviour of bankers.

This will also bring to the fore the issue of moral hazard. And what is moral hazard? As Mohamed A El-Erian writes in The Only Game in Town: “[It] is the inclination to take more risk because of the perceived backing of an effective and decisive insurance mechanism.” If the government bails them around this time around, the banks know that they can count on the government bailing them out the next time around as well. And this means that they can follow fairly loose standards of lending, in order to lend money quickly.

d) As I keep saying, bank lending among other things is also a function of whether there is demand for such lending. The public sector banks have gone slow on lending to corporates (in fact they have contracted their loan book) because of a lack of capital. Or so we are told. But this lack of capital doesn’t seem to have hindered their lending to the retail segment. Now that they will have access to more capital, will this reluctance to lend to corporates go away? I am not so sure.

e) Also, some of the banks are in such a bad state, that they really don’t deserve this capital. They shouldn’t be in the business of banking in the first place. Take a look at Table 1. Table 1, lists out the bad loans ratio of all the public sector banks. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.

Table 1:

Name of the bankBad loans ratio (in per cent)
IDBI Bank24.11
Indian Overseas Bank23.6
UCO Bank19.87
Bank of Maharashtra18.59
Central Bank of India18.23
Dena Bank17.37
United Bank of India17.17
Corporation Bank15.49
Oriental Bank of Commerce14.83
Allahabad Bank13.85
Punjab National Bank13.66
Andhra Bank13.33
Bank of India13.05
Union Bank of India12.63
Bank of Baroda11.4
Punjab and Sind Bank11.33
Canara Bank10.56
State Bank of India9.97
Syndicate Bank9.96
Vijaya Bank7.3
Indian bank7.21

Source: www.careratings.com 

As can be seen from Table 1, only two public sector banks have a bad loans ratio significantly lower than 10 per cent (Actually its four, but State Bank of India and Syndicate Bank are very close to 10 per cent).

Eight out of the 21 banks have a bad loans ratio of greater than 15 per cent. This basically means that out of every Rs 100 of lending carried out by these banks, at least Rs 15 is no longer being repaid.

Some of these banks with extremely high bad loans are way too small to make any difference in the overall lending carried out by banks. Take a look at Table 2.

Table 2:

Name of the BankTotal advances as a percentage of gross advances of banks (as on March 31, 2017)Bad loans rate (as on June 30, 2017)
United Bank of India0.82%17.17%
Dena Bank0.90%17.37%
Bank of Maharashtra1.18%18.59%
UCO Bank1.48%19.87%
Central Bank of India1.73%18.23%
Indian Overseas Bank1.74%23.60%

Source: Author calculations on Indian Banks’ Association data and www.careratings.com 

These public sector banks have now reached a stage wherein there is no point in the government trying to spend time and money, in reviving them. It simply makes more sense to shut them down and sell their assets piece by piece or to sell them, lock, stock and barrel, if any of the bigger private banks or any other private firms, are willing to buy them. But what the government is doing instead is using taxpayer money to maintain its control over banks.

f) Also, recapitalising banks does not take care of the basic problem at the heart of public sector banks, which is that they are public sector banks. Allow me to explain. Let’s take the example of the State Bank of India, the largest public sector banks. As of June 30, 2017, the bad loans ratio of the bank when it came to retail lending was 1.56 per cent. At the same time, the bad loans ratio when it came to corporate lending was 18.61per cent.This basically means that State Bank of India, does a terrific job at retail lending but really screws up when it comes to lending to industry. What is happening here? Thomas Sowell, an American economist turned political philosopher, discusses the concept of separation of knowledge and power, in his book Wealth, Poverty and Politics.

How does it apply in this context? In public sector banks, managers who have the knowledge to take the right decisions may not always have the power to do so. Take the case of retail lending. The manager looks at the ability of the borrower to repay a loan, and then decides to commission or not commission one. This explains why the bad loans ratio in case of retail lending is as low as 1.56 per cent (in fact, it was just 0.55 per cent before the merger). A proper process to give a loan is being followed in this case.

But when it comes to lending to corporates, there are people out there (or at least used to be) who are trying to influence the manager’s decision; from bureaucrats to ministers to politicians. In this scenario, the manager ends up giving out loans even to those corporates who do not have the wherewithal to repay it.

The separation between knowledge and power has led to a situation where bank loans were given to many crony capitalists who have defaulted, and what we are seeing now is a fall out of that. In many cases, the corporates have simply siphoned off the loan amounts by over declaring the cost of the projects they borrowed against.

Of course, as long public sector banks continue to remain public sector banks, this risk will remain. But this government (and the ones before it) likes the idea of owning banks, and because it gives some relevance to ministers and bureaucrats.

Also, the employee unions of public sector banks have a huge nuisance value. No government has had the balls to take them on, in the past. Neither does this one. And this basically means that taxpayers will have to continue rescuing the public sector banks.

The column originally appeared on Equitymaster The column originally appeared on Equitymaster with  a different headline on October 25, 2017.

जल्द आ रहा है — पंडित दीन दयाल उपाध्याय बैंक बचाओ सेस

हमारे एक मित्र हैं, जो किन्ही कारणों से सोशल मीडिया से ज़रा बच कर रहते हैं. उनके बचपन और जवानी के दिन थोड़े रंगीन थे. एक आधी गर्ल फ्रेंड ज़्यादा बना ली. अब शादी शुदा हैं. और बीवी से थोड़ा ज़्यादा ही प्रेम करते हैं, या ये कहिये के डरते हैं, या फिर ये कहिये के अब भी खुद पर भरोसा नहीं, कभी कोई पुराणी यादाश फिर से ताज़ा हो जाये, तो फिर क्या करेंगे?

खैर इन बातों को रहने दीजिये.आज सुबह सुबह उन्होंने पुछा, के आज PDDU के बारे में तुमने कुछ नहीं लिखा? मैंने कहां, शाम तक रुकिए सरकार ज़रूर मौका देगी. और कुछ ऐसा ही हुआ. दोपहर को 4-4.30 जब मैं बहुत ही मीठी सी नींद सो रहा था, वित्त मंत्री अरुण भाई जेटली ने Rs 2,11,000 करोड़ के बैंक recapitalisation प्लान की घोषणा की.

कोई भी धंदा करने के लिए अपना पैसा लगता है. इस पैसे को कैपिटल कहते हैं. जब धंदे में नुकसान होता है, तब कैपिटल जो है वो कम होता जाता है. अगर नुक्सान बरकरार रहे, तो एक समय के बाद ये स्थिति आ जाती है के धंदा कम करना पड़ता है, या फिर बंद भी.

अगर इस परिस्थिति को बदलना हो तो धंदे में नया पैसा यानि की नया कैपिटल लगाना पडता है. भारत सरकार 21 बैंकों की मालिक है. इन बैंकों की हालत ख़राब है. आज सरकार ने ये निर्णय लिया के इन बैंकों में और पैसा डाला जाए, की वो ठीक से धंदा कर सके.

प्रॉब्लम ये है, के इन में से काफी बैंक ऐसे है, जो इतना ज़्यादा नुकसान पहले ही उठा चुके हैं, के इनको बैंकिंग के धंधे में होना ही नहीं चाहिए.

और इस से बड़ी बात इतना ज़्यादा पैसा, Rs 2,11,000 करोड़, आएगा कहाँ से? सरकार के पास तो अपना पैसा कुछ होता नहीं। वो ये पैसा आपसे और मुझसे लेंगी. इस लिए एक नया टैक्स, पंडित दीन दयाल उपाध्याय बैंक बचाओ सेस, आना तय है. बस इंतज़ार कीजिये. क्योंकि, जैसा के जावेद अख्तर साहब कह गए हैं, इंतज़ार मोहब्बत का नसीब है.

एक बात और याद दिला दूँ, “there is no free lunch in economics”. किसी न किसी को तो भरपाई करनी पडती है. इस केस में भरपाई करेंगे मैं और आप, ताकि सरकारी दामाद लोगों की नौकरियां बरकरार रहे.


मित्र Manjul का कहना है, के हमारे देश में लोगों को satire समझ नहीं आता, इसलिए मेरी पिटाई जल्द ही होने वाले ही.

कुछ लोगों ने ये पुछा के मैं केवल ;पंडित दीन दयाल उपाध्याय का नाम क्यों लेता हूँ. बार बार उनका ही मज़ाक क्यों उडाता हूँ?

तो उनको मैं ये कहना चाहता हूँ, के पंडित जी का मज़ाक बिलकुल भी नहीं उड़ा रहा हूँ. ये कटाक्ष उन लोगों पर है, जो उनका नाम हर जगह घुसाने में लगे हुए हैं.

ये कटाक्ष उन लोगों पर भी है, जिनको पंडित जी से पहले, केवल तीन और नाम सूझते थे, जवाहर, इंदिरा और राजीव.

बहुत बड़ा देश है हमारा और बहुत सारे नामचीन लोग हुए हैं. थोड़ा उनके नामों का भी इस्तेमाल हो? जैसे के महिंद्रा सिंह धोनी रांची एयरपोर्ट? क्या ख्याल है?

Has Arun Jaitley Been Reading India’s Big Government?


Self-employment is the new buzzword in the Narendra Modi government. And it is going to rescue the one million youth that are entering the workforce every month. Or at least that is what we are being told.

As finance minister Arun Jaitley recently told ET Now“Bulk of the jobs in India are created by SMEs, by the micro industries, by self employment. Gone are the days where only the government sector created jobs in the government or the organised sector created jobs.”

This statement sort of makes me feel that Mr Jaitley has been reading my book India’s Big Government. (The good news is that the book is available at a huge discount on Amazon till Friday, 27th October. The Kindle version is going at Rs 199, against a maximum retail price of Rs 749, and the paperback is going at Rs 499, against a maximum retail price of Rs 999.). What Jaitley said in his statement are some of the points that I make in the book as well:

  • The government (includes all forms from central government to state government to central public sector enterprises etc.) do not create jobs anymore.
  • Globally, the small and medium enterprises as they grow bigger, end up creating a bulk of the jobs.
  • In India, the unorganised/informal sector creates a bulk of the jobs. This is something that the Economic Survey of 2015-2016 points out: “The informal sector should… be credited with creating jobs and keeping unemployment low.”

The thing is that there is nothing new in this. Self-employment may have become the new buzzword with ministers of the Narendra Modi government, but it has been around for a while.

As the report titled Ease of Doing Business: An Enterprise Survey of Indian States: “A major challenge in India has been the preponderance of employment in very small enterprises. Formal sector jobs that exhibit high productivity and pay high wages are limited. According to the latest Economic Census, conducted during 2013 and the first quarter of 2014, of 131 million workers in industry and services, 44.4% were employed in Own Account Enterprises (OAE), which are managed exclusively by their owners and do not employ a single regular worker. Establishments with five or fewer workers, including the OAE, employed 69.5% workers and those with nine or fewer workers employed 79% workers. In other words, establishments with 10 or more workers employed just 21% of the workers in industry and services.”

The above paragraph says multiple things. Let’s look at them one by one.

  1. According to the latest Economic Census, conducted during 2013 and the first quarter of 2014, of 131 million workers in industry and services, 44.4% were employed in Own Account Enterprises (OAE), which are managed exclusively by their owners and do not employ a single regular worker.

    Own account enterprises form a bulk of total Indian firms in services and industry. What does this mean? It basically means that anyone who does not find a job, drifts towards self-employment. Further, he starts small and continues to remain small.

    Jaitley in his interview said that in order to promote self-employment “you have to have a skilling campaign which is going on.” Skilling is very important, given that the Indian education system doesn’t exactly make people employable. This is a point that I make in great detail in India’s Big Government.

    The trouble is that skilling is not happening at the scale that it needs to. Let’s take a look at how things panned out in 2016-2017. The different ministries in the government had accepted a target of training 99,35,470 individuals. Of this, only 19,58,723 or around less than one-fifth had been trained up to December 2016.

    As I keep pointing out, nearly 1.2 crore individuals are entering the workforce every year. This means a bulk of them continue to remain unskilled. At this rate a huge number of people who are and will enter the workforce over the next few years, will continue to remain unskilled. And given that their chances of creating social mischief remain high.

    One challenge the government (and even the private sector) is facing as it tries to scale up skilling quickly is the shortage of individuals who can impart skill training. To get around this, to some extent, the talent and experience of the retired personnel of the army as well as the railways could be used. Between them, the army and the railways have many personnel who introduce, maintain and upgrade electrical and mechanical equipment of various kinds for their own use.i

  2. Establishments with five or fewer workers, including the OAE, employed 69.5% workers and those with nine or fewer workers employed 79% workers. In other words, establishments with 10 or more workers employed just 21% of the workers in industry and services.

    This basically means that most Indian firms start small and continue to remain small. (Again, this is a point that I have made multiple times). So, just saying that small and medium enterprises create jobs, is not enough. They create many sasjobs only if they grow bigger, which in India is clearly not the case with close to 80 per cent of the firms employing less than ten workers.

    So, self-employment and small and medium enterprises creating jobs, are solutions if they are allowed to grow bigger. Currently, that is not the case due to various reasons like rigid labour laws, the lack of ease of doing business and so on.

In the recent past, the informal sector has been declared to be a bad thing because it does not pay its share of taxes. The question is, does it really need to pay taxes? The own-account enterprises form a large part of this sector. And people running these firms, clearly do not make enough money to be paying taxes. Take a look at Table 1.

Table 1: Self Employed/Regular wage salaried/Contract/Casual Workers according to
Average Monthly Earnings (in %) All India 

Table 1 clearly shows that 96 per cent of the self-employed make up to Rs 2,40,000 a year. Income up to Rs 2,50,000 per year does not come under tax bracket. This basically means that a large section of the informal sector in India simply does not pay tax because it does not earn enough to pay tax.

As economist Jim Walker of Asianomics wrote in a research note sometime back: “There is nothing intrinsic that says that the informal economy is a less effective or beneficial source of activity than the formal economy.” This is something that the Modi government needs to understand.

In its quest for more taxes, it is working towards destroying large parts of the informal economy, which is a huge part of Indian economy.

Yes, self-employment is important. But then the government is saying one thing and doing exactly the opposite thing. What explains this dichotomy?

The column originally appeared in Equitymaster on October 23, 2017.

Mr Adhia, GST Needs “Complete Overhauling”, “Some Rejig” Just Won’t Help


Yesterday evening, the social media was abuzz with a statement that Hasmukh Adhia, the revenue secretary, had given in an interview to the Press Trust of India (PTI) regarding the Goods and Services Tax (GST). As he said: “There is a complete overhauling that is required… it is possible that some items in the same chapter are divided.”

The website of The Hindu still has this report. You can also read it on Scroll.in.
This statement was later changed to: “There is need for some rejig in rates… it is possible that some items in the same chapter are divided.” The interview on the PTI website, currently has this statement and not the earlier one.

The phrase complete overhauling [of GST] has been replaced by some rejig in [GST] rates, by the PTI. Of course, a complete overhauling is majorly different from some rejig, but this is the closest that someone senior in the Modi government has publicly admitted that the implementation of the GST has been a disaster.

There are questions that need to be asked, even though the chances of getting any answers from the Modi government, remain nil.

1) Why was the government in such a hurry to launch the GST, when it was clearly not ready for it. This lack of preparation was already visible even before GST became the order of the day.

As Navin Kumar, the chairman of the GST network, in an interview published on June 27, 2017, told Business Standard: “It should be a stable system. Problems that surfaced during the first phase of the testing have been resolved. We did the testing on the basis of the rules that came in December. After that, some changes were made to the rules. Those changes we have absorbed now, so there is no time to do beta testing for that.”

Here is the Chairman of the network on which the GST is implemented saying that they haven’t had the time to test it properly. What more evidence is needed for the system not being completely ready?

Bharat Goenka, the managing director of Tally Solutions, one of the companies which has made a software for customers to help them file the GST returns, made a similar

In an interview with the Business Standard published on June 23, 2017, he was asked: “Is the problem essentially with the cramped timeline? Is July 1 too optimistic?” He answered: “It is indeed very cramped. While it is easy to add a new feature to software with respect to its functioning, developing robust software takes time. Whenever you make a change, you need to harden the software and that takes time. If you do not give it time, you end up with fragile software and get potentially surprising results. It is a high-risk environment. So, it is not sensible to try and do such mega rollouts without robust backing.

Obviously, the government was in a hurry to launch the GST without adequate preparation. In the process, it ended up creating the mess that currently prevails. And given that concerns were raised by people who were part of the process of the launch, this is clearly not benefit of hindsight.

2) Nearly four months after the launch, a lot of confusion prevails on many fronts. Even the chartered accountants lack clarity on issues. This tells us again that there wasn’t enough communication from the government on this front. In countries where GST (or value added tax as it is more popularly called) has been successfully implemented, an adequate amount of time is spent in training those who will be a part of the system implementing the GST (both inside and outside the government). This, has clearly not happened in India.

3) In fact, much before the GST was launched, analysts had pointed out that there were way too many GST rates, and that made the entire system fairly complicated, for those who need to follow the system.

The examples are now out.  A newreport in The Times of India quotes a supermarket chain owner as saying: “Tax on snacks like aloo bhujia, potato chips, samosa, kachori is 12%. Now the tax rate for cashews is 5%, but I can’t figure out if masala cashew is a snack or a standalone item.”

Similar issues have cropped up when it comes to sweets. Milk sweets come under the 5 per cent bracket, but the moment a silver foil is put on it, tax shoots up to 18 per cent. As Congress leader Veerapa Moily put it: “For example, is Kitkat a chocolate or a biscuit? Is coconut oil considered as hair oil or cooking oil?

A ministry of finance press release towards the end of September 2017 pointed out: “The total number of tax payers who were required to file monthly returns for August 2017 is 68.20 lakhs, of which, as on 25th September, 2017, 37.63 lakh GSTR 3B returns have been filed.” Around 55 per cent of those who needed to file GST returns, actually filed it.

Given the way, in which the system has been designed, this isn’t surprising at all. What this has also brought out is the fact that Indian traders are digitally challenged, and it will take time for them to catch up to GST. Meanwhile, the economy will have to suffer because of this.

4) The multiplicity of tax rates has led to a situation where the tax rates on different products make very little sense.  While the GST on condoms is 0 per cent, that on sanitary napkins is 12 per cent. One explanation provided for this is that only branded sanitary napkins invite a GST. But why even make this distinction? Does the GST apply only on branded condoms? Or more importantly, is there anything like an unbranded condom? These issues will simply not arise if there were fewer rates of tax.

Another explanation provided is that the mandate of the GST Council which decided on the GST rates, was fitment of taxes i.e. the GST rate on a product must be close to the existing taxes on it.

This is a rather silly observation given the status of the GST Council. If the idea was mere fitment any junior level bureaucrat could have done it. The fact that GST Council comprised of the finance ministers of all states and the finance minister of the central government, means that such anomalies could have been easily corrected.

There are several such inconsistencies, for the lack of a better word. The GST on environmentally friendly hybrid cars as well as fossil fuel guzzling SUVs is the same at 43 per cent (28 per cent GST and 15 per cent surcharge). Before GST became the order of the day, the total taxes on SUVs added to around 50 per cent.[i] In case of hybrids the tax before GST was around 29 per cent.[ii] This has led to the companies increasing the prices of the hybrid models of their cars.

And there is more. The GST rates on diamonds and gold are at 0.25 per cent and 3 per cent respectively. But the GST on something as useful as matchboxes (handmade ones) is 5 per cent. Why is this the case? Is it because those who run diamond and gold firms have deeper pockets funding political parties, than those running firms making matchboxes?

5) The rate of tax for most services has gone up from 12.36 per cent in 2014 and 15 per cent till June 30, 2017, to 18 per cent under GST. Of course, a part of this jump was supposed to be neutralised because of the input tax credit available under GST. But anecdotal evidence clearly suggests that the price of services has gone up because of GST. The government needs to study this and if this is true, it needs to cut the rate of tax on services to 15 per cent.

6) Also, the Modi government has tried to implement a convoluted and a complicated GST, which has “privatised compliance”. This has hit the small and medium enterprises(SMEs) the hardest. This also shows that we haven’t really learnt the lessons from our past.

One reason for India’s big black economy has been the high income tax rates over the years. In the early 1970s, the highest marginal rate of tax was as high as 97 per cent. Of course, at such a high rate most people who should have been paying income tax, did not. Not surprising, why would anyone give away Rs 97 out of every Rs 100 that he earned over a certain level, to the government.

The point being that tax compliance is always better at lower rates. At 28 per cent and higher, the peak Indian GST rate is among the highest in the world. Hopefully, as the number of tax rates under GST gets slashed in the years to come, the higher rates will go.

To conclude, GST has hit the small and medium enterprises (SMEs), which were already reeling under the negative impacts of demonetisation very hard. This is something that needs to be corrected very quickly, simply because it is the SMEs which create jobs in any growing economy. As finance minister Arun Jaitley recently told ET Now“Bulk of the jobs in India are created by SMEs, by the micro industries, by self employment. Gone are the days where only the government sector created jobs in the government or the organised sector created jobs.”

And given that one million Indian youth are entering the workforce every month, the country needs SMEs to create jobs more than it ever did before. Given this, the GST needs complete overhauling, in order make it simple and uncomplicated. A simple rejig won’t do. Hope Mr Adhia and his boss in the finance ministry are listening.

[i] A.Modi, Planning to buy a luxury car or an SUV? GST may save you up to Rs 85,000, http://www.business-standard.com, May 21, 2017.

[ii] A. Khan, Hybrid Cars May Become A Thing Of The Past Because Of GST, www.businessworld.in, July 4, 2017.

The column originally appeared in the Huffington Post on October 23, 2017.

The Problem With Rs 10 Coin


It costs Rs 60 to cross the Bandra-Worli sealink in Mumbai. If you pay for this using a Rs 100 note, chances are you will get four Rs 10 coins in return, as change. These coins tend to make the wallet a little heavy, hence, whenever I order food, I tend to tip the delivery boy using these coins. At least, I used to do this, until very recently.

Whenever I tipped the delivery boy using Rs 10 coins, I got a weird look back. This happened multiple times, until I came up with an explanation for it. Coins just don’t feel like money earned. They feel more like small change. Paper notes feel more like money. And this I thought led to the weird look from the delivery boys.

Last week I was in Visakhapatnam and was simply roaming around the city, until I saw a paanipuri (also referred to as phuchka, golgappa etc., in different parts of the country) stall. I ordered one plate of paanipuri and handed over a Rs 10 coin to the stall owner. He refused to take it and asked me to give him a Rs 10 note.

While, people had refused to take torn notes before, nobody had ever refused a coin.

This was the first time. I got talking to the stall owner and tried telling him that the coin was issued by the government and there is no reason he should be refusing it.
He told me that many Rs 10 coins were nakli (counterfeited) and hence, people don’t take them. Anyway, I handed him a Rs 10 note and walked back to my hotel.

As I was walking back, I wondered, why would anyone in their right mind, take the risk of counterfeiting a Rs 10 coin. Given the risk involved, it just did not make any economic sense. If anyone wanted to counterfeit, it simply made sense to counterfeit the highest denomination note, which happens to be the Rs 2,000 note.

On the social media, I was told that many people believe that Rs 10 coins are counterfeited and hence, they refuse to accept it. It seems, the ministry of finance, which is in charge of minting coins, has introduced Rs 10 coins of different designs. Like there are Rs 10 coins with the rupee symbol as well as without the rupee symbol. This has created the confusion among people.

This also brings us to a more important point regarding fiat money. In an earlier era, money used to have a value on its own. Metals like gold, silver, copper and iron, were money at different points of time in history. So, were agri-commodities like rice, salt and tobacco. In fact, tobacco was money in large parts of United States, longer than gold was.

This started to change around the time of the First World War. Since then the world has gradually moved towards paper money, or a form of money which the government decrees as money, which includes coins as well. A Rs 10 coin has a value of Rs 10 because the government says so. If you were to melt it and sell the metal(s) it is made of, you will not end up recovering Rs 10.

But at the same time, the government decreeing a coin to have a value of Rs 10, is just not enough. People should also be ready to accept it.

As Charles Wheelan writes in Naked Economics—Undressing the Dismal Science: “Rational people refuse legal tender because they believe that it might not be accepted by someone else…The whole bizarre phenomenon underscores the fact that our faith in paper currency [coin in this particular case] is predicated on the faith that others place in the same paper.”

Hence, in order to restore this confidence it is important that the government and the Reserve Bank of India, communicate regularly on this issue, and tell the people that all is well with the Rs 10 coin.

The column originally appeared in the Bangalore Mirror on October 18, 2017.