Personal income tax comes to Narendra Modi govt’s rescue as corporate tax falls

Earlier this week, the government released some interesting data on direct taxes which essentially are composed of corporate taxes, personal income tax. They also include tax collected through the income tax amnesty schemes launched by the governments over the years.

How have these taxes done over the years? Has the Narendra Modi government managed to collect more direct taxes than the earlier government’s (as is often said)? The recently released data provides the answers.

Take a look at Figure 1. It basically plots the direct taxes to the GDP ratio over the years.

Figure 1:

Tax to GDP

Source: http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

 

What does Figure 1 tell us? It tells us very clearly that the direct taxes collection as a proportion of the GDP, has remained flat over the last few years, including the three years of the Modi government. It also tells us very clearly that whenever a politician talks about the collection of direct taxes (or for that matter any other tax) going up, it should be in the context of the size of the economy (i.e. the GDP).

If that is not the case, then he or she is clearly bluffing or does not understand how taxes are reported. As I said earlier, the direct taxes are comprised of personal income tax, corporate tax and other direct taxes. First and foremost, let’s take a look at how things look if we ignore the other direct taxes. This is important for the year 2016-2017, when the government managed to collect a significant amount of tax, through two income-tax amnesty schemes, one launched before demonetisation, and one after it.

Figure 2:

Net direct tax

Source: Author calculations based on data taken from http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

Unlike Figure 1, which curves up at the end, Figure 2 is more flattish, once we adjust for the other direct tax. This matters in a year like 2016-2017, when the government collected Rs 15,624 crore as other direct tax, much of which was collected from income tax amnesty schemes. Once adjusted for this, the direct taxes to GDP ratio in 2016-2017 falls to 5.49 percent. In 2015-2016, it was at 5.46 percent of the GDP. This is much lower than the 6.30 percent achieved in 2007-2008. Hence, the direct taxes to GDP ratio has fallen over the years.

It is important to take a look at how does the situation look for corporate tax and personal income tax, as a proportion of the GDP, the two most important constituents of direct taxes. Let’s take a look at Figure 3, which plots the corporate income tax as a proportion of GDP.

Figure 3:

Corp tax

Source: Author calculations based on data taken from http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

Figure 3 tell us very clearly that corporate income tax to GDP ratio has been falling over the years. It has fallen from a peak of 3.88 percent of the GDP in 2007-2008 to 3.19 percent in 2016-2017. One reason for this has been the slow growth in corporate earnings over the last few years. Finance Minister Arun Jaitley has talked about lowering corporate income tax rates, but that hasn’t really happened. Whether lower taxes lead to higher collections remains to be seen.

Now let’s take a look at Figure 4, which plots to the personal income tax to GDP ratio.

Figure 4:

personal tax

Source: Author Calculations based on data taken from http://www.incometaxindia.gov.in/Documents/Direct%20Tax%20Data/Time-Series-Data-2016-17.pdf

Figure 4 makes for an interesting reading. While, personal income tax to GDP ratio like the corporate tax to GDP ratio also fell, it has managed to recover over the years. Basically, the loss of income tax from the corporates has been covered by getting individuals to pay more income tax, on the whole. One reason for this lies in the fact that the number of individual assessees have risen at a much faster rate over the years, than the number of corporate assessees. And this jump has basically ensured that the tax collections of the Narendra Modi government have continued to remain flat. They would have fallen otherwise.

The column originally appeared on Firstpost on December 21, 2017.

Gujarat Elections: In 2018 and 2019, with More Socialism, Modi Will Become More Like Manmohan

narendra_modi

As expected the Bhartiya Janata Party (BJP), won the state assembly elections in Gujarat. The margin of victory though left much to be desired.

Before the elections, the party president Amit Shah had talked about the party winning 150 out of the 182 seats in the state assembly. The party finally ended up with 99. So, there was a clear gap between expectation and reality. I say this because Amit Shah is a brilliant electoral strategist and his words should never be taken lightly.

Finally, it is the massive support that the BJP enjoys in the cities of Gujarat that pushed it through. In the four biggest cities of Gujarat, Ahmedabad, Surat, Vadodara and Rajkot, the party won 46 out of the 55 seats (Ahmedabad 16 out of 21 seats, Surat 15 out of 16 seats, Vadodara nine out of 10 seats and Rajkot six out of eight seats).

What this clearly tells us is that the Goods and Services Tax (GST) wasn’t as big an issue in the cities of Gujarat, as was made out to be in the days leading up to the elections, in the media. It clearly impacted a section of the population, but that wasn’t large enough to make an electoral difference. The only other explanation for this lies in the fact that even those impacted negatively by the GST, couldn’t get themselves to vote for the Congress.

The other interesting point here was that more than 5.5 lakh voters chose the NOTA (none of the above) option while voting. This amounted to 1.8 per cent of the total eligible votes. The NOTA votes were more than or close to the winning margins in nearly 24 constituencies. One explanation for this that has been offered is that a small section of the population which is unhappy with the BJP didn’t want to vote for Congress either.

Manmohan-Singh_0

The trouble with this explanation is that there is no way to verify it. It could even be the opposite.

Anyway, getting back to the point I was trying to make—the BJP won 46 out of the 55 seats in the four biggest cities of Gujarat. How did the electoral results look in the remaining 127 seats? The BJP won 53 of these seats. The Congress won 71. Hence, the Congress clearly did much better than the BJP beyond the four biggest cities.

There will be economic and political implications of these electoral results in other states like Rajasthan and Madhya Pradesh, where the elections are scheduled in the months to come. Some points are as follows:

a) The basic problems in India’s rural economy are not going to go away any time soon. The size of the average agricultural holdings in India has fallen as land has been divided across generations, making agriculture as a profession very non-remunerative.
Over and above this, India has too many people in agriculture than is economically feasible. A recent discussion paper by Niti Aayog points out that as of 2011-2012, agriculture employed 64 per cent of the rural workforce but produced only 39 per cent of the total rural economic output. Hence, for agriculture to be economically feasible 8.4 crore agricultural workers need to be shifted out of agriculture. This is around 70 per cent of the non-farm workforce in the rural areas. This isn’t going to happen overnight.

b) Of course, given this huge disguised unemployment in agriculture, people working in agriculture try to work in other areas as well. But the trouble is that there aren’t enough jobs going around for them. Data from the Labour Bureau suggests that only 52.7 per cent of the people looking for jobs all through the year, in rural India, are able to find one. Given this, nearly one in two people in rural India do not have jobs all through the year.

Hence, rural India has a problem at two levels: 1) Agriculture as a profession is no longer as remunerative as it used to be. 2) There are not enough other jobs, given their low skillsets, which people working in agriculture can take on, to add to their income over and above what they make in agriculture.

This explains why land-owning castes have been protesting all across the country. This includes the Patidar Patels of Gujarat.

c) Given this, the BJP in every state that it goes to election after Gujarat, it is likely to promise a farm loan waiver, as it has done in other states over the last one year. This is going to cost state governments all across the country a lot of money. It will also create moral hazard with future borrowers waiting for farm loan waivers than paying off their loans.

The question is why did the BJP not promise a farm loan waiver in Gujarat? The rural areas in Gujarat are not as badly placed as in other states. One reason for this lies in the fact that the livestock economy in the state, has continued to grow robustly. Also, over and above this, the non-farm economy in the rural areas, created job opportunities because of the overall faster growth in the state.

In fact, farm loan waive offs will become even more important given that, the states of Madhya Pradesh and Rajasthan, are not as urbanised as Gujarat is.

Also, in the run up to 2019 Lok Sabha elections, I see the minimum support price of agricultural crops going up. As per the Shanta Kumar Committee, the minimum support price system benefits under 6 per cent of the farming households in the country. While, increasing MSPs may not benefit many farmers, it does have a strong signalling effect.

d) The Modi government will also look to consolidate its position in the urban and semi-urban areas. And for that, chances are it will waive off Mudra loans of Rs 50,000 or lower. In total, over 7 crore of Mudra loans of less than Rs 50,000 have been given out.

e) As far as the Congress is concerned, it needs to start rebuilding itself, particularly in the rural areas because that is where its support is. This is a rather obvious insight.
To, conclude, the Modi government will give out doles and waive off loans, in order to improve its position. This strategy will not be much different from what the Congress led UPA government led by Manmohan Singh, did in the 2009 elections. This again goes with the broader point that I keep making—India has only one model of governance and that is the Congress model.

In the end, socialism will win. We will have a bigger government in areas that we really shouldn’t.

The column was originally published in Equitymaster on December 19, 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.

Will Narendra Modi Win 2019?

narendra modi
The Prime Minister, Shri Narendra Modi addressing the Nation on the occasion of 71st Independence Day from the ramparts of Red Fort, in Delhi on August 15, 2017.

I am writing this on Sunday, October 22, 2017. The prime minister Narendra Modi will visit Gujarat the third time this month. In the runup to the state assembly elections, he will inaugurate and lay the foundation stones to a number of projects.

The prime minister’s multiple visits to Gujarat have led to the question—is the BJP on a weak wicket in Gujarat? A strong anti-Bhartiya Janata Party (BJP) front seems to be emerging in the state. The leader of the other backward classes(OBCs) Alpesh Thakor is expected to join the Congress on October 23, 2017. Hardik Patel, the leader of the Patidar Patels, through his tweets seems to have indicated his preference for the Congress, though some of his aides have joined the BJP. Also, Patel currently is not old enough to fight elections.

On the flip side, Gujarat (unlike many other Indian states) has always been a two-horse race between the BJP and the Congress. And in this race, the Congress has gone nowhere in the recent decades. It’s vote share has moved between 33-38 per cent of the votes polled and hence, India’s grand old party has not managed to displace the BJP. The extra 5 per cent vote that the Congress would need to give tough competition to the BJP, have never really come.

How will things turn out this time around? Honestly, I am not a political analyst and don’t know the answer to this. But what I do know is that the BJP has built a formidable election management system under its president, Amit Shah.

Prashant Jha in his new book How the BJP Wins—Inside India’s Greatest Election Machine describes this election management system in detail. And after reading this book I can say with reasonable confidence that displacing BJP at the state level (in the various assembly elections scheduled up to 2019) and in the Lok Sabha elections scheduled in 2019, will be no cakewalk.

This, despite the fact, that the Modi government has managed to screw up the economy big time through the disastrous decision to demonetise Rs 500 and Rs 1,000 notes, and a terrible implementation of the Goods and Services Tax.

I will not get into the details of the election management system of the BJP that Jha writes about in his book, given that a single Letter cannot do justice to it. Hence, dear reader, if you do have the time and the inclination, do check out the book.

Nevertheless, in this Letter I will talk about the factors that go in favour of the BJP and Modi, and the factors that go against them, when they fight an election in the days to come and this includes the Lok Sabha elections of 2019. Let’s look at these factors one by one.

1) Let’s start with the performance on the economic front. The promised acche din are nowhere in sight. In fact, the informal part of the economy which forms around 40 per cent of the GDP and employs more than three-fourths of the labour force, has collapsed. Economic growth has collapsed from more than 9 per cent to now less than six per cent. As far as the non-government part of the economy is concerned, which forms close to 90 per cent of the economy, it is now growing at just 4.3 per cent. So, there clearly are issues on the economic front. Having said that the government has time up until 2019 to set it right.

2) Also, more importantly does economic performance of the nation, really matter to the core supporters of Modi and the BJP. Or are they simply happy with the stand that the government is taking on the Ram temple in Ayodhya and all the rhetoric that surrounds the protection of the cow.

This will be a really important factor in any election. It remains difficult to figure out to what portion of the voters are these issues important. Not surprisingly, a narrative is already being built around these issues, for the core support base. And as May 2019 approaches, things could get murkier on this front.

As Evan Davis writes in Post Truth—Why We Have Reached Peak Bullshit and What We Can Do About It: “Like-minded groups of individuals share a narrative about many things… These narratives are sometimes true, sometimes not, but they are often like stereotypes… Once embedded in our minds though, they can easily gain excessive traction and trample over truth as willing believers put too much weight on propositions that conform to their narrative without looking for evidence in support of them.

3) Further, it is worth asking whether voters vote based on the economic policy being practiced by the government. As Davis writes: [The] argument that who you are matters more than the substantive point you are making is especially true about politicians. Voters focus on character rather than policy partly because they are better able to judge character and are relatively uninformed on policy… So, for a politician, having a good reputation is worth a hundred quick victories in specific arguments.”

Modi’s personal brand still remains strong, though it may have been battered a bit. Over and above this, his brand will always be compared to those he is competing against and on that Modi wins hands down.

4) Expanding on the third point, the question is who will be the leader of the opposition parties. Will it be Rahul Gandhi? Or will it be a leader like Mamata Banerjee? As Jha writes in How the BJP Wins: “Will Rahul Gandhi accept a regional leader? Will a powerful regional leader like Mamata Banerjee accept a Rahul Gandhi?

It will be imperative for the united opposition (if anything like that emerges) to have a consensus candidate and fight their elections under him, because a presidential style contest is likely to emerge, in the fight against Modi.

5) Other than choosing the right candidate, the opposition parties will have to build a credible narrative around him and what they have to offer. The narrative will be necessary to expand the core base. Just saying that we are there to displace Modi is unlikely to work. As Jha writes: “If ‘remove Modi’ is the only message, and the glue that binds them together, then they have a problem. Modi will project it, much like Indira Gandhi did, as a battle between him – a man committed to removing India’s poverty, man committed to India’s vikas – against a conglomeration of small, scattered, disparate units – united only by their hatred for him.”

6) Also, do these parties have the organisational muscle to take on the organisational muscle of the BJP and the Rashtriya Swayemsevak Sangh (RSS). The BJP always had access to the organisational muscle of the RSS, but the Sangh in the past, has not always deployed those resources totally, to help the BJP. That has changed now because of the personal relationship that Modi shares with the Sangh boss Mohan Bhagwat.
Narendra Modi was practically brought up in the RSS. And as Jha writes: “To top it all, Modi’s mentor in the Sangh happened to be Bhagwat’s father.” How do you tackle an equation like this?

7) In many states, like Gujarat, Rajasthan, Madhya Pradesh, Chhattisgarh and Karnataka, any election will be a direct contest between the Congress and the BJP. Does the                Congress have the organisational strength to take on BJP and the RSS?

The bigger problem for the Congress is that it does not have full time politicians at the top. Narendra Modi and Amit Shah are full time politicians. They don’t have any other interests in life. The same cannot be said about the Congress leadership. Whatever people might say about the recent revival of Rahul Gandhi, he just doesn’t inspire enough confidence. I am just waiting for him to take his next holiday at a point of time, when he should be in the country.

The Congress Party for the last many years has always been led by a Gandhi. The Gandhis brought in the votes. But now that is no longer the case. So, the question that is being asked can a non-Gandhi lead the Congress. For a moment, let’s assume that the Gandhis take a backseat. Will the other leaders of the Congress be ready to work under the leadership of a non-Gandhi? I don’t think so. Without, the Gandhis at the top, the glue that holds the party together, the party is likely to break up and if not that the factionalism is bound to increase dramatically.

8) A big advantage that the Modi government has, and which the opposition doesn’t, is that it can use the official machinery in its favour. Recently, the Election Commission announced the election dates for the assembly elections in Himachal Pradesh, but did not do so for the assembly elections in Gujarat and offered a very flimsy reason for it. This gave Modi and the BJP more time to launch more new projects in the state and offer more sops to the voters, something they wouldn’t have been able to do, if the election dates would have been announced.

Over and above this, the government (like the previous governments) can continue using taxpayers’ money to keep building their brand. They can also announce waive offs closer to the election date. I have a feeling that sometime in late 2018, early 2019, a big Mudra loan waive off is on its way. More than 9 crore Mudra loans have been distributed till date. And any waive off of these loans, will give a huge push to the electoral chances of the BJP in 2010, given that it will impact 45 crore individuals in total (assuming a family of 5 per household) are likely to be impacted by the move.

9) Up until now, I have offered reasons which go for the BJP. Now that doesn’t mean that all is well with the BJP. The section of the population is clearly not happy with the economy not doing well. A million youth are entering the workforce every month and the job scene continues to remain bad. The trouble is that the government is simply unwilling to recognise this problem and keeps talking about self-employment opportunities that it has created. These claims are rarely based on any data. The problem with trying to be too clever all the time is that ultimately you get found out. This something that the BJP leaders need to seriously think about.

So, it remains to be seen whether this issue emerges as a strong political issue. It further remains to be seen whether the opposition parties are able to tap into the frustration of the youth who are entering the workforce and not been able to find decent jobs.
Many land owning communities like Marathas, Jats, Patidar Patels and Kapus, have launched protests in the recent past, demanding reservations in government jobs. This remains a tricky issue to handle.

10) In states like Uttar Pradesh, where the BJP has done well, it has built a broad coalition of castes. In Uttar Pradesh, along with the support of upper castes, the BJP was able to reach out to backwards particularly those who did not like the rise of the Yadavs under the previous regime, and the Dalits, particularly those who did not like the rise of the Jatavs under Mayawati. The trouble is that the any government has only so many resources to share and distribute.

As Jha writes: “Caste groups end up competing with each other for state patronage, resources, access to power. There are limited opportunities available and so certain caste groups and, within the caste groups, certain individuals end up cornering more than their share of positions… A road is constructed or schemes are more effectively implemented depending on whether the constituents of that village are supporters of the regime in power. Given weak institutions, access to political power often determines if a person of a specific caste has access to the local police station.”

If sabka saath sabka vikaas has to become a reality, then the current governance structures will have to be changed. Local police officials need to respond to various complaints, irrespective of the caste of the individual making the complaint.  This remains very difficult to implement.

Already, in Uttar Pradesh there are accusations of Thakurs, the caste to which chief minister Yogi Adityanath belongs to, taking over the police administration.

11) For a very long time, the BJP was a party supported by the upper castes and the business castes. Under Modi and Shah, the support base of the party has expanded and includes a large section of the poor as well. While, this has benefitted the party tremendously, the party organisation hasn’t changed to reflect this new reality. As a top BJP leader told Jha: “The party organisation has still not transformed itself. At the moment the party’s character and the PM’s support base may slowly diverge. You cannot have an SUV driving rich contractor as your district president if your target is the poor voter.”
This can lead to a situation where the party’s political messaging is neither here nor there.

To conclude, these are the factors which will matter in the runup to the 2019 elections. While, BJP is on weaker wicket in comparison to 2014, a small industry seems to have emerged in writing off the electoral chances of BJP in 2019, on the basis of a few recent losses in assembly, Lok Sabha, and a few other smallish elections. But they are really jumping the gun, on the basis of very little evidence.

The BJP’s election machinery is very strong, and it will take on these defeats in its stride.

The column was originally published in Equitymaster on Nov 1, 2017.

Lower Cash to GDP Ratio is a Reason to Worry, Not Celebrate

rupeeTime flies.

In 10 days time, it will be a year, since the prime minister Narendra Modi, made his rather “infamous” decision to demonetise Rs 500 and Rs 1,000 notes.

One of the claimed successes of demonetisation has been that the cash to gross domestic product (GDP) ratio has come down. In a speech made on October 4, 2017, Modi said: “Demontisation के बाद Cash to GDP Ratio अब 9 प्रतिशत पर आ गया है। (after demonetisation, the cash to GDP ratio has come down to 9 per cent.”

Let’s take a look at Figure 1, it plots the currency in circulation (a measure of cash in the financial system) on a weekly basis, from the week before demonetisation was announced.

Figure 1: 

Figure 1 clearly tells us that currency in circulation has still not come back to the level it was before demonetisation was announced. As on October 20, 2017, the currency in circulation was at 91.6 per cent of the currency in circulation as on November 4, 2016, four days before demonetisation was announced.

Now let’s calculate the currency in circulation to GDP ratio (cash to GDP ratio). As on March 31, 2017, the cash to GDP ratio had stood at 8.8 per cent. How did things look as on June 30, 2017? The cash to GDP ratio had improved to 9.9 per cent of the GDP.

How did things look before demonetisation? As on March 31, 2017, the cash to GDP ratio had stood at 12.2 per cent. Currently, it must be a little over 10 per cent of GDP (the exact figure can be calculated only once the GDP number as on September 30, 2017, becomes available).

This fall in cash to GDP ratio is being passed off as an achievement and the fact that nation as a whole has become more honest. As Modi said in the speech referred to earlier in the piece: “भाइयों और बहनों, इस सरकार ने देश में संस्थागत ईमानदारी को मजबूत करने का काम किया है। ये सरकार के अथक परिश्रम का ही परिणाम है कि आज देश की अर्थव्यवस्था कम Cash के साथ चल रही है। (Brothers and sisters, this government has worked to strengthen the institutional honesty of the country. It is due to the tireless hard-work of this government that today the country’s economy is running on less cash.)”

There are two points being made here. The first point is that less cash in the financial system means more honesty. The second point is that it is because of the hard work of the government that the country is running on less cash. Let’s take the second point first.

When PM Modi decided to demonetise Rs 500 and Rs 1,000 notes, in one shot he made 86.4 per cent of the currency in circulation useless, overnight. This impacted the economic activity in the country, given that bulk of the economic transactions in India (anywhere from 80 per cent to 98 per cent, depending on which estimate you believe) are carried out in cash.

This slowdown in growth of economic activity has continued. Ultimately, economic activity translates into economic growth.

For the period of three months ending March 2017 and June 2017, the non-government part of the GDP (which forms around 90 per cent of the GDP) has grown by a little over 4 per cent. When growth in economic activity slows down, the growth in currency in circulation is bound to be impacted as well.

So, yes, the hard work of the government has led to a lower cash to GDP ratio, but at the cost of slowing down economic activity. Hence, claiming this as success, is more of trying to build a narrative around demonetisation being successful, rather than being an actual success of any sort.

Another point that needs to be looked at here are digital transactions. Take a look at Figure 2. It plots the total value of digital transactions over a period of time. It does not take RTGS transactions (which are over Rs 2 lakh and are usually carried out by banks to settle among themselves) into account.

Figure 2: 

As Figure 2 clearly tells us, the total value of digital transactions is now lower than the months running up to demonetisation. This basically tells us that digital transactions haven’t replaced cash transactions. Hence, economic transactions which were earlier carried out in cash are still being carried out in cash.

This buttresses the point I made earlier about the cash to GDP ratio coming down because economic transactions are not growing at the same rate as they were growing earlier. Hence, a lot of money continues to remain deposited in banks. And this means a slower growth in currency in circulation, and as a result a lower cash to GDP ratio.

Now let’s talk about a lower cash to GDP ratio meaning that the country has become more honest. This is something I have addressed earlier as well, in February. Take a look Figure 3. It basically plots the cash to GDP ratio of different countries.

Figure 3: 

Take a look at Figure 3. Japan has the highest cash to GDP ratio at 19.4 per cent. India is nearly half of that at around a little over 10 per cent? Is India a more honest nation than Japan? As per the Transparency International’s Corruption Perception Index for 2016, Japan is the twentieth least corrupt country in the world. India stands at the 79th position, despite having a much lower cash to GDP ratio.

Or take the case of Brazil, which has a cash to GDP ratio of 3.31 per cent. Like India, it is the 79th least corrupt country in the world. Then there is the Eurozone (country’s which basically use euro as their currency). Their cash to GDP ratio is higher than that of India. Is the Eurozone more corrupt than India?

Hence, the link between a low cash to GDP ratio and low corruption is basically very weak. It is basically something that the Modi government has invented in order to build a positive narrative around demonetisation.

To conclude, there is enough data to suggest that a lower cash to GDP ratio is a reason to worry and not a reason to celebrate. Hope, the Modi government, at least internally realises this.

The column originally appeared on Equitymaster on October 30, 2017.