Why Govt of India Isn’t Acting Like a Spender of the Last Resort

It’s 2019, and you are out watching an international cricket match.

You didn’t book tickets quickly enough and are sitting in one of the upper stands, pretty far away from where the action is.

Instead of sitting and watching the match, you stand up to get a better view. Of course, by doing this, you end up blocking the person behind you. He also has to get up to get a better view of the cricket.

When he does this, he ends up blocking the view of the person behind him. And so, it goes. Pretty soon, everyone in the rows behind you has also stood up to get a better view.

Economists have a term for a situation like this. They call it the fallacy of composition or the assumption that what’s good for a part (that’s you in this case) is good for the whole (the people sitting behind you) as well.

As economist Thomas Sowell writes in Basic Economics-A Common Sense Guide to the Economy: “In a sports stadium, any given individual can see the game better by standing up but if everybody stands up, everybody will not see better.”

So, why are we talking about cricket and sports here? What’s true about watching sports in a stadium is also true for the economy as a whole.

John Maynard Keynes, the most famous and influential economist of the twentieth century (and perhaps even the twenty first), came up with a concept called the paradox of thrift, where thrift refers to the entire idea of using money carefully.

Keynes studied the Great Depression of 1929. He concluded that during tough economic times, when the going is difficult, people become careful with spending money and try and save more of it. While this makes perfect sense at the individual level, it doesn’t make much sense at the societal level because ultimately one man’s spending is another man’s income.

If a substantial portion of the society starts saving, the paradox of thrift strikes, incomes fall, jobs are lost, businesses shutdown and the governments face a pressure on the tax front. The government also faces the pressure to do something about the prevailing economic situation.

This is precisely the situation playing out in India currently. The paradox of thrift is at work. Bank deposits between March 27 and September 25, the latest data that is available, have gone up by 5.1% or Rs 6.9 lakh crore to Rs 142.6 lakh crore. This is twice more than the increase that happened during the same period last year.

As far as loans are concerned, outstanding loans of banks have shrunk during this financial year. On the whole they haven’t given a single rupee of a new loan  (loans are again meant to be spent).

Keynes had suggested that during tough economic times, when the private sector, both individuals and corporations are not spending much money, the government needs to step in and act as the spender of the last resort. In fact, Keynes rhetorically even suggested that if nothing, the government should get workers to dig holes and fill them up, and pay them for it.

When the workers spend this money, it would start reviving the economy. Economists refer to the situation of the government spending money in order to get economic growth going again as a fiscal expansion or a fiscal stimulus.

Since the start of this financial year, everyone who is remotely connected to economics in India in anyway, be it journalists, economists, analysts, corporates, fund managers and even politicians, have been demanding a bigger fiscal stimulus from the government to get economic growth going again.

The government has responded in fits and starts. Last week the central government came up with a few more steps including the LTC cash voucher scheme, special festival advance scheme, loans to states for capital expenditure and an additional capital expenditure of Rs 25,000 crore.

The fact that one week later one’s not hearing much about these moves, tells us they have already fizzled out. They didn’t have much legs to stand on in the first place. Let’s look at these moves pointwise before we get into greater fiscal stimulus as a strategy, in detail.

1) The government announced last week that in lieu of leave travel concession (LTC) and leave encashment, the central government employees can opt for a cash payment. This money has to be used to take make purchases.

LTC is a part of the salaries of central government employees. Instead of traveling in these difficult times in order to avail the LTC, the employees can opt for a cash payment. But this cash payment comes with certain terms and conditions.

Employees who opt for an encashment need to buy goods/services which are worth thrice the fare and one time the leave encashment. Only the actual fare of travelling can be claimed as a tax exemption. Tax has to be paid on the money spent on other expenses during travelling, like hotel and restaurant bills.

This money will have to be spent on buying stuff which attract a minimum 12% goods and services tax (GST), by paying through the digital route to a GST-registered vendor. It is expected that the scheme will cost the government Rs 5,675 crore. Over and above this, it will cost the public sector banks and public sector units another Rs 1,900 crore. This works out to a total of Rs 7,575 crore.

The question is will people opt for this scheme or not, given that they need to spend money out of their own pocket (i.e. their savings) in order to get a tax deduction. It needs to be mentioned here that the increase in dearness allowance of central government employees has been postponed until July 1, 2021. This will act against the idea of spending. Also, there is paperwork involved here (always a bad idea if you want people to spend money).

2) Over and above this, all central government employees can get an interest-free advance of Rs 10,000, in the form of a prepaid RuPay Card, to be spent by March 31, 2021. This is expected to cost the central government Rs 4,000 crore. It’s not clear from the reading of the press release accompanying this announcement, whether it’s compulsory for central government employees to take this card, given that this money will have to ultimately be repaid.

Also, this is not fiscal expansion in the strictest sense of the term given that LTC is already a part of the employee pay and has been budgeted for. As far as the Rs 10,000 being given as an advance is concerned, it is an interest free advance. The government will bear the interest cost on this, which will be an extremely small amount. The employees will have to repay the advance.

3) The central government is also ready to give state governments Rs 12,000 crore for capital expenditure. These loans will be interest free and need to be repaid over a period of 50 years. This money needs to be spent by March 31, 2021. A state government will be given an amount of 50% of what it is eligible for first. The second half will be given after the first half has been spent.

One can’t really question the logic behind this move. But the question that arises here is, are state governments in a position to spend this money in the next five and a half months?

4) Finally, the government has decided to spend an additional Rs 25,000 crore (over and above Rs 4.12 lakh crore allocated in the budget) on roads, defence, water supply, urban development and domestically produced capital equipment. Again, one can’t question the basic idea but one does need to ask here whether this is yet another attempt to manage the narrative.

The total capital expenditure that the government has budgeted for this financial year is Rs 4,12,009 crore. In the first five months of the financial year (April to August 2020), the government has managed to spend Rs 1,34,447 crore or around a third of what it has budgeted for. Last year, in the first five months, the government had spent around 40.6% of what it had budgeted for.

In this scenario, it is more than likely that the government will not get around to spending the extra Rs 25,000 crore. The government systems can only do a certain amount of work in a given period of time, their scale cannot be suddenly increased.

If one doesn’t nit-pick with the four above points, it needs to be said that the amounts involved are too small to even make a dent into the economic contraction expected this year. The economy is expected to contract by 10% this financial year. This means destruction of Rs 20 lakh crore of economic value, given that the nominal GDP in 2019-20, not adjusted for inflation, was Rs 203.4 lakh crore.

The government expects the moves announced last week to boost the expenditure in the economy by Rs 1 lakh crore. The mathematics of this Rs 1 lakh crore is similar to the mathematics of the Rs 20 lakh crore stimulus package (which actually added up to Rs 20.97 lakh crore) earlier in the year. As we saw earlier, the chances that the government ending up spending the Rs 4.12 lakh crore originally allocated for capital expenditure is difficult. Hence, how will it end up spending the newly allocated Rs 25,000 crore?

The government also expects the private sector spending to avail of the LTC tax benefit to be at least Rs 28,000 crore. What no one has talked about here is the fact that while there is an income tax benefit available, one also needs to pay a GST. Net net, there isn’t much benefit left after this. For someone in the marginal bracket of 20% income tax, after paying a GST of 18% to make these purchases, there isn’t much of a saving. Also, to spend three times the amount to avail of tax benefits, isn’t the smartest personal finance idea going around.

In the recently released OTT series Scam 1992 – The Harshad Mehta Story, there is a scene in the second episode, in which a newsreader is seen saying that this year’s budget has a deficit of Rs 3,650 crore for which no arrangements have been made (or as the newsreader in the series said, jiske liye koi vyawastha nahi ki gayi hai).

Given that the makers of the series have stuck to details of that era as closely as possible, I was left wondering if the Rs 3,650 crore number was correct or made up. I went looking for the budget speech of 1986-87 made by the then finance minister Vishwanath Pratap Singh, and found it.

This is what Singh said on page 32 (and point 168) of the speech: “The proposed tax measures, taken together with reliefs, are estimated to yield net additional revenue of Rs 445 crores to the Centre. This will leave an uncovered deficit of Rs 3650 crores. In relation to the size of our economy and the stock of money, the deficit is reasonable and non-inflationary [emphasis added].”

The number used in the series is absolutely correct. Hence, the makers of the Scam 1992, have gone into this level of detailing.

Dear Reader, you must be wondering by now, why have I suddenly started talking about the budget speech of 1986-87. This random point in the OTT series made me realise something. At that point of time, the government could get the Reserve Bank of India to monetise away the fiscal deficit or the difference between what it earned and what it spent.

This meant that the RBI could simply print money and hand it over to the government to spend it. Of course, money printing could lead to a higher amount of money chasing a similar number of goods and services, and hence, higher inflation. This explains why Singh in his budget speech emphasises that the uncovered deficit of Rs 3,650 crore will be non-inflationary. Not that he knew this with any certainty, but there are somethings that need to be said as a politician and this was one of those things.

As a result of two agreements signed between the RBI and the government (in 1994 and 1997) and the Fiscal Responsibility and Budget Management (FRBM) Act, 2003, the automatic monetisation of government deficit was stopped.

The government funds its deficit by selling bonds to raise debt. The FRBM Act prevented the RBI from subscribing to primary issuances of government bonds from April 1, 2006. In simple terms, this meant that it couldn’t print money and hand it over directly to the government by buying government bonds.

Now why I have gone into great detail in explaining this will soon become clear.

As I wrote at the beginning of this piece, many journalists, economists, analysts, corporates, fund managers and even politicians, have been demanding a greater fiscal stimulus from the government. In short, they have been wanting the government to spend more money than it currently does.

The International Monetary Fund  recently said that India needs a greater fiscal stimulus. Former Chief Statistician of India Pronab Sen has gone on record to say that India needs a fiscal stimulus of Rs 10 lakh crore. Business lobbies have demanded stimulus along similar levels.

The question is why is the government not going in for a bigger stimulus? The answer lies in the fact it simply doesn’t have the money to do so. The gross tax revenue of the government has fallen by 23.9% this year. Hence, it doesn’t even have enough money to finance the expenditure it has budgeted for. So, where is the question of spending more?

Of course, people who have been recommending a larger fiscal stimulus understand this. They simply want the RBI to print money and finance the government expenditure. Well, the RBI has been indirectly doing so. Take a look at the following table.

RBI –The Rupee Machine.

Source: Monetary Policy Report, October 2020.

What does the table tell us? It tells us that between early February and end September, the RBI has pumped in Rs 11.1 lakh crore into the financial system. How has it done so? Simply, by printing money in most cases. This does not apply to the cash reserve ratio cut, which meant banks having to maintain a lower amount of money with the RBI and hence, leading to an increase in the money available in the financial system to be lent out.

Here is the thing. The RBI prints money and buys bonds to introduce money into the financial system. Of course, it does not buy these bonds directly from the government. Nevertheless, even this indirect buying ends up financing  the government  fiscal deficit.

How? Let’s say the government sells bonds to finance its fiscal deficit. The financial institutions (banks, insurance companies, provident funds, mutual funds etc.) buy these bonds directly from the government (actually through primary dealers, but let’s keep this simple because the concept is more important here).

When they do this, they have handed over money to the government and have that much lesser money to lend. By printing money and pumping it into the financial system, the RBI ensures that the money that banks have available for lending doesn’t really go down or doesn’t go down as much, because of lending to the government.

Hence, in that sense, the RBI is actually indirectly financing the government. (It’s just buying older bonds and not newer ones).

The point being that despite the 1994 and 1997 agreements and the FRBM Act of 2003, the RBI is already financing the government fiscal deficit, albeit in an indirect way.

Of course, this financing is only enough to meet the current budgeted expenditure of the government. The thing is that the journalists, economists, analysts, corporates, fund managers and even politicians, want the government to spend more.

In fact, people in favour of a larger fiscal stimulus are okay with the RBI financing the government directly instead of this roundabout way. It seems that might be possible as well. As Viral Acharya, a former deputy governor of the RBI, writes in Quest for Restoring Financial Stability in India, published in July earlier this year:

“A recent amendment of the RBI Act allows the central bank to re-enter the primary market for government debt under certain conditions, annulling the reform of 2003 and recreating investor expectations of deficit monetization.”

Hence, the RBI can directly finance the government fiscal stimulus by printing money, buying government bonds and giving the government the money required to spend.

The question is why has the government not gone down this route? The fear of an even higher inflation seems to  be the answer. If there is one thing in economics that the current government is bothered about, it is inflation, in particular food inflation. The food inflation in September 2020 stood at 10.7%. During this financial year, it has been at a very high level of 9.8%.

The money supply in the economy (as measured by M3) has gone up at a pace greater than 12% since June, thanks to the RBI printing and pumping money into the financial system. For fiscal expansion more money will have to be printed and pumped into the financial system, hence, there is the risk of inflation rising even further.

A few experts have said that in a situation like this growth is more important than inflation. Some others have said that inflation is not a real danger currently.

A government focussed on narrative and perception 24 x 7 would not want to take the risk of inflation at any point of time, especially when food inflation is already close to 11% and there is grave danger of it seeping into overall retail inflation (as measured by the consumer price index).

There are other risks to printing money directly and the country’s public debt going up. Foreign investors can leave India. The rating agencies can cut the ratings. (You can read about it here). This stems from the fact that investors are not as comfortable holding investment assets in a currency like the Indian rupee vis a vis a currency like the American dollar or the British pound or the currency of any other developed country.

As L Randall Wray writes in Modern Monetary Theory: “There is little doubt that US dollar-denominated assets are highly desirable around the globe… To a lesser degree, the financial assets denominated in UK pounds, Japanese yen, European euros, and Canadian and Australian dollars are also highly desired.” This allows these countries to print money in a way that India cannot even dream of.

Also, if the government wanted to go the fiscal stimulus route, it should have done so at the very beginning. But instead it chose monetary expansion, with the RBI printing money and pumping it into the financial system, cutting the repo rate or the interest rate at which it lends to banks and getting banks to lend to certain sectors.

All this, in particular money printing by the RBI to drive down interest rates, has already led to the money supply going up. A larger fiscal stimulus will lead to the money supply going up even further increasing the possibility of a higher inflation.

There is a new theory going around especially among the stock market wallahs who think they understand economics.

The foreign currency reserves with the RBI have gone up from $440 billion towards the end of March to around $509 billion as of October 9. What if a part of this can be converted into rupees and the money can be handed over to the government to spend, is the crux of the new theory going around.

Only someone who does not understand how these foreign currency reserves ended up with the RBI in the first place, would suggest something like this. The RBI buys foreign currency (particularly the American dollar) in order to intervene in the foreign exchange market.

Let’s say a lot of foreign money is coming into India. This increases the demand for the rupee and it leads to the appreciation of the rupee. The appreciation of the rupee makes imports more competitive, hurting domestic producers (not good for atmanirbharta). It also makes exports uncompetitive. In this scenario, the RBI intervenes. It sells rupees and buys dollars (Of course, these rupees have to be printed or rather created digitally these days).

The point being that the dollars end up on the balance sheet of the RBI, only after it has introduced rupees against them into the financial system. So, where is the question of printing and introducing more rupees against the same set of dollars?  (Which is why I keep saying that stock market wallahs should stick to earnings growth and not make a fool of themselves by coming up with such silly theories).

One way of raising money against these foreign exchange reserves is to borrow against them. But that would make India look very desperate and weak on the international as well as the domestic front. Do we really want to do that?


Does all this mean that the government can’t do anything? Not really. I had written about lots of solutions a few weeks back.

One thing that the government needs to pursue seriously is an asset monetisation programme. This involves selling its stake in public sector units which are in a position to be sold. Even public sector units that cannot be sold have a lot of land lying idle.

This land needs to be monetised. This will take time. Nevertheless, the thing is that the Indian economy will need massive government support even in 2022-23. And if the government starts the monetising process now, it will be prepared in 2022-23 to help the economy.

Lower Interest Rates Good for Govt, Banks and Corporates, Not for Average Indian

The new monetary policy committee which met for the first time over the last two days has decided to keep the repo rate unmoved at 4%. Monetary policy committee is a committee which decides on the repo rate of the Reserve Bank of India (RBI). Repo rate is the interest rate at which RBI lends to banks and is expected to set the broad direction for interest rates in the overall economy.

The RBI has been trying to drive down the interest rates in the economy since January 2019. In January 2019, the repo rate was at 6.5%. Since then it has been cut by 250 basis points and is now at 4%. One basis point is one hundredth of a percentage.
This has had some impact in driving down fixed deposit interest rates of banks. Take a look at the following chart.

The Crash

Source: ICICI Securities, October 3, 2020.

From the peak they achieved between March and June 2019, fixed deposit interest rates have fallen by 170 to 220 basis points.
This in an environment where the inflation has been going up. In March 2019, inflation as measured by the consumer price index was at 2.9%. It had jumped slightly to 3.2% by June 2019. In August 2020, the latest data available for inflation as measured by the consumer price index, had jumped to 6.6%. Meanwhile, fixed deposit rates which were around 7-8%, are largely in the range of 4-6% now (of course, there are outliers to this).

Hence, inflation is greater than interest rates on fixed deposits, meaning the purchasing power of the money invested in fixed deposits is actually coming down.

In fact, interest rate on savings bank accounts, which in some cases was as high as 6-7%, has also come down. Take a look at the following chart.

Another crash

Source: ICICI Securities, October 3, 2020.

Savings bank accounts now offer anywhere between 2.5-3%.

The fall in interest rates is not just because of the RBI cutting the repo rate. A bulk of this fall has happened post the covid breakout. Banks haven’t lent money post covid.

Between March 27 and September 25, the outstanding non-food credit of banks has fallen by 1.1% or Rs 1.1 lakh crore to Rs 102 lakh crore. This means that people and firms have been repaying their loans and net-net in the first six months of this financial year, banks haven’t given a single rupee of a fresh loan.

Banks give loans to Food Corporation of India and other state procurement agencies to buy rice and wheat directly from the farmers. Once these loans are subtracted from overall lending by banks, what remains is non-food credit.

During the same period, the deposits of banks have risen by 5.1% or Rs 6.97 lakh crore to Rs 142.6 lakh crore. With people saving more, it clearly shows that the psychology of a recession is in place.

Banks have not been lending while their deposit base has been expanding at a rapid pace. The point being that banks are able to pay an interest on their deposits because they give out loans and charge a higher rate of interest on the loans than they pay on their deposits.

When this mechanism breaks down to some extent, as it has currently, banks need to cut interest rates on their deposits, given that they are not earning much on the newer deposits. This is bound to happen and accordingly, interest rates on fixed deposits have fallen.

While the supply of deposits has gone up, the demand for them in the form of loans, hasn’t. This has led to the price of deposits, which is the interest paid on them, falling.

But there is one more reason why interest rates have fallen. There is excess money floating around in the financial system. The RBI has printed money and pumped it into the financial system by buying bonds from financial institutions.

This excess money has also helped in driving down interest rates. While banks haven’t been able to lend at all in the first six months of the year, the government borrowing has gone through the roof. As the debt manager of the government, the RBI has printed and pumped money into the financial system to drive down the returns on government bond, in the process allowing the government to borrow at lower interest rates. Take a look at the following chart, which plots the returns (or yields) on 10-year bonds of the Indian government.

Going down

Source: Investing.com

The yield on a government bond is the return an investor can earn if he continues to own the bond until maturity. The above chart clearly shows that as the government has borrowed more and more through the year, the interest rate at which it has been able to borrow money has come down, thanks to the RBI and its money printing.

Of course, with banks not lending on the whole, they are happy lending to the government. In fact, in his speech today, the RBI governor Shaktikanta Das said that the central bank planned to print and pump another Rs 1 lakh crore into the financial system in the days to come.

With more money expected to enter the financial system the 10-year government bond yield fell from 6.02% yesterday (October 8) to 5.94% today (October 9), a fall of 8 basis points during the course of the day.

The monetary policy committee also decided to keep the “accommodative stance as long as necessary”, with only one member opposing it. In simple English this means that the RBI will keep driving down interest rates as long as necessary “at least during the current financial year and into the next financial year – to revive growth on a durable basis and mitigate the impact of COVID-19 on the economy.”

The assumption here is that as interest rates fall people will borrow and spend more and corporations will borrow and expand more. This will help the economy grow, jobs will be created and incomes will grow. While, this sounds good in theory, it doesn’t really play out exactly like that, at least not in an Indian context.

Let’s take a look at this pointwise.

1) A bulk of deposits in Indian banks are deposited by individuals. In 2017-18, the latest data for which a breakdown is available, individuals held around 55% of deposits in banks by value. This had stood at 45% in 2009-10 and has been constantly rising. Hence, it is safe to say that in 2020-21, the proportion of bank deposits held by individuals will clearly be more than 55%.

When interest rates on deposits (both savings and fixed deposits) go down individuals get hurt the most. There are senior citizens whose regular expenditure is met through interest on these deposits. When a deposit paying 8% matures and has to be reinvested at 5.5%, it creates a problem. Either the family has to cut down on consumption or start spending some of their capital (the money invested in the fixed deposit).

This also disturbs many people who use fixed deposits as a form of long-term saving. The vagaries of the stock market are not meant for everyone. Also, in the last decade returns from investing in stocks haven’t really been great.

2) When interest rates go down, the families referred to above cut down on consumption and do not increase it, as is expected with lower interest rates. This may not sound right to many people who are just used to economists, analysts, bureaucrats, corporates and fund managers, mouthing, lower interest rates leading to an increase in consumption all the time. But there is a significant section of people whose consumption does get hurt by lower interest rates.

3) It’s not just about bank interest rates going down. Returns on provident fund/pension funds which hold government bonds for long time periods until maturity and post office schemes (despite being higher than banks), also come down in the process.

4) Also, no corporate is going to invest just because interest rates are low right now. Corporates invest and expand when they see a future consumption potential. This is currently missing. Also, banks lending to industry peaked at 22.43% of the GDP in 2012-13. It fell to 14.28% of the GDP in 2019-20. During the period, interest rates have gone up and down, but corporate lending as a proportion of the GDP has continued to fall. So clearly increased borrowing by corporates is not just about interest rates.

But corporates love to constantly talk about high interest rates as a reason not to invest. This is just a way of driving down interest on their current debt.

As former RBI governor Urjit Patel writes in Overdraft:

“Sowing disorder by confusing issues is a tried-and-trusted, distressingly often successful routine by which stakeholders, official and private, plant the seeds of policy/regulation reversal in India.”

One can understand interest rates going down in an environment like the current one, but there is a flip side to it as well, which one doesn’t hear the experts talk about at all. Also, anyone has barely mentioned the excess liquidity in the financial system, which currently stands at Rs 3.9 lakh crore. Why is that? Let’s look at this pointwise.

1)  The equity fund managers love it because with interest rates going down further, many investors will end up investing money in stocks despite very high price to earnings ratio that currently prevails. The price to earnings ratio of the Nifty 50 index currently is at 34.7. This is a kind of level that has never been seen before.

But with post tax real returns from fixed deposits (after adjusting for inflation) in negative territory, many investors continue to bet on stocks, despite the lack of earnings growth.

2) The debt fund managers love it because interest rates and bond prices are negatively related. When interest rates come down, bond yields come down and this leads to bond prices going up. This means that the debt funds managed by these fund managers see capital gains and their overall returns go up. Hence, debt fund managers love lower interest rates.

3) Banks invest a large proportion of the deposits they gather into government bonds. When bond yields fall, bond prices go up. This leads to a higher profit for banks. This in an environment where banks aren’t lending. Hence, bankers love lower interest rates.

4) Corporates love lower interest rates at all points of time, irrespective of whether they want to borrow or not. I don’t think this needs to be explained.

5) The government loves low interest rates because it can borrow at lower rates. Second, with the stock market going up, it can sell a positive narrative. If the economy is doing so badly, why is the stock market doing well?

6) This leaves economists. Economists love lower interest rates because the textbooks they read, said so.

The question is do lower interest rates or interest rates make a difference when it comes to borrowing by an average Indian? Let’s take a look at non-housing retail borrowing from banks over the years. In 2007-08 it stood at 5.34% of the gross domestic product (GDP). In 2019-2020, it stood at an all-time high of 5.97% of GDP.

In a period of 12 years, non-housing retail borrowing from banks, has barely moved. What it tells us to some extent is that the idea of taking on a loan to buy something (other than a house), is still alien to many Indians.

So, the idea that interest rates falling leading to increased retail borrowing is a little shaky in the Indian context.

To conclude, today the RBI governor Shaktikanta Das gave a speech which was more than 4,000 words long. In this speech, the phrase fixed deposit interest rate did not appear even once.

A whole generation of savers is getting screwed (for the lack of a better word) and the RBI Governor doesn’t even bother mentioning it in his speech. The RBI seems to be constantly worried about the interest rate at which the government borrows.

A central bank which only bats for the government, corporates and bond market investors, is always and anywhere a bad idea.

Shaktikanta Das’ RBI is at the top of this bad idea.


Has RBI Lost Control of Monetary Policy?

On August 31, 2020, the Reserve Bank of India (RBI), published an innocuously titled press release RBI Announces Measures to Foster Orderly Market Conditions. The third paragraph and the fourth line of the release said this: “The recent appreciation of the rupee is working towards containing imported inflationary pressures [emphasis added].”

What did this line mean? Take a look at the following chart. As of June 18, one dollar was worth Rs 76.55. By August 31, one dollar was worth Rs 73.13. The rupee had gained value or appreciated against the dollar.

Rupee Up, Dollar Down

Source: Yahoo Finance.

What has this got to do with inflation? When the value of the rupee appreciates against the dollar, the imports become cheaper.

Let’s say the price of a product being imported into India is $10. If the dollar is worth Rs 76, it costs Rs 760. If the dollar is worth Rs 73, it costs Rs 730. Hence, if the rupee appreciates, imports become cheaper and in the process the inflation (or the rate of price rise) that we import from abroad, comes down as well.

The trouble is that if imports become cheaper, things become difficult for the home-grown products. Hence, an appreciating rupee goes against the government’s pet idea of atmanirbhartha or producing goods locally.

Given that the current dispensation at the RBI is more or less in line with what the government wants, this move to allow the rupee to appreciate, so that it reduces imported inflation, is even more surprising. (On a different note, I am all for consumers getting to buy things cheaper than in the past. The point of all economic activity, at the end of the day, is consumption. But most people don’t think like that).

Also, RBI’s Monetary Policy Report released in April, suggests that the impact of the appreciation of rupee on inflation is at best marginal: “An appreciation of the Indian Rupee by 5 per cent could moderate inflation by around 20 basis points.” One basis point is one hundredth of a percentage.

The trilemma

So what’s happening here? The RBI has basically hit the trilemma, something which it can’t admit to. Trilemma is a concept which was originally expounded by the Canadian economist Robert Mundell. Basically, a central bank cannot have free international movement of capital, a fixed exchange rate and an independent monetary policy, all at the same time. It can only choose two out of these three objectives. Monetary policy refers to the process of setting of interest rates in an economy, carried out by the central bank of the country.

Of course, this is economic theory and in practice things are slightly different. The more a central bank allows free international movement of capital (i.e. money) and has a tendency to continuously intervene in the foreign exchange market and not allow free movement in the price of the local currency against the dollar, the lesser control it has over its monetary policy.

Let’s try and understand this through an example. Let’s consider the central bank of a country which allows for a reasonable movement of capital. At the same time, it wants to ensure that the value of its currency against the US dollar doesn’t move much.

This is to ensure that its exporters don’t face much volatility on the exchange rate front. Over and above this, the central bank does not want its currency to appreciate because that would hurt the exporters and make them less competitive.

In this scenario, let’s say the central bank sets interest rates at a higher rate than the rates in the United States and other parts of the world. What will happen is given that reasonably free movement of capital is allowed money from other parts of the world will come flooding in to cash in on the higher interest.

When the foreign capital comes into the country in the form of dollars and other currencies, it will have to be converted into the local currency. This will lead to the demand of the local currency going up and the local currency will appreciate against the dollar. Of course, when this happens, the value of the local currency will no longer remain fixed against the US dollar.

This is where the trilemma comes to the fore. If the country wants monetary independence and free movement of capital, it cannot have a fixed exchange rate. If it wants a fixed exchange rate then it has to set interest rates around the interest rate set by the Federal Reserve, so that it doesn’t attract capital because of a higher interest rate. In the process, it loses control of monetary policy.

In the Indian case, in the recent past, the RBI has tried to pursue all the three objectives, reasonably free movement of capital, a currency (the rupee) which doesn’t appreciate against the dollar and an independent monetary policy.

The repo rate, or the rate at which the RBI lends to banks, was cut from 5.15% to 4%, in the aftermath of the covid-pandemic. The RBI has also flooded the financial system with money by buying government bonds.

Between February 24 and April 23, the RBI lent a lot of money to banks through long-term repo operations, targeted long-term repo operations and targeted long-term repo operations 2.0. These schemes have essentially lent money to banks at the repo rate for the long term. On February 24, the RBI lent Rs 25,021 crore to banks for a period of 365 days at the prevailing repo rate of 5.15%. The repo rate is the interest at which RBI lends to banks, typically for the short-term.

After this, the RBI has lent around Rs 2.13 lakh crore for a period of around three years at the prevailing repo rate. Around Rs 1 lakh crore out of this was lent at 5.15%. In late March, the RBI cut the repo rate by 75 basis points to 4.4%. The remaining Rs 1.13 lakh crore has been lent at this rate. The idea here was to encourage to lend money to banks at a low interest rate and then encourage them to lend further, under certain conditions. There has been more bond buying over and above this.

The idea was to drive down interest rates to lower levels, so that companies borrow and expand, people borrow and consume. In the process, the economy starts to recover. Also, with the government borrowing more this year, lower interest rates would help it as well.

Along with this, the reasonably free movement of capital that India allows has continued. The RBI has also intervened in the currency markets trying to ensure that the rupee doesn’t appreciate against the dollar.

What’s happening here? In the aftermath of covid, Western central banks have gone on a money printing spree, some to drive down interest rates and to get businesses to expand and people to consume, and some others to finance the expenditure of their government. Take the case of the Federal Reserve of the United States. Between February end and early June, it printed a close to $3 trillion and expanded its balance sheet by three-fourths in the process.

To cut a long story short, interest rates have been driven down globally and there is a lot of money going around looking for some extra return. Some of this money has been coming to the Indian stock market.

In 2020-21, the current financial year, the foreign institutional investors (FIIs) have net invested $7.62 billion in the Indian stock and bond market. A good amount of this, $6.66 billion, came in August, when FII investment turned into a deluge. Of course, there were months like April and May, when the FIIs net sold. Between June and August, the FIIs net invested $10.54 billion in the Indian stock and bond markets.

The foreign direct investment (FDI) coming into India between April and July stood at $5.86 billion, with $4.01 billion coming just in July. The outward FDI (Indians investing abroad) in the first four months, stood at $3.17 billion. This means that the net FDI number (foreign investments made by Indians deducted from investments in India by foreigners) has been in positive territory. Net-net dollars have come into India on the FDI front.

Over and above this, the net receipts from services (i.e. services exports minus services imports) stood at around $28 billion between April and July.

Other than this, the demand for dollars, from within India, has come down. The import of crude oil and petroleum products between April and August 2020 has fallen by 53.7% to $26.02 billion. This has been both on account of fall in price of oil as well as lower consumption. In fact, on the whole, the goods exports have fallen at a lesser pace than goods imports, again implying a reduced demand for dollars within India.

Internal remittances, the money sent by Indians working abroad back to India, must have definitely fallen this year (I say must because the data for this isn’t currently available). Nevertheless, at the same time, outward remittances, everything from money spent on health, education and travel, has also come down, given that barely anyone is travelling abroad.

What does this basically mean? It means more dollars are coming into India than leaving India. When dollars come into India they need to be converted into rupees. This increases the demand for rupees and the rupee then appreciates against the dollar. This, as I have explained above, hurts atmanirbharta, domestic producers of goods and exporters, all at once.

Preventing the appreciation of the rupee

To prevent the rupee from appreciating against the dollar, the RBI buys dollars by selling rupees. In fact, that is precisely what the RBI has done between April and July this year. It has net purchased $29 billion, the highest in this period in the last five years. The August press release suggests that the RBI stopped trying to defend the rupee from appreciating sometime during the month or at least didn’t try as hard as it did in the past.

If we look at the foreign currency assets of the RBI they have barely moved between August 28 (three days before the press release) and September 18 (the latest data available), barely increasing from $498.36 billion to $501.46 billion. This tells us that the RBI isn’t really intervening much in the foreign exchange market in the recent past. But that might also be because of the fact that in September (up to September 29), the FIIs have net sold stocks and bonds worth just $4 million. Net net, FIIs didn’t bring any dollars into India in September.

By buying dollars, the RBI releases rupees into the Indian financial system and thus increases the money supply. In the normal scheme of things, the RBI can sterilise this by selling bonds and sucking out this money. But that would have gone against the easy money policy that the Indian central bank has been running through this financial year.

The excess liquidity (or the money that the banks deposit with the RBI) in the financial system suggests that the RBI hasn’t really been sterilising the rupees it has put into the system to prevent the appreciation of the rupee. On the whole, the bond buying by the RBI in order to release money into the financial system, has been in the positive territory. The following chart plots this excess liquidity in the system.

Easy Money

Source: Centre for Monitoring Indian Economy.


The excess liquidity in the system, money which banks had no use for and parked with the RBI, even crossed Rs 6 lakh crore in early May. It has since fallen but is still at a very high Rs 2.72 lakh crore.

So, what does all this mean?

The inflation between April and August, as measured by the consumer price index, has been at 6.63%. The inflation in August was at 6.69%. As per the RBI’s agreement with the government the inflation should be 4% within a band of +/- 2%.

This means that the current inflation is way beyond range. A major reason for this is high food inflation which between April and August has been at 9.58%. The food inflation in August was at 9.05%.

If we look at the core inflation (which leaves out food, fuel and light), it is at 5.16%. If we add fuel inflation to this (thanks to the government increasing the excise duty on petrol and diesel), the inflation is higher.

Where does this leave the RBI? All the liquidity in the financial system hasn’t led to even higher inflation primarily because there has been an economic collapse and people are not spending money as fast as they were in the past.

Food inflation has primarily been on account of supply chains breaking down thanks to the spread of the covid-pandemic. The trouble is that covid is now spreading across rural India. As Crisil Research put it in a recent report: “Of all the districts with 1,000+ cases, almost half were rural as on August 31, up from 20% in June.” This basically means that the supply chain issues when it comes to movement of food are likely to stay, during the second half of the year as well.

Food on its own makes up for 39.06% of the overall index and 47.25% of the index in rural India. As the Report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework (better known as the Urjit Patel Committee) said:

“High inflation in food and energy items is generally reflected in elevated inflation expectations. With a lag, this gets manifested in the inflation of other items, particularly services. Shocks to food inflation and fuel inflation also have a much larger and more persistent impact on inflation expectations than shocks to non-food non-fuel inflation.”

An IMF Working Paper titled Food Inflation in India: The Role for Monetary Policy suggests the same thing: “Food inflation [feeds] quickly into wages and core inflation.” This is something that the country saw in the five-year period before 2014, when food inflation seeped into overall inflation.

What this means is that if covid continues to spread through rural India and food supply chains continue to remain broken, food inflation will persist and this will seep through into overall inflation, which is anyway on the high side.

In this situation what will the RBI do in the months to come? As mentioned earlier, all the money that the RBI has pumped into the Indian financial system hasn’t led to an even higher inflation simply because the consumer demand has collapsed. But as the economy continues to open up and the demand picks up, there is bound to be some amount of excess money chasing the same amount of goods and services, leading to higher inflation.

In this scenario what will the RBI do to prevent the appreciation of the rupee against the dollar, especially if foreign capital continues to come to India and the demand for the rupee continues to remain high?

As mentioned earlier, if the RBI buys dollars and sells rupees to prevent appreciation, it will continue to add to money supply. Interestingly, the money supply (as measured by M3 or broad money) has been growing at a pace greater than 12% (year on year) since June. This kind of rise in money supply was previously seen only before 2014, a high inflation era.

If RBI keeps trying to intervene in the foreign exchange market to prevent the appreciation of the rupee against the dollar, it will keep adding to the money supply and that creates the risk of even higher inflation. To counter this risk of higher inflation, the RBI will need to raise the repo rate or the interest rate at which it lends to banks.

This goes against what the Indian economy or for that matter any economy, needs, when it is going through an economic contraction. This in a way suggests that the RBI has lost control over the monetary policy. In fact, even if the monetary policy committee (MPC) of the RBI, whenever it meets next, keeps the repo rate constant, it suggests a lack of control over monetary policy. This also explains why the RBI hasn’t made any inflation projections since February this year.

Of course, the RBI has the option of sterilising the extra rupees it releases into the financial system by buying dollars coming into India. In order to sterilise the extra rupees being released into the financial system, the RBI needs to sell government bonds. The RBI needs to pay a certain rate of interest on these bonds. These bonds are a liability for the RBI.

As far as assets of the RBI go, a significant portion is invested in bonds issued by the American and other Western governments and the International Monetary Fund. These assets pay a much lower rate of interest than the interest that the RBI needs to pay on bonds it sells to sterilise excess rupees in the financial system. This is referred to as the quasi fiscal cost and needs to be kept in mind.

The second problem with sterilisation is that it might lead to a situation where interest rates might go up, creating further problems. As an RBI research paper titled Forex Market Operations and Liquidity Management published in August 2018 points out:

“For example, when a central bank undertakes open market sale of government securities to absorb the surplus liquidity as a part of the sterilised intervention strategy, it could harden sovereign yields, which, in turn, could attract further debt inflows driven by higher interest rate differentials.”

What does this mean in simple English? When the RBI sells government bonds to carry out sterilisation, it sucks out excess rupees from the market. This might lead to interest rates going up. If interest rates go up more foreign money will come into India looking to earn that higher interest rate. And this will create the same problem all over again, with the demand for rupee going up and the RBI having to intervene in the foreign exchange market.

Any increase in interest rates will not go down well with the government which will end up borrowing a lot of money this year, thanks to a collapse in tax revenues. Take a look at the following chart which plots the 10-year government bond yield from the beginning of 2020. The 10-year government bond-yield is the return an investor can expect per year, if they continue owning the bond until maturity.

Down and then slightly up

Source: https://in.investing.com/rates-bonds/india-10-year-bond-yield-historical-data

Thanks to all the easy money created by the RBI there has been excess money in the Indian financial system, since the beginning of this year. This has helped drive down bond yields from around 6.5% at the beginning of the year to a low of 5.76% in July and to around 6.04% currently. Hence, the Indian government has been able to borrow at a lower rate thanks to the excess liquidity created by the RBI and it wouldn’t want that to change. Also, the yields have been rising gradually since July, making sterilising even more difficult.

If the RBI keeps intervening it creates the risk of increasing money supply and that leading to the risk of even higher inflation. A high inflation in a poor country is never a good idea. If the RBI does not intervene that leads to the rupee appreciating and in the process creating problems for the domestic industry as well as the atmabnirbhar strategy. The exporters suffer as well.

What’s the RBI’s best strategy here? It can pray that foreign inflows slow down for a while, like they have in September. But that was basically the FIIs reacting to the Indian economy contracting by nearly a fourth between April to June. This data point was published on August 31. Also, as the economy keeps opening up more and more, imports and other spending pick up, the demand for the dollar will go up as well. All this will help the RBI. Nevertheless, if Western central banks unleash even more money printing, then all this will go for a toss.

The RBI ended up in this position by abandoning its main goal of managing price inflation. The agreement between the government and the RBI states clearly that “the objective of monetary policy is to primarily maintain price stability [emphasis added], while keeping in mind the objective of growth.”

Instead of managing inflation, the RBI chose its role as the debt manager of the government to outshine everything. This led to all the excess liquidity in the system so that interest rates were driven down and the government could borrow at lower interest rates. The Times of India reports on October 1, 2020: “The weighted cost of borrowing [for the government] during the first half was 5.8%, the lowest in 15 years.”

While the government has borrowed more, the overall non-food credit given by banks has shrunk between March 27 and September 11, from Rs 103.2 lakh crore to Rs 101.6 lakh crore. The banks lend money to the Food Corporation of India and other state procurement agencies to primarily buy rice and wheat (and some oilseeds and pulses in the recent past) directly from the farmers. Once this credit is subtracted from overall credit of banks what remains is non-food credit.

What this tells us is that despite lower interest rates overall lending by banks has shrunk. This might primarily be because of people and firms prepaying loans as well as a general slowdown in loan disbursal. Of course, the fall in interest rates has hurt savers and nobody seems to be talking about them.

To conclude, the RBI abandoned its main goal and is now stuck because of that. As economists Raghuram Rajan and Eswar Prasad wrote in a 2008 article : “The central bank is also held responsible, in political and public circles, for a stable exchange rate. The RBI has gamely taken on this additional objective but with essentially one instrument, the interest rate, at its disposal, it performs a high-wire balancing act.”

By trying to do too many things at the same time, RBI ends up being neither here nor there. As Rajan and Prasad put it: “What is wrong with this? Simple that by trying to do too many things at once, the RBI risks doing none of them well.” This was a mistake the RBI used to make pre-2015, before the agreement with the government was signed. It has gone back to making the same mistake again.

As Rajan wrote in the 2008 Report of the Committee on Financial Sector Reforms“The Reserve Bank of India (RBI) can best serve the cause of growth by focusing on controlling inflation.”

But that’s not to be, given that politicians, bureaucrats and even economists, expect monetary policy to perform miracles it really can’t.

I would like to thank Chintan Patel for research assistance. 


An Appreciating Rupee and Atmnirbharta Don’t Go Together

One dollar was worth around Rs 77.6 in mid-April. Since then, the rupee has appreciated against the dollar and now one dollar is worth around Rs 73.5.

In a press release on August 31, the Reserve Bank of India (RBI) explained the mystery of the appreciating rupee by saying: “the recent appreciation of the rupee is working towards containing imported inflationary pressures.

Before analysing this statement, it is important to understand what it means. India’s imports are consumption oriented and not capital goods oriented. This can be gauged from the fact that non-oil, non-gold and non-silver imports, a very good indicator of consumer demand, moved from 55.8% of the total imports in 2011-12 to 69.7% in 2016-17. In 2019-20, these imports at 65.9% of total imports.

What this also tells us is that Indians prefer to buy imported goods than what is produced in India, wherever there was a choice. Their revealed preference is very clear on this front.

In this scenario, when the rupee appreciates against the dollar, the cost of imports comes down. Let’s say a product is imported for $10. At one dollar being worth Rs 77.6, it costs Rs 776. At one dollar being worth Rs 73.5, it costs Rs 735. There is a clear fall in price as the rupee appreciates. This helps control inflation or the overall rate of price rise.

As the RBI pointed out in its monetary policy report released in April earlier this year: “An appreciation of the INR by 5 per cent could moderate inflation by around 20 basis points.” One basis point is one-hundredth of a percentage.

An appreciating rupee is basically an indicator of excessive dollar inflows into India. When these dollars come into India, they need to be converted into rupees. This pushes up the demand for rupees, leading to the rupee appreciating.

One way of preventing this is the RBI buying the dollars that are coming in by selling rupees, in order to ensure that there are enough rupees in the system and in the process, the rupee doesn’t appreciate against the dollar or at least appreciates at a gradual pace. The RBI is not doing this or to put it more specifically isn’t doing as much of this as it was in the past.

This, as the RBI has explained is being done to control imported inflation.

The inflation as measured by the consumer price index, between April and July this year, was at 6.7%. Core inflation which ignores food, fuel and light items, was at 5.1%, with non-core inflation being at 8.6%. The high non-core inflation was on account of food inflation being at 9.8% between April and July. RBI has no control over food inflation.

Also, food inflation has been primarily on account of supply chains breaking down on account of the spread of the covid-pandemic. So, is the RBI getting too desperate, is a question well-worth asking here.

An appreciating rupee benefits imports and importers. This in a scenario where the government of the day has been talking about India becoming atmnirbhar or promoting self-reliance. In order to promote this, higher-tariffs on imports, like a higher customs duty on specific-imports, has been the way to go.

As the late Arun Jaitely said in the 2018-19 budget speech: “In this budget, I am making a calibrated departure from the underlying policy in the last two decades, wherein the trend largely was to reduce the customs duty.” This has been the policy stance of the government over the last few years.

But all this gets undone if the rupee is allowed to appreciate against the dollar. It makes imports cheaper and domestic producers will find it even more difficult to compete against the imports. Hence, this goes against the entire idea of atmnirbharta or encouraging domestic producers. It also goes against the idea of getting foreign companies to produce within India. If the rupee keeps appreciating they might just like the idea of importing most of the inputs and then assembling the end product in India.

This is quite weird, given that since Shaktikanta Das took over as the governor of the RBI, India’s central bank has more or less acted on the instructions of the government, rarely having a mind of its own. That makes me wonder what is really happening here?

Having said that, this is good news for the Indian consumer. As David Boaz writes in The Libertarian Mind: “The point of economic activity is consumption. We produce in order to consume… For each participant in international trade, the goal is to acquire consumption goods as cheaply as possible.”

So, is the RBI really batting for the Indian consumer in the aftermath of the economy being hit by the covid-pandemic? Or is there something more to the entire thing? On that your guess is as good as mine.

RBI Gives a Covid Spin to Cash Touching Pre-Demonetisation Levels

We live in an era of narratives. Politicians create them. Corporates create them. Social activists create them. Commentators, public intellectuals, economists and analysts also create them. And there are days when we are even lying to ourselves in our heads and creating narratives for ourselves.

In all this, it is hardly surprising that the Reserve Bank of India (RBI), with Shaktikanta Das at its helm, has also padded up and gotten into the business of narratives and spin. Before I explain this in detail, let me give you some background to this piece.

In November 2016, the central government demonetised Rs 500 and Rs 1,000 notes. The citizens had to deposit these notes into their bank accounts. The result was that 86% of the currency by value suddenly went out of the financial system.

Paper money has different uses, but its main use is as a medium of exchange. It basically facilitates the process of buying and selling. Of course, if people want to, the process of exchange can be carried out through other means like issuing a cheque, making a demand draft, carrying out a money transfer or even paying money digitally.

But India back in 2016 was a country which believed in operating in cash. When the cash went out of the system, the economic transactions especially in the informal sector took a beating. The gravity of the situation never really came out fully, except perhaps anecdotally, given that the government data collection for the informal part of the economic system was and continues to remain abysmal. I guess, which is why it is called an informal sector in the first place.

Between November 2016 and now, I have closely tracked the total amount currency in circulation gradually increasing. Of course, as the economy expands, the currency in circulation is bound to go up. In order to take care of this, the data that needs to be tracked is the currency in circulation divided by the gross domestic product (GDP), expressed as a percentage. (I will refer to this as cash in the system). The GDP is the measure of the size of any economy. The cash in the system basically adjusts for the size of the economy.

My contention over the years has been that the cash in the system will eventually rise to touch the pre-demonetisation level. Earlier this year, in April 2020, writing in the Mint, I had said: “The cash in the system [as of March 2020] works out to 12% of GDP.” I had made this calculation on the basis of the currency in circulation as of March 27 and the GDP forecast for 2019-20 (up until then, the actual GDP numbers were yet to come in).

A formal confirmation of this came yesterday with the RBI  releasing its annual report. In the annual report, the RBI says: “The currency-GDP ratio increased to its pre-demonetisation level of 12.0 per cent in 2019- 20 from 11.3 per cent a year ago, indicating the rise in cash-intensity in the economy in response to the pandemic [emphasis added].” The currency in circulation constitutes of cash with banks and cash with the public.

Before analysing this statement, let’s look at the following figure, which plots the currency in circulation to the GDP ratio or the cash in the system, over the years.

Cash in the System

Source: Reserve Bank of India.

In March 2017, a few months after demonetisation was carried out and after the whole country had queued up to deposit the demonetised Rs 500 and Rs 1,000 notes into their bank accounts, the cash in the system fell to 8.7% of the GDP.

The reason for this was very straightforward; the government and the RBI couldn’t replace the cash in the system at the same pace as they had taken it out. There were all kinds of problems, including banks having to reset ATM trays in order to take care of the smaller size of the new notes.

As of March 2020, the cash in the system is back to 12% of the GDP, which is at an almost similar level of 12.1% of the GDP as of March 2016, before demonetisation was carried out. The RBI feels this has happened because there has been a dash for cash in light of the spread of the covid-19 pandemic. People hoarded on to more cash than they normally do and this led to a faster rise in the cash in the system than it normally would have.

The point to be remembered here is that we are talking cash in the system as of March 2020 and not August 2020. At that point of time, people had just started to take covid-19 seriously. Let’s take a look at the monthly increase/decrease in currency in circulation during the course of 2019-20.

Changes in currency in circulation

Source: Author calculations on data from Reserve Bank of India.

It is very obvious from the above chart that at Rs 99,040 crore, the maximum monthly increase in cash in the system during the year, happened in March 2020. Does this then imply that there was a dash for cash as the fear of the pandemic spread? In order to say this with surety we will have to look at weekly increase in cash levels in the system during the course of March 2020.

Dash for Cash?

Source: Author calculations on Reserve Bank of India data.

India went into a physical lockdown starting March 24, 2020. It is only around then that most of the country realised the gravity of the pandemic. This can be seen by increase in cash in the system in the week ending March 27. This implies a higher than normal increase in currency with public with a higher withdrawal of money from the banking system than would have been the case if all was well.

But the bulk of the increased withdrawals in March had happened before March 20. Close to 62% of the withdrawals in March (at Rs 61,354 crore) had happened before March 20. Interestingly, up until then the fear of the pandemic hadn’t really spread. This weakens the entire dash for cash argument.

Let’s say if things had gone on normally then it is safe to say that the increase cash in the system in March would have been around 80-85% of what it eventually got to. At this level of increase, the cash in the system as of March end would have been around 11.95% of the GDP, which is not significantly different from 12.03% of the GDP, it eventually came to. The RBI’s dash for cash argument hangs on a few basis points.

Even if assume, that increase in the cash in the system in March 2020 was at around 60% of the actual number, the cash in the system would have worked out to 11.84% of the GDP, which is slightly lower than 12.03% of the GDP. And even at 11.84% of the GDP, the cash in the system would have been higher than where it was as of March 2019, and would have continued to go up, as it has since November 2016. This is the more important point.

While India of November 2016 was a country which believed in operating in cash, so is the India of March 2020. Yes, digital transactions have gone up along the way and that’s a good thing. But that could have happened anyway without putting the country through the trouble that demonetisation did.

Also, it is time we realised that people don’t store their black money in cash. In fact, data from a White Paper on black money published in May 2012 showed that around 4.9% of the total undisclosed income admitted to during search and seizure operations between 2006 and 2012 was held in the form of cash. Cracking down on black money is much more complicated operation than just cracking down on cash in the system.

Further, societies with more cash aren’t necessarily more corrupt. If that was the case Japan with a cash in the system of around 20% of the GDP would be more corrupt than India. On the flip side, Nigeria which has a cash in the system comparable to that of Norway, wouldn’t be a country as corrupt as it is. The government needs to make peace with this fact.

To conclude, I think one reason the RBI might have resorted to this spin and is trying to create a narrative, lies in the fact that when demonetisation was carried out, the current RBI governor Shaktikanta Das was the finance secretary.

My guess is that a part of Das still wants to justify demonetisation as a good thing and show it by telling the nation that the cash in the system rose to the pre-demo level simply because of the Covid-19 pandemic, something that wouldn’t have happened otherwise.

But as I showed above that is a very weak argument. It is time the RBI sang a different tune on this front and moved a dash for cash to Das for cash.