demonetisation

Why Demonetisation Did Not Hurt Modi

narendra_modi

Later this week, the prime minister Narendra Modi will complete three years in office. In the recent past, there have been a spate of articles analysing the performance of the Modi government.

The general conclusion seems to be that the prime minister continues to remain politically popular. The recent wins of the Bhartiya Janata Party in the Uttar Pradesh state assembly elections and the Delhi municipal elections, is evidence of the same.

Over and above this, there has been a lot of analysis around the impact of demonetisation, as more data becomes available. Most data show that the economic impact of demonetisation has been negative. For all the trouble that people were put through, the income tax department hasn’t been able to identify much of black money.

Further, barely any fake currency was identified during the process of demonetisation. Digital transactions peaked in December 2016 and have fallen since then. Hordes of informal businesses were shut down and many people lost their jobs, in the process. And if all this wasn’t enough, on some days ATMs still run out of cash.

Nevertheless, despite all this Modi continues to be a popular prime minister. What is happening here? The negative economic environment created in the aftermath of demonetisation hasn’t impacted the prime minister.

Narendra Modi is what political scientists call a populist leader. What is the definition of a populist leader? Jan-Werner Müller, a professor of politics at Princeton University, defines this in his book What is Populism?

First and foremost “it is a necessary but not sufficient condition to be critical of elites in order to count as a populist”. Over and above this, there are other factors that go into the making of a populist leader like Modi is.

As Müller writes: “Populists claim that they, and they alone, represent people… The claim of exclusive representation is not an empirical one; it is always distinctly moral. When running for office, populists portray their political competitors as part of the immoral, corrupt elite; when ruling, they refuse to recognise any opposition as legitimate. The populist logic also implies that whoever does not support populist parties might not be a proper part of the people—always defined as righteous and morally pure.”

A populist leader also likes cutting out the middleman. This means relying as little as possible on party organisations and the media, which acts as intermediaries between party organisations and the people.

This explains why Modi chose to directly address the nation on Doordarshan while announcing demonetisation on November 8, 2016. He spoke to the nation through the mann ki baat programme on radio on November 27, 2016. He addressed the nation again on December 31, 2016.

The focus of the message delivered was on how black money of the morally corrupt elite was hurting India big time and how important it was to tackle this problem on a war footing on an immediate basis. By doing this a situation of a crisis was created.

As Müller writes: “A “crisis” is not an objective state of affairs but a matter of interpretation. Populist will often eagerly frame a situation as a crisis, calling it an existential threat, because such a crisis then serves to legitimate populist governance. Put differently, a “crisis” can be a performance, and politics can be served as a continuous stage of siege.”

And this direct talking by populists attacking the so called morally corrupt elite goes down well with the true people, something which all the data and the numbers offered against decisions made by them can’t do anything about.

As Müller writes: “Populists ultimately appeal to a certain symbolic rendering of the “true people,” the appeal of that image will not vanish automatically when voters are presented with a some set of correct statistics about a particular policy area”.

And that best explains why demonetisation was a politically popular decision though numbers clearly show that it hurt the Indian economy.

The column originally appeared in the Bangalore Mirror on May 24, 2017

Why Demonetisation Did Not Hurt Modi

narendra_modi

Later this week, the prime minister Narendra Modi will complete three years in office. In the recent past, there have been a spate of articles analysing the performance of the Modi government.

The general conclusion seems to be that the prime minister continues to remain politically popular. The recent wins of the Bhartiya Janata Party in the Uttar Pradesh state assembly elections and the Delhi municipal elections, is evidence of the same.

Over and above this, there has been a lot of analysis around the impact of demonetisation, as more data becomes available. Most data show that the economic impact of demonetisation has been negative. For all the trouble that people were put through, the income tax department hasn’t been able to identify much of black money.

Further, barely any fake currency was identified during the process of demonetisation. Digital transactions peaked in December 2016 and have fallen since then. Hordes of informal businesses were shut down and many people lost their jobs, in the process. And if all this wasn’t enough, on some days ATMs still run out of cash.

Nevertheless, despite all this Modi continues to be a popular prime minister. What is happening here? The negative economic environment created in the aftermath of demonetisation hasn’t impacted the prime minister.

Narendra Modi is what political scientists call a populist leader. What is the definition of a populist leader? Jan-Werner Müller, a professor of politics at Princeton University, defines this in his book What is Populism?

First and foremost “it is a necessary but not sufficient condition to be critical of elites in order to count as a populist”. Over and above this, there are other factors that go into the making of a populist leader like Modi is.

As Müller writes: “Populists claim that they, and they alone, represent people… The claim of exclusive representation is not an empirical one; it is always distinctly moral. When running for office, populists portray their political competitors as part of the immoral, corrupt elite; when ruling, they refuse to recognise any opposition as legitimate. The populist logic also implies that whoever does not support populist parties might not be a proper part of the people—always defined as righteous and morally pure.”

A populist leader also likes cutting out the middleman. This means relying as little as possible on party organisations and the media, which acts as intermediaries between party organisations and the people.

This explains why Modi chose to directly address the nation on Doordarshan while announcing demonetisation on November 8, 2016. He spoke to the nation through the mann ki baat programme on radio on November 27, 2016. He addressed the nation again on December 31, 2016.

The focus of the message delivered was on how black money of the morally corrupt elite was hurting India big time and how important it was to tackle this problem on a war footing on an immediate basis. By doing this a situation of a crisis was created.

As Müller writes: “A “crisis” is not an objective state of affairs but a matter of interpretation. Populist will often eagerly frame a situation as a crisis, calling it an existential threat, because such a crisis then serves to legitimate populist governance. Put differently, a “crisis” can be a performance, and politics can be served as a continuous stage of siege.”

And this direct talking by populists attacking the so called morally corrupt elite goes down well with the true people, something which all the data and the numbers offered against decisions made by them can’t do anything about.

As Müller writes: “Populists ultimately appeal to a certain symbolic rendering of the “true people,” the appeal of that image will not vanish automatically when voters are presented with a some set of correct statistics about a particular policy area”.

And that best explains why demonetisation was a politically popular decision though numbers clearly show that it hurt the Indian economy.

The column originally appeared in the Bangalore Mirror on May 24, 2017

Of “Shaky” Demonetisation Statistics, Arun Jaitley and Black Money

We don’t live in a perfect world. And given this, governments like to showcase the positive impact of the decisions they make, all the time. Sometimes, they get very desperate in the process.

Take the case of the economic impact of demonetisation. Most data now coming out clearly shows that the decision did not have a positive impact on the Indian economy. It might have helped the Bhartiya Janata Party to win the Uttar Pradesh assembly elections, but that doesn’t necessarily make it a right decision on the economic front.

Nevertheless, the Modi government would like us to believe that demonetisation has helped the country on the economic front. Early last week the finance minister Arun Jaitley said that “more than 91 lakh people were added to the tax base due the result of the actions taken by the income tax department.”

It was later clarified that 91 lakh people were added to the tax base in 2016-2017(i.e. between April 1, 2016 and March 31, 2017). As per Jaitley’s statement 91 lakh individuals were added to the tax base post demonetisation, which is incorrect.

Meenakshi Goswami, Income Tax Commissioner and the official spokesperson of the Central Board for Direct Taxes (CBDT), told NDTV later in the week that “91 lakh was the total number of new taxpayers enrolled in the financial year 2016-2017.”

Now this makes things interesting. On the face of it, the addition of 91 lakh individuals to the income tax base sounds like a huge number. But when we are talking about any increase or decrease, a number should never be viewed in isolation.

The trouble is that we don’t have long term data on this front because of a change in the definition of “tax base” and “new tax payer added during the year”. The annual report of the ministry of finance for 2015-2016 points out that new taxpayers “added during the year 2014-15 is 76,04,154”. This basically means that 76 lakh new taxpayers were added during 2014-2015. I couldn’t find any data for 2015-2016. Now compare the 91 lakh additions in 2016-2017 to 76 lakh additions in 2014-2015, and suddenly the number doesn’t seem too high, given that no demonetisation was carried out in 2014-2015.

Even if the government doesn’t do anything, taxpayers get added every year, especially when the minimum tax slab continues to remain the same. In 2014-2015, the minimum tax slab was Rs 2,50,000, which is where it continues to be. This basically means that inflation alone would have ensured that more people came into the tax bracket and thus increased the tax base.

Over and above this, as the economy grows and people earn more, more people come into the tax bracket.

Once we take these factors into account, the addition of 91 lakh taxpayers suddenly doesn’t sound much, especially taking into account the disruption that demonetisation caused through the length and the breadth of the country.

Further, Sushil Chandra, chairman of CBDT said that between November 2016 and March 2017, the search actions of the income tax department revealed an undisclosed income of Rs 16,398 crore. On the other hand, the surveys had led to a detection of Rs 6,746 crore during the same period.

Again, if we look at these numbers in isolation, they sound like a lot of money. But that doesn’t turn out to be the case if we look at numbers over a period of time. Take a look at Table 1. It shows the undisclosed income admitted to and detected during the search operations as well as surveys conducted by the income tax department over the last few years.

Table 1: Undisclosed income

Financial YearNumber of groups searchedUndisclosed income admitted (in Rs Crore)Number of surveys conductedUndisclosed income detected (in Rs Crore)Total undisclosed income (in Rs Crore)
2012-201342210,291.61463019,337.4629,629.07
2013-201456910,791.63532790,390.711,01,182.34
2014-201554510,288.05503512,820.3323,108.38
2015-1644511,066.2444229,654.820,721.04
2016-17*2226,304.7197717,62.518,067.22

*Up to September 2016 in case of search numbers and August 2016 in case of survey numbers
Source: Ministry of Finance Annual Reports and the Press Information BureauThe numbers for 2016-2017 are incomplete. But there is enough detail that lets us analyse the issue. Between April and September 2016, the total undisclosed income (or black money) admitted through search operations of the income tax department stood at Rs 6,304.71 crore. The undisclosed income detected through surveys conducted between April and August 2016 had stood at Rs 1,762.51 crore. If we add these numbers we get Rs 8,067.22 crore.

Between November 2016 and March 2017, the search actions of the income tax department revealed an undisclosed income of Rs 16,398 crore, as pointed out earlier. On the other hand, the surveys had led to a detection of Rs 6,746 crore during the same period. Adding both these numbers we get Rs 23,144 crore. Adding this to the earlier Rs 8,067.22 crore, we get around Rs 31, 211 crore.

This is the total undisclosed income identified by the income tax department during the course of 2016-2017. The number is incomplete because the information for the month of October 2016 is missing in case of search operations and information for the months of September-October 2016 is missing in case of survey operations.

Nonetheless, it is a good ballpark number to work with. Hence, the total amount of undisclosed income or black money identified by the income tax department in 2016-2017 stood at more than Rs 31,211 crore.

Is it such a big deal? Look at Table 1. The total amount in 2012-2013 had stood at Rs 29,629 crore. This amount hasn’t been adjusted for inflation. It is safe to say that in inflation adjusted terms more undisclosed income was identified by the income tax department in 2012-2013 than in 2016-2017. In 2013-2014, the number stood at Rs 1,01,182 crore, which is significantly more than 2016-2017. And it is worth remembering here that these numbers happened without demonetisation. In fact, as the numbers clearly show the efficacy of the income tax department when it comes to identification of black money has come down since 2014-2015.

To conclude, the rosy picture of demonetisation that the government is trying to paint, is really not true. The more data we look at the clearer this becomes.

Postscript: I recently did a podcast with the writer Amit Varma who is currently the editor of the Pragati magazine, on the Right to Education and how it has screwed up our education system. Most of what I spoke was based on my new book India’s Big Government—The Intrusive State and How It is Hurting Us. You can listen to the podcast here.

The column originally appeared in Equitymaster on May 22, 2017.

New IIP Shows Demonetisation Slowed Down Indian Manufacturing Growth Big Time

India_textile_fashion_industry_workers

India has a new Index of Industrial Production (IIP). It is bigger and according to economists who track such things, it is better than the previous one. The IIP basically gives growth estimates of three sectors-manufacturing, mining and electricity. The manufacturing sector forms more than three-fourths of the IIP.

The base year for the new IIP has been changed to 2011-2012 from the earlier 2004-2005. This has been done to capture the changes in the industrial sector that have happened over a period of time and “to also align it with the base year of other macroeconomic indicators like the Gross Domestic Product (GDP), Wholesale Price Index (WPI)”.

Like any other index, the IIP tracks various items that make for the manufacturing, mining and electricity sectors. These items need to be changed or relooked at from time to time in order to ensure that the IIP continues to maintain a representativeness of the manufacturing, mining and electricity sectors in particular and the industry as a whole in general.

The new IIP has a total of 809 items in the manufacturing sector. The earlier one had 620. While, the number of items which constitute the manufacturing part of IIP have gone up, 124 items have been removed as well. These include items like gutka, calculators and colour TV picture tubes. Items like cement clinkers, medical and surgical accessories, refined palm oil etc., have been added. Along similar lines, the electricity sector now includes data from the renewable energy sector as well.

Over and above this, there has been an increase in number of factories in panel for reporting data and closed ones have been removed. All in all, these steps have been taken in order to ensure that the new IIP is a better representation of industry than the old one was.

Given that, items that constitute IIP have change majorly, it is not surprising that the growth figures of IIP have changed as well. Take a look at Figure 1. It plots both the new IIP and the old IIP growth rates over the last half decade, April 2012 onwards.

Figure 1: 

One look at Figure 1 is enough to tell us that the old IIP and new IIP are different beasts altogether, though both are very volatile. Now take at data from March 2013. As per the old IIP series, the growth was at 3.5 per cent. The new IIP series puts the growth at 15.1 per cent. That’s how different the old and the new IIP are.

In fact, as per the new IIP, the industrial growth stood at 3.3 per cent in 2014-2015, the last year of the Congress led UPA government. As per the old IIP the growth had stood at – 0.1 per cent. Hence, we can conclude that the state of the industry in the last year of the Congress government wasn’t as bad as it seemed at that point of time. It’s just that the old IIP may have no longer remained a good representation of the Indian industry.

In fact, the new IIP shows that industrial growth picked up in 2016-2017, the last financial year. The growth stood at 5.1 per cent. As per the old IIP the industrial growth was at 0.6 per cent, during the course of the year. What this also tells us is that the two IIPs are as different as chalk and cheese.

There is an interesting trend that the new IIP catches on to in the manufacturing sector. Manufacturing makes up for 77.6 per cent of the new IIP as against the 75.5 per cent in the old one. Take a look at Table 1.

Table 1: Manufacturing Growth

PeriodManufacturing Growth(in %)
Dec 2012 to Mar 20139.4
Dec 2013 to Mar 20143.7
Dec 2014 to Mar 20153.2
Dec 2015 to Mar 20164.9
Dec 2016 to Mar 20171.6

Source: Centre for Monitoring Indian Economy.

The manufacturing growth between December 2016 and March 2017 stood at 1.6 per cent. This has been the slowest in comparison to the same period in previous years. Why is this the case? The one word answer to this is demonetisation. The Modi government announced demonetisation of Rs 500 and Rs 1,000 notes on November 8, 2016, and sent the economy into a tailspin. The interesting thing is that the average manufacturing growth between April 2016 and October 2016 had stood at 6.9 per cent. This signalled the revival of the manufacturing sector after having grown by around 3 per cent in 2015-2016 and 3.8 per cent in 2013-2014.

Demonetisation managed to scuttle that revival in this growth. Also, it is worth pointing out here that the IIP data is collected from “entities in the organised sector units registered under the Factories Act, 1948”. This means that the unorganised sector is not covered. And as I have often written in the past, the impact of demonetisation on the unorganised sector has been far greater.

Up until now, the government has refused to admit that demonetisation has had a negative impact on the economy (Subscription Required). I guess it’s time it looked at the new IIP numbers to realise the obvious.

(The column was originally published in Equitymaster on May 16, 2017)

Mr Subramanian, Lower Interest Rates Do Not Always Lead to More Bank Loans

Arvind_Subrahmaniyam

“Lower interest rates lead to higher lending,” is something that most economists firmly believe in. The beliefs of Arvind Subramanian, the chief economic adviser to the ministry of finance, are not an exception to this rule.

Hence, not surprisingly in a lecture a few days back he came out all guns blazing against the Reserve Bank of India(RBI) for not cutting the repo rate. Repo rate is the rate at which RBI lends to banks and acts as a sort of a benchmark to the interest rates that banks pay for their deposits and in turn charge on their loan. We say sort of a benchmark here because there are other factors which go into deciding what rate of interest that banks charge on their loans.

Subramanian wants the RBI to cut the repo rate further from its current level of 6.25 per cent. As he said: “Inflation pressures are easing considerably… the inflation outlook is benign because of a number of economic developments… Against this background, most reasonable economists would say that the economy needs all the macroeconomic policy support it can get: instead, both fiscal policy and monetary policy remain tight.”

The point here being that current inflation is under control and from the looks of it, future inflation should also be under control. And given this, the RBI must cut its repo rate. The RBI last cut the repo rate in October 2016. And as and when it cuts the rate further, the hope is that the banks will cut their lending rates. Only then will people and industries both borrow and spend more. This will give a flip to the economy. QED.
Subramanian’s point is well taken. Nevertheless, does it make sense? We will deviate a little here before we arrive at the answer.

The RBI Monetary Policy Report released in early April 2017 points out that the decline in the one-year marginal cost of funds based lending rates (MCLRs) of banks between April and October 2016 was just 15 basis points. This when the repo rate was cut by 50 basis points. Hence, even though the RBI cut its repo rate by 50 basis points, the banks cut their lending rates by just 15 basis points, a little under a one-third. One basis point is one hundredth of a percentage.

Post demonetisation “27 public sector banks have reduced their one-year median MCLR in the range of 50 to 105 bps, and 19 private sector banks have done so in the range of 25 to 148 bps.” This when the repo rate has not been cut at all. On an average the one year MCLRs of banks fell by 70 basis points to 8.6 per cent.

What has happened here? A cut in the repo rate barely makes any difference to the cost at which banks have already borrowed money to fund their loans. But demonetisation did. The share of the “low cost current account and savings account (CASA) deposits in aggregate deposits with the SCBs went up to 39.2 per cent (as on March 17, 2017) – an increase of 4.0 percentage points relative to the predemonetisation period”. This is because people deposited the demonetised notes into the banks and this money was credited against their accounts.

This basically meant that banks suddenly had access to cheaper deposits because of demonetisation. And this in turn led them to cut interest rates on their loans, despite no cut in the repo rate. The RBI’s repo rate continued to be at 6.25 per cent during the period.

A cut in lending rates is only one part of the equation. The bigger question has it led to higher borrowings? Are people and businesses borrowing more because lending rates are now lower than they were in the past? And this is where things become interesting.
The total deposits of banks between October 28, 2016 (before demonetisation) and December 30, 2016 (the last date to deposit demonetised currency into banks) went up by 6.41 per cent to Rs 10,568,17 crore. This was a huge jump during a period of two months. This sudden increase in liquidity led to banks cutting their deposit rates and then their lending rates.

Interestingly, the total deposits of banks have continued to remain stable and as of April 30, 2017, were at Rs 10,509,337 crore. This is a minor fall of 0.6 per cent since December 2016.

Between end October 2016 and end April 2017, only around 36 per cent of the incremental deposits raised by banks were loaned out. (We are looking at non-food credit here. The total bank loans that remain after we adjust for the loans that have been given to the Food Corporation of India and other state procurement agencies for the procurement of rice and wheat produced by farmers).

This means for every new deposit worth Rs 100, the bank loaned out just Rs 36, despite a cut in interest rates.

If we were to look the same ratio between end October 2015 and end April 2016, it projects a totally different picture. 116 per cent of the incremental deposits during the period were lent out. This means for every new deposit worth Rs 100, the bank loaned out Rs 116.  This means that deposits raised before the start of this period were also lent out.

Hence, a greater amount of lending happened at higher interest rates between October 2015 and April 2016. And this goes totally against Subramanian’s idea of the RBI needing to cut the repo rate. It also goes against the idea of banks lending more at lower interest rates.

Given this, low interest rates are only a part of the story. If that is not leading to higher lending, it doesn’t help in anyway. Lending isn’t happening due to various reasons, which we keep discussing. Demonetisation has only added to this issue.

Also, a fall in interest rates hurts those who depend on a regular income from fixed deposits to meet their expenditure. It also hurts those who are saving for their long-term goals. In both the cases, expenditure has to be cut down. In one case because enough regular income is not being generated and in another case in order to be able to save more to reach the investment goal. And this cut in spending hurts the overall economy. Interest rates are also about the saver and depositor.

We are yet to see a professional economist talk from this angle. To them it is always a case of garbage in garbage out i.e. lower interest rates lead to increased lending. This is simply because most professional economists these days get trained in the United States where the system is totally different and lower interest rates do lead to a higher borrowing by businesses and people.

But that doesn’t necessarily work in India. It is a totally different proposition here.

The column originally appeared in Equitymaster on May 15, 2017.