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Tag: demonetization

  • Demonetization: good or bad- Part II

    Demonetization: good or bad- Part II

    Adverse effects of demonetization are finally trickling down into the economy. Although a lot can be said about the poor implementation part of the policy, this article will focus just on the economics. One very important point to keep in mind during this whole discussion is to not cloud the economics judgement of policy through moral lenses.

    The developments in the last few weeks have confirmed YP predictions in the past:

    1) It would lead to slowdown of economy: The service sector contracted in November which is the first time in last 18 months. The Nikkei Services Purchasing Managers’ Index fell to 46.7 in November from 54.5 in the previous month, the sharpest reduction in three years. You can also take car sales as another metric of economic performance. Here again, November saw an 8% decrease in car sales pointing towards decrease in demand.

    2) Big fish have found ways to escape: IT raid at the residence of two government officials found 6 crores of unaccounted cash, out of which 4.7 crore was in new currency. So while the poor and middle class are lining up at banks and ATMs and are restricted to withdraw puny amounts, those with large stash of black money have found illegal ways to change their currency.

    The worst part in this whole exercise is the chest thumping by free market economists on rise of temporary tax revenue for GoI. Tax money for the Govt is just tax money of the government. It does not indicate the actual GDP of the country or economic growth.

    For example, if people of the country are earning/producing 150Tn ₹ in total output and government tax rate on it is 10%, the Govt tax revenue will be 15Tn ₹. Let’s say if the Govt raises the tax rate by 1% to 11%, and the economy “contracts” by 1%, then GDP of the economy will go down by 1.5Tn ₹ to 148.5 Tn ₹, while the tax income for the Govt will still increase by 1.15 Tn ₹ to 16.33 Tn ₹. So, tax income increase for the Govt doesn’t automatically equal to GDP increase/growth/income for the public/citizens.

    The same can be said about the other assumptions used by the author. Most of the figures quoted everywhere for black money are just guess-estimates with government or economists having little clue about the numbers.

    But the analysis is flawed even from the welfare perspective of the policy. The way regular economists would evaluate any policy is by comparing growth with the counter-factual scenario. Agricultural sector picking up due to better monsoon is not an effect of demonetization and would have been there irrespective of the policy implementation.

    The gains also rest on future increase in tax net. People who pay taxes today are in no way liable to pay taxes in the future and a large number of them can drop out again. Hence the push for digitizing the economy to make it easy to track the transactions.

    And it is really difficult to understand how increase in government tax revenue at the cost of decrease in overall GDP growth is hailed as success of the policy. Once accounting for the pain faced by regular citizens plus deceleration of GDP growth, some temporary increase in GoI revenues does not seem such a great policy.

    As predicted by YP, thanks to the jugadu nature of Indians and help of government officials, people have converted their old notes to new notes. Effectively, the claims of removing 4-5 Tn ₹ of black money from the total stock of money would not materialize. So, GoI has failed on its primary goal in the short run. On top we are witnessing a contraction in the economy, which would linger on for the next few quarters. Once taking into account all these factors, it seems that the whole policy was big farcical show for nothing substantial.

  • Currency demonetization is a bad or at best no impact idea

    Currency demonetization is a bad or at best no impact idea

    The recent decision by PM Modi government to take out Rs 500/1000 notes out of circulation has caught the media and the whole country into a frenzy. The policy seems to be the government antidote against the issue of black money in the economy.

    The main reason behind this demonetization decision is to cut down the black economy in the country and dry up the illegal funds of those who have collected it over the years. So if you have large unaccounted cash, it is as good as piece of paper beginning November 8.

    The government is acting on the premise that there is large amounts of black money in India and it is held in cash. This gives us two scenarios in the wake of this decision-

    1) There is really large amount of black money in the economy. So if you take this money out of economy, it will hit the economy hard post this decision, thus making demonetization a bad decision

    or

    2) There is no large amount of black money in the economy and there would be no impact on the economy. If this is the case, then it hardly makes sense to demonetize.

    Having seen how an average medium sized business operates in India, one should lean towards the first scenario that economy will be hit hard by this decision. There are large number of inefficient and unseen taxes on businesses, which makes them less productive and also makes it essential for them to engage into unlawful activities to keep the business running.

    So who might have large amounts of cash sitting at their place? Just think of any neighbourhood shop which does not give a receipt for your purchase, the owner there might have generated some amount of black money. And if the amount of black money hoarded by them is really high, expect them to fire their employees and shut shops in the wake of this decision.

    One of the sectors which is supposedly flushed with large amounts of black money is the real estate sector. The real estate sector has not done well for the past two years and it might get hit even more post this decision. There might be many people with white money, who have invested in unfinished projects, and they would lose all their investment because the real estate company cannot complete the project now.

    Also, the whole exercise seems a bit futile once you take into account that the government has decided to reissue new Rs 2000 notes. The rules of the game i.e. the discretionary power with the babus, have not changed and those who earlier collected Rs 500/1000 notes will now switch to hoarding money in Rs 2000 notes. So, this will have no impact on the future generation of black money.

    So, what should you make out of this policy? Brace yourself for a rude shock if you really believed that black money formed a significant part of Indian economy. And if you don’t get this rude shock, then it was just an empty noise without any substance and black money was not even an issue to begin with. Black money is a symptom of the inefficiencies and bad laws in the economy, which forces a large number of businesses to cut corners to remain viable.

    P.S. 1- The article only dealt with the economic issues of black money and some people will point out its impact on terrorist infrastructure or future state elections.

    P.S. 2- There is 3rd scenario not mentioned above, if you believe in super powers of black money hoarders- they have large amounts of money but they find a way to fool Modi government.