Decoding Demonetization

Recently, RBI published a report recently stating that 99.3% of cash was returned to banks. With this, many economic (supposed) 'gurus' have reached an immediate conclusion that demonetization was a failure, there was no black money in the market and that the entire exercise was futile. Let's nominate them for "Nobel prize in Economics" at the earliest.

This report was just a "status" on what happened with the banned notes. It was not a report on Demonetization's success or failure. Its made to look like that. Second, the effect of Demonetization should not be measured in how much currency came back to the banks. The effect is not to be measured short-term, but rather long-term, 5-10 years commencing from the day demonetization was implemented

• Does 99.3% return of money mean there is no Black money? That is a funny argument, seriously. And Mr. Chidambaram, the 'economist' actually made that argument. 99.3% return does not mean all returned money is white. It means the owners of the black money found out smart ways to get that money into the banks (bribing the bank officers for the exchange of old notes with the new, putting money into banks via their employees, paying employees months of advance salaries in cash, etc.). In fact the owners of the black money can now be identified. This sudden spurt of money has brought lakhs of people (~18 Lakh) with disproportionate income are under scrutiny, around 7 Lakh registered companies which did not show any transactions in years in their accounts (but which suddenly showed mountains of money appear in their accounts). The tax hounds are expected to get behind the culprits. A key intention of Demonetization successfully achieved. 
• Before demonetization, about 86% of the total money circulated was in form of 500 and 1000 rupee notes. This is an absolute "No". In 2004, it was 34% of total currency circulating.  Instead of that % going down, it grew to a whopping 86% in 10 years ( thanks to Mr. Chidambaram - who for most of the time from 2004-2014 was the Finance minister). Infusing huge cash under the pretext of making cash flow available for the poor, was a mere short-sightedness. It did help the poor (liquidity), but it kept the unorganized sector unorganized (in other words - ensured poor remain poor). For an economy to develop, the unorganized sector (informal economy) needs to convert to an organized (formal) one. 
• 86% high denomination encouraged massive black money. A 'zataka' like demonetization was a must. (Why then 2000 and 500 rupee notes were brought in?. I explain this later in this post).
• With massive cash available between 2004 and 2014, many folks pulled cash out of India via "participatory notes", deposited it in foreign banks and then infused it back into India as "foreign investments". A false alarm of economic growth. An average 8% growth in 2004-2009 should have created massive jobs. It didn't.
• Important point - this 86% got back into the banks. Earlier it was not and that was a big problem. For any country to economically advance, the bulk of the country's money has to be in the banks. This allows infusion of capital, promotion of businesses, lending/borrowing, and thus stimulate economic growth. More importantly, it converts the unorganized sector into an organized one. With more ability to loan, the interest rates would go down. This stimulates investments. With demonetization, banks became ₹15.28 Lakh Crore richer without impoverishing the poor. Also, it forced the masses to put money in banks (always a good practice).
• The massive growth of 500 and 1000 notes (from 34% in 2004 to 86% in 2015) brought in high inflation. Asset prices grew 9-10 times more than the growth in the 1999-2004 era (gold, stocks, real estate etc.). Eg. Real estate prices grew from 200% to 2000%. Any asset that was purchased via cash conventionally (gold, silver, real estate) inflated multi-fold. Economic principles state that a good growth should be based upon how many assets "creation/production" happened rather than Asset inflation. With Demonetization, the inflation tamed, real-estate prices tamed.
• What about fake money? 99.3% does not contain "fake" money. That fake money got demolished overnight. There has been no true account of the fake money that was in circulation.
• The other key outcomes of demonetization: 21% reduction in currency in circulation, 55+ Lakh new tax-payers, 25% increase in ITRs filed, INR 1.7 L Crore inflows in Mutual Funds compared to INR 9K Cr last year. Digital Payments has increased by 56%. This is significant.

Printing New Currency - Cost and Implications:

Mr. Chidambaram tweeted that INR 24K was spent in printing the replacement for 16K Cr of notes. You are hiding some other important facts, Mr. Ex-Finance Minister. Why was India printing bank notes from foreign companies? 95% of paper for Indian currency was coming from 3 international companies and took up to 40% of the total printing cost. Second, the earlier 500 and 1000 rupee notes were printed outside of India (surprising isn't it?). Modi government decided in 2015 to bring all of that paper manufacturing into India. It was also important to change the design of those notes completely. Else it would have given rise to significant fake currency. Mr. Chidambaram, who was the FM for most of the 2004-2014 years, should provide an explanation as to why he did not think of overhauling India set up to print "all" money in India? And why are you hiding the fact that the estimated savings for India for printing all its notes in India from now on is at least 1L Crore? 24K crores to save 1L crores. The math is simple Mr ex-FinMin. And what about the sudden gain for the government of INR 36K crores of unclaimed (benami) deposit as the result of sealing 3L fake companies? Chidambaram does not highlight this gain either.

Why were 2000 rupee notes printed at all?

With sudden removal of 86% of currency, it was important to circulate an equivalent money back into the system immediately. With higher denomination notes you have to make lesser number of notes in the same cost to quickly fill the void. Second, the government deliberately printed 2K notes before 500 notes post demonetization. Although this created immediate availability of cash, it also introduced (a planned) artificial crunch. Merchants were reluctant to accept 2K notes, but ATMs were generously dispensing them. The inconvenience pushed many to go to digital payments. This was a planned move.

If the last 1.5 years are to be observed, the government has been reducing the number of 2K notes in circulation. The 2K notes returned to the banks are not getting recirculated. Neither are new 2K notes being printed. ATMs are rarely providing 2K notes. They instead are providing the new 500, 200 and 100 rupee notes. The grand idea is to make 500 K the highest denomination note (If this Govt comes to power for the second term, they will reduce/remove the 500 rupee notes in circulation as well). In the larger plan, if the country needs to have only lower denomination notes, the number of notes required to be printed is going to be higher. And in that case, it is going to be important to print all of them in India at a much lower cost than what it was earlier. Do the Harvard graduate economists criticizing demonetization understand this? Do they even understand that 86% of high currency denomination is bad for an economy? These are the basics, right?

GDP Growth before and after Demonetization:

The following graph shows the GDP growth rate trend from Q3 ‘14 to Q2 ‘18. 

The GDP was on the decline for 3 consecutive quarters before demonetization. Post demonetization, the GDP declined for 2 more quarters and hit the lowest (5.6) in Quarter ending Jul '17. But then it changed course. It has been on the rise for 4 quarters back-to-back from then reaching 8.2 in Q2 of 2018. If Demonetization was responsible for the two consecutive declining quarter, what is the explanation for the 4 quarters of decline before demonetization? The real reason for this trend is the rise in NPAs (Non-performing assets), in general borrowing and lending declined, money circulation declined. Demonetization did add to the decline in growth in 2 subsequent quarters, but that impact was much smaller a factor. The larger factors were - 1) destocking (because of GST rollout  -manufacturing slowed down) and 2) NPAs. Anti-demonetization economists do not wish to explain these factors and the real reasons. And anti-demonetization politicians (non-economist by degree) have a miserable understanding of economics and don't have the ability to grasp the reasons for GDP decline, let alone the ability to explain it. Now the same politicians are keeping their mouths shut after seeing a rise in GDP for 4 consecutive quarters.

Inflation trend:

The following graph shows the Inflation trend for the last 6 years. The inflation has declined since 2014. If you observe the period before and after demonetization, you would see the inflation has reduced marginally. However, overall, demonetization has had no impact in inflation.

Economic growth should also be measured by parameters like - growth in total assets (rather than just the value of the assets), jobs created, enablement of job creation in future). Demonetization is just one pillar of a four-pillar strategy that the government is trying to build. The GST, Aaadhar, and Jan-Dhan are the other three. These together are positioned to bring in a massive change in India and will put India on a growth trajectory for decades to come, and that too in a right manner. What do I mean by the "right manner"? Assets will grow, infrastructure (physical, educational, economic, connectivity) will grow and not just the GDP. We always measure growth in terms of % of GDP. GDP is "gross" value of the total domestic production. This means if the values of those domestic products get inflated, the GDP becomes higher.  E.g. - Gold prices shot up massively in 2004-2014 era (thanks to the huge cash in the economy, the remained a cash-based purchase. It should have converted to a Digital transaction-based purchase). Real estate prices (which also contribute to GDP) came down - and this was only a sensible thing to have happened. This one single reason was largely responsible for inflation. 

Demonetization was a fantastic move positioned to reformat India economically and position it for future advancement. Its impact should be measured across next 5-10 years and not based on how much money was returned to the banks.

Authored by: Mandar Garge

Ramadoss, mind stopping your overdose ?

Why doesn't the Union Health Minister, Anbumani Ramadoss just stop using his authority in insignificant issues? There are ample of *real* health problems facing this nation that the health ministry should concentrate on fixing rather than spending time and energy in pursuing insignificant policies that really make no difference to those who desperately need healthcare the most.

First his feud with the AIIMS director Dr. Venugopal. Ramadoss should be punished for wasting unprecedented amount of his, his ministry's and Supreme Court's time in pursuit of his fight against Venugopal, and his blatant defiance of court order in ousting Venugopal from his job. The feud arose out of Anbumani's insistent that Government should have more control in administration and decision making of AIIMS, the most coveted medical institute in the nation. When Venugopal tried to fight Ramadoss's attempt to reduce the institution's autonomy, Ramadoss changed the employment rules to put a limit of 65 yrs on the age of retirement. Why? So that he could get rid of Venugopal who was 67. A shameless way to remove a rival who actually was a only few months away from his retirement. The fierce fight ended with Supreme Court reinstating Venugopal with all respect due to the AIIMS director. A loss of face for Anbumani at the cost of damage to India’s premier institute’s image.

One of the insignificant policies he tried to deploy was ban on smoking in movies and TV ads. God knows how that would have reduced addiction of smokers to cigarettes. I don’t think people in this country, or for that matter anywhere in the world resort to smoking because they see their movie icons do so. Next on his plate was harassing film personalities like Amitabh Bacchan and Shahrukh Khan by asking them to quit smoking. Then next was banning smoking at public places. Why is he so much after smoking related issues ? Although the thinking behind a ban on smoking in public places is noble, that’s not what is driving Ramadoss to act. Staying in news is the reason driving him. And what about the enforcement of this law? Not very effective. I tried reminding a person smoking in public place about the ban once and he told me to shut up and mind my business. Why is Ramadoss spending so much of his valuable time on upliftment of those who are smart and capable enough of figuring out the ill effects of smoking on their own health ? Don’t the more deprived citizens in the society, desperate for good health care but incapable of affording it, deserve more favor from the health ministry ?

It’s true that Ramadoss has done some real good work as a Health Minister. But his penchant to get sucked into controversies relating to issues that hardly matter to anyone dwarf all his good work. If the Health Minister was so much after adding accomplishments to his credit, to begin with he could have thought about systems he can put in place to make the deliverance of government's Expanded Program of Immunization (EPI) scheme (an initiative by government to eradicate all the common epidemics) more effective. He could have set an aim for his ministry, of pioneering total eradication of epidemics that have been wiped out in western nations years ago, but still cause casualties across the length and breadth of India.

Another big problem harassing the nation is 'Malnutrition'. Come out with new schemes to eradicate malnutrition or make existing ones more deliverable. Smoking problem needs no attention when you have graver health problems in this country. Even if you clamp down all smoking related advertisements and messages, people who want to smoke are going to find out ways to do so no matter what.

Ramadoss is more inclined toward implementing policies that do *not*matter than those that do. PMK, one of those nonsense political parties supports the UPA and in return the PMK chief’s son - Anbumani Ramadoss - is granted a crucial cabinet berth. Thanks to coalition politics. Elections are round the corner and we can only hope that we don’t get to bear the brunt of Ramadoss’s overdose ever again.

Authored by: Mandar Garge

Brief story of the Indo-U.S. Nuclear Deal

(Note: several readers may be aware of most of the things mentioned in here. This is my humble attempt to explain in simple words, what the deal is about)

In order to battle its energy crisis, when India in 2004 tried to acquire civilian Nuclear technology from France and Russia, the NSG regulations prevented those countries from having any sort of nuclear association with India. Having undergone Nuclear isolation for more than 3 decades, India had two options – reinvent the wheel and spend huge amounts of money and few more decades to indigenously develop advanced Nuclear technology (that too with limited nuclear fuel resources) – OR – get technology and fuel from those countries who already were decades ahead of India in this aspect. India obviously tried to pursue second option – and this time with the USA. The U.S. (mainly Condoleezza Rice, US Secretary of State) saw great sense in having such a deal with India - huge business, strategic alliance, influencing India’s defense Nuclear usage to some extent to bring it under a more regulated non-proliferation regime (given that India had not signed the Non-Proliferation Treaty (NPT) and Comprehensive Test Ban Treaty (CTBT) ) etc.

But in order to do any nuclear trade with India, USA had to:
a) - get a consent from the Nuclear Suppliers Group (NSG) – a 45 member nation organization, of which U.S. is one of the founder members, and
b) - bend its existing internal laws.
The first task was mainly creating a strong case for India at NSG asking it to permit its member nations to allow technology transfer to India. The second was convincing U.S. law makers to accept the 123 agreement that would be signed with India.

On India’s part it was quite an uphill task. It meant two things:
a) – sign the Safeguards Agreement with the International Atomic Energy Agency (IAEA) (this was the easy part) and
b) – get a special waiver from NSG without succumbing to non-proliferation pressures from its member nations and without jeopardizing India’s ability to continue building N-weapons.

To accomplish the first task, India needed to separate its nuclear facilities into Civilian and Defense streams. The Civilian reactors (currently, out of 22 reactors, 14 are civilian) would have to be made open to inspection and regulations by IAEA. Defense reactors and equipment would not be subjected to international regulations or inspection. No technology transfer would happen between civilian and defense sectors and any such issue will have to be first approved by IAEA. That’s not a bad situation for India because India gets the latest technology and equipment to satisfy its civilian energy demands and also gets to indigenously keep on working on improving and increasing its Nuclear arsenal without resorting to testing (unless neighboring countries pose a threat by carrying out their N-tests, in which case we will have to use our diplomatic might to pursuade NSG of carrying out a test in response)

The second task (getting NSG waiver) was probably the biggest hurdle the Indian diplomacy had to face in decades. Opposition from even a few members of the 45-member nation NSG meant demise of the deal. Nations like Sweden, Japan, Switzerland, Austria, Australia, New Zealand were opposing India's efforts from the start. China (which promised support to the deal initially) showed it true colors by trying to scuttle the deal at the last minute. These nations (with the exception of China) have strictly followed the Non-Proliferation paradigm and according to them India, having not signed NPT or CTBT was not an acceptable candidate to be granted such a waiver. Moreover this could set wrong precedent for several other developing nations (like Iran) aspiring to develop nuclear reactors amidst tremendous international opposition. But on the basis of a) its Non-proliferation record, b) pressure tactics from Bush’s administration to these opposing nations, and c) bait of tremendous business opportunity for these nations, the Indian diplomacy succeeded in convincing NSG that India indeed was a trustworthy nuclear power. NSG - the formation of which was in fact partly triggered by India's use of N-technlogy (supposedly aquired for civilian purpose) to build its first N-bomb in 1974, and the rules of which were formatted to keep N-technology out of reach of countries like India - finally granted India the historical waiver. This waiver meant India could practically get technology from any of the willing NSG member nations even if the Indo-U.S. nuclear deal failed to materialize.

The third and final thing needed in order to sign the deal (read 123 agreement) with the U.S. was to get the U.S. congressional nod (meaning changing that country’s law so that it can carry out technology/fuel transfer to India). Bush’s team (led by Sec. of State Condoleezza Rice) led the efforts to convince the naysayers to give up and support the deal. The US House of Representatives passed the deal by overwhelming 298 - 117 votes and the Senate, passed it by 86 – 13 votes.

What does this mean to India:

- End of Nuclear apartheid and decades of isolation. India can now work towards meeting its energy demands.
- Assertion of India as the Sixth Nuclear (civilian) Power (it's already an N-power w.r.t weapons) and an important Nation with substantial geopolitical influence in Asia and the World.
- India gets to maintain rights to reprocess used nuclear fuel.
- More than 40 Billion dollars of US investment in immediate future – this also means opening up of thousands of new jobs in India. According to Imagindia Institute, an Indian lobby group - the economic benefits that will accrue to India's economy by 2030, as a result of nuclear trade could touch $500 billion.
- NSG waivermeans India is free to do similar Nuclear agreements with other NSG nations without having to secure any waivers from them (An N-Deal has already been inked with France)


What does it mean for the U.S. ?

- Billions of dollars of business in N-technology along with business from subsequent defense equipment sale to India
- Creation of thousands of jobs in the US in Nuclear Power related fields as well as indirectly related fields. A recent report in TOI mentioned that around 2,50,000 jobs would be created in the US in next few years of materializing the N-Deal with India
- Closer and stronger strategic and diplomatic ties with India in order to keep growing Chinese influence under check.

All in all, there might be some compromises India have to make (like avoid nuclear tests as much as possible, subjecting civilian reactors to international inspection, etc.), but in the long run, the positives of this deal will outweigh the negatives far more.

Authored by: Mandar Garge