demonetisation

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.

Cash is Back: Ill-Effects of Demonetisation are Finally Going Away

We had written about this issue, earlier this month.

At that point of time, the currency in circulation was approaching its pre-demonetisation level.

As of March 9, 2018, the currency in circulation crossed its pre-demonetisation level, for the first time. This is a significant event, which has largely gone unreported in the mainstream media. We wonder why? Dear Reader, guess you know the answer to this one.

Take a look at Figure 1.

Figure 1:The currency in circulation as on November 4, 2016, four days before demonetisation was announced, had stood at Rs 17.98 lakh crore. After that the currency in circulation fell, as people deposited Rs 500 and Rs 1,000 notes in their bank accounts. It fell to low of Rs 8.98 lakh crore as on January 6, 2017, and has had largely had an upward trend since then.

Of course, it is not fair to look at currency in circulation, just in isolation. Then there would be no difference between what passes of as analysis on the social media and us.

The currency in circulation is also a function of the size of the economy. Between November 2016, when demonetisation happened and now, the economy has also increased in size. Hence, we need to adjust for this, and the right metric to look at is the currency in circulation to the Gross Domestic Product (GDP) ratio.

In order to come up with this ratio for the end of this financial year, we will have to project the currency in circulation. A projection for the GDP is available.

We basically look at the weekly growth rate of currency in circulation over the last one year (i.e. from March 10, 2017 to March 9, 2018). We ignore the rate of increase in currency in circulation from January 6, 2017 and March 2, 2017, because it was growing at a very fast rate at that point of time.

Using the weekly rate of increase of currency in circulation from January 6, 2017, onwards, is likely to lead to a higher currency in circulation at the end of this financial year and we like to be slightly conservative in our calculations.

Using the rate of weekly increase in currency in circulation between March 10, 2017 and March 9, 2018, the currency in circulation at the end of March 2018, is likely to be around 18.53 lakh crore. As of March 9, 2018, it was at 18.14 lakh crore.

The GDP at the end of the year is projected to be at Rs 167.51 lakh crore. This means a currency to GDP ratio of 11.1%. Take a look at Figure 2, which basically plots, the currency to GDP ratio of the Indian economy, over the years.

Figure 2:The currency in circulation as of March 31, 2017, had stood at 8.8% of the GDP. By March 31, 2018, it is expected to be at 11.1% of GDP, a jump of 230 basis points. One basis point is one hundredth of a percentage. While, this has still not crossed the pre-demonetisation level, it is a tremendous recovery from the March 2017 low.

There are multiple interpretations that can be made from this. Firstly, it tells us very clearly that Indians have gone back to cash as a medium of exchange. It also tells us very clearly that fundamental habits cannot be changed overnight, a point we have been hammering away at for a while now. An economy which used cash for close to 98% of its transactions (in volume terms), cannot be suddenly expected to use substantially less cash.

The increasing currency in circulation as a proportion of the GDP, is a sign of people carrying out more economic transactions with each other than they were in the past. Only when economic transactions happen do people need cash or currency to pay for stuff. If economic transactions are not happening, the currency can continue to stay in the bank account. Only, when transactions start to happen, money is withdrawn from banks and currency in circulation goes up.

Of course, many transactions are carried out in cash. Informal economy forms a huge part of India’s total economy. It also employs a major part of the workforce.

Depending on which estimate you want to believe the informal economy forms around 40-45% of India’s economy and employs anywhere between two-thirds to 92% of its workforce. The currency in circulation going up is clearly good news for the informal sector.

It shows that life seems to be gradually getting back to normal, for this sector, which was badly hit in the aftermath of demonetisation. This should gradually translate into good news for the formal sector as well. If the informal sector does well and people working in it earn money and spend it, the firms operating in the formal sector are bound to benefit, as well.

Of course, the propaganda these days is that everybody who operates in the informal sector is bad, because they don’t pay tax. But that is incorrect. As we have written in the past, a bulk of the individuals working in the sector do not come under the tax bracket and hence, they don’t pay tax. Hence, painting everyone with the same brush is neither fair nor required.

Having said that, there are people and firms operating in the informal sector not paying their fair share of taxes. This means the income tax department needs more efficient targeting, instead of painting everyone with the same brush, as the government has been doing since November 2016. But that is easier said than done.

Propaganda is way easier than doing the right things.

The column originally appeared on Equitymaster on March 22,2018.

Of Falling Real Estate Prices, Dr Arvind Panagariya and the Art of Continuing to Suck Up

220px-Arvind_Panagariya

Dr Arvind Panagariya, the former vice-chairman of the Niti Aayog, today in a column titled Demonetisation: Evaluating the Critics, in the Business Standard, writes: “The second avenue through which demonetisation has directly expunged unaccounted wealth is real estate…Unsurprisingly, an attack on unaccounted cash struck at the heart of this black wealth by cutting real estate prices by a quarter.”

There are multiple questions that this statement raises:

1) What is the source for this data? This isn’t exactly a conversation between two property dealers, or two prospective real estate buyers, who can quote any offhand numbers, while having a conversation. This is a statement being made by someone who was at the top of an economic institution run by the Indian government. This is a statement by an economist working in a top university in the United States.

Also, if real estate prices have fallen by 25 per cent after demonetisation, why isn’t this visible in official data sources. Take the case of Reserve Bank of India’s All India House Price Index, which has been plotted as Figure 1.

Figure 1: 

Figure 1 clearly shows that housing prices across the country have been on their way up. There has “clearly” been no dip, as Dr Panagariya claims. How do things look if we plot one-year return instead of index values? Let’s take a look at Figure 2, which does that.

Figure 2: 

Figure 2 tells us clearly that the one-year return in real estate has been falling over the last six and a half years. This trend started much before demonetisation took place. Also, how have the returns been post demonetisation? Between the end of December 2016 and June 2017 (the latest data available), real estate prices as per the All India House Price Index have gone up by 4.3 per cent. The returns between September 2016 and June 2017, have been 6.9 per cent.

Other than RBI’s All India House Price Index, there is NHB’s Residex. As of now this index has data only up to March 2017. And the one year median return between March 2016 and March 2017, as per this index, across 49 cities, was 2.8 per cent. This is very low. But where is the 25 per cent fall that Dr Panagariya has written about?

2) For a moment let’s assume that Dr Panagariya is right and real estate prices have fallen by 25 per cent. If real estate price all across the country have fallen by 25 per cent on an average, then there will be cities/town/localities where the price has fallen by more than 25 per cent. Which are these places? Can Dr Panagariya provide us with a list? This would make for a super investment right now.

Let’s say there is this town where real estate prices have fallen by 50 per cent post demonetisation. It is worth remembering that a 50 per cent loss wipes off a 100 per gain. (If the price of an asset moves from Rs 50 to Rs 100 that makes for a 100 per cent gain. When it falls back to Rs 50 that is a 50 per cent loss). If there exists such a town, it would make for a great real estate investment right now. Can Dr Panagariya provide us with names of a few such places?

3) Also, if prices have fallen by 25 per cent, why are real estate transactions not happening? Why has the total number of unsold homes of real estate companies, only continued to grow? It is worth remembering here that a 25 per cent fall within a time period of a year, is a huge fall. Falls like these in case of real estate, only happen once in a few decades. And if something like this has happened, as Dr Panagariya claims, then why aren’t people buying? Interest rates on home loans have also fallen post demonetisation.

Take a look at Figure 3. It plots the growth in home loans outstanding with banks.

Figure 3: 

Figure 3 clearly shows that the growth in home loans outstanding has fallen post demonetisation. What this means is that people are not buying as many homes as they were in the past. If prices have fallen by 25 per cent post demonetisation, people would have bought homes and the curve in Figure 3 would slope upwards i.e. people would take on more and more home loans to buy homes.

4) Further, if real estate prices have fallen by 25 per cent, as claimed by Dr Panagariya, it is time that the state governments cut the ready reckoner rates on which stamp duty needs to be paid, by a similar proportion. This should be fairly easy given that BJP governments govern most of the big states across India and a direction from the PMO should be suffice to get them to do the needful. But nothing of that sort has happened. Why hasn’t this been done till date, is a question that only Dr Panagariya can answer.

5) To conclude, it is safe to say that Dr Panagariya has just made up this data, in order to justify demonetisation. It’s a sad day today, when an Indian economist, working in one of the best American universities has had to fudge data in order to please his former political bosses.

The irony is that Dr Panagariya is no longer a part of the government. And he doesn’t really need to say things which do not hold up against data, unless, he is looking for another stint with the Modi government. That changes things.

The column originally appeared on November 13, 2017.

Demonetisation–The Unanswered Question

Time flies.

It has been one year since that fateful day last year, when prime minister Narendra Modi, suddenly announced that Rs 500 and Rs 1,000 notes, would be useless, in a matter of few hours.

Modi was lauded for this “brave” decision. In a country, where politicians do not like to take decisions, here was one politician who had decided to make one.

The trouble is that nobody told us on what basis had the decision been taken. Every decision, has consequences, especially a decision as disruptive as demonetisation turned out to be. And given this, there has to be some logic behind why the decision was made in the first place.

It doesn’t take rocket science to understand that if 86.4 per cent of the currency in circulation is made useless overnight, in a country where 80-98 per cent of the transactions happen in cash (depending on which estimate you would like to believe), the buying and selling of things is bound to crash. When economic transactions crash, it leads to a slowdown of the overall economy, which is precisely what happened in India.

As Jean Drèze writes in Sense and Solidarity—Jholawala Economics for Everyone: “For instance, a study by Nidhi Aggarwal and Sudha Narayanan… shows that mandi arrivals of non-perishable agricultural commodities crashed across the board within a week of demonetisation. The declines range from 23 per cent for cotton to 87 per cent for soybean.”

This happened because agricultural markets in India operated in cash and with no cash around, the farmers were in no position to sell what they had produced. The onion market in Lasalgaon (near Nashik, and India’s largest onion market) continues to face this problem, a year later.

Many informal markets crashed in the aftermath of demonetisation and haven’t been able to revive again. The growth of the non-government part of the economy, which forms close to 90 per cent of the economy, for the period April to June 2017, fell to a little over 4 per cent, in the aftermath of demonetisation.

On top of that the total amount of deposits with banks increased dramatically and because of that the interest rates crashed. This hurt many people (especially senior citizens) who depend on interest from deposits for their survival. It also hurt those who use fixed deposits to save for the long-term. At the same time, the fall in interest rates did not lead to an increase in bank lending. In fact, bank lending in the aftermath of demonetisation has crashed.

The question that remains is on what basis was the decision to demonetise taken? Was there any logic to it or was it just taken on a whim? The closest answer to this has come from Arjun Meghwal, a junior minister in the Modi government. He told the Lok Sabha in February 2017: “RBI held a meeting of its Central Board on November 8, 2016. The agenda of the meeting, inter-alia, included the item: “Memorandum on existing banknotes in the denomination of Rs500 and Rs1000 -Legal Tender Status.””

Meghwal passed the buck on to the Reserve Bank of India (RBI). A Right to Information query was filed with the RBI by a correspondent of the Press Trust of India (PTI). In the query, the central bank was asked to provide the minutes of the meeting in which the decision to demonetise Rs500 and Rs1,000 notes was taken. Over and above this, it was also asked to share its correspondence with the Prime Minister’s Office (PMO) and the Finance Ministry, on the issue of demonetisation.

The RBI replied: “The information sought in the query carries sensitive background information including opinions, data, studies/ surveys etc. made prior to the completion of the process of withdrawal of legal tender character of Rs500 and Rs1,000 notes… Disclosure of such information would detriment economic interest of the country from the viewpoint of the objectives sought to be achieved by such decision.”

Basically, the RBI refused to answer the RTI query. And a year later, we still don’t know on what basis was demonetisation carried out.

The column originally appeared in the Bangalore Mirror on November 8, 2017.

Demonetisation’s negative impact on economy is not done yet, it will continue; be warned

rupee
In a few days, the first anniversary of demonetisation will be here. The Narendra Modi government will continue doing what it has done in the last one year—give demonetisation a positive spin.

But how can a decision which made 86.4 per cent of the currency in circulation, useless overnight, in a country where 80-98 per cent of the transactions were carried out in cash (depending on which estimate you would like to believe), be a positive one?

Let’s take a look at Figure 1. It basically plots the annual growth in non-oil non-gold non-silver imports.

Figure 1:
Vivek story chary1

What does Figure 1 tell us? First, it tells us that the annual growth in non-oil non-gold non-silver imports had been rather subdued since January 2015. In fact, it has been in the negative territory several times, especially in a few months before November 2016, when demonetisation was announced.

But after November 2016, the growth in non-oil non-gold non-silver imports simply took off and reached a peak of 42.5 per cent in April 2017. This basically means that these imports where 42.5 per cent higher in April 2017 in comparison to April 2016.

What does this tell us? It tells us that a significant portion of the consumer demand post demonetisation has been fulfilled through higher imports. So far so good.

Demonetisation basically disrupted and destroyed supply chains, both in the formal as well as the informal economy. With supply chains being destroyed, the supply of domestic goods has been replaced by imports and has not been fulfilled through the production of domestic firms.

It is worth remembering here that imports are a negative entry into the gross domestic product (GDP) formula.
Y = GDP
C = Private Consumption Expenditure
I = Investment
G = Government Expenditure
NX = Exports minus imports

Hence, if imports grow at a faster pace than exports, they pull down the GDP to that extent. Exports during this year (between April to September) have gone up by around 10.9 per cent in comparison to last year. Imports are up by 22.3 per cent. Given this, it is not surprising that the economy has slowed down. The economic growth for the non-government part of the economy, which forms around 90 per cent of the economy, was around 4.3 per cent, for the period between April to June 2017. This was more than 9 per cent in early 2016.

Hence, demonetisation has played a huge role in slowing down economic growth. And this is tragic given that one million Indians are entering the workforce every month. In fact, it has also rendered a standard tactic in reviving economic growth, pretty much useless.

Allow me to explain. When countries are not doing well on the economic front, the standard prescription offered by economists is for the government to spend more. When the government spends more, the extra spending becomes somebody’s income. When that income is spent, businesses benefit, and the economy revives.

The trouble is that in the current situation if such a prescription is applied on India (actually to some extent it already has been), the government spending will eventually create consumer demand, a substantial portion of which will be fulfilled through imports. Imports, as we have already seen, are a negative entry into the GDP formula. Given this, a fiscal expansion instead (the act of government spending more) of creating faster economic growth might just slow it down.

The point being that we aren’t done yet with the negative effects of demonetisation. There’s more to come.

The column originally appeared on Firstpost on November 3, 2017.