Sometime in December, MINT wrote a balanced Edit on the economic growth impact of the demonetisation exercise. The Edit was written in the context of the RBI holding off from cutting rates in its last Monetary Policy Committee Meeting. The Edit argued that there was no basis to back either optimistic or pessimistic assessments of its fallout. Not yet.
Further, staying with MINT, Manas Chakravarty, in my view, has been focusing on the right issue – the hydra-headed phenomenon of informality in the Indian economy. See his more recent piece here. This is a more pessimistic take on the prospect of the government succeeding in capping and reversing the informal economy’s reach and size. Earlier in December, he had written a slightly more optimistic piece, despite calling PM Modi’s move the equivalent of Mao’s ‘The Great Leap forward’.
For an economy of this size (USD2.0trn +), it is quite a big problem. Between future economic growth and informality, it is a Catch-22 situation. That is one of the reasons I have been supporting this move (currency swap). There are no precedents in the world on tackling the problem of informality in a country of this size. See this paper, for example. It provides a good summary of the body of knowledge available on informality. But, it advocates letting economic growth do the job. It is clear that there are no obvious answers to the pervasive informality in India.
Hence, there was no harm in the Government of India trying something new. That is why I called the government’s announcement of Nov. 8 as policy entrepreneurship.
But, having taken such a big and unprecedented decision, the government gives the impression of not having a real game plan. At least based on public evidence of its announcements, it is not clear that it knows its own mind on why you did it, what the next steps are, their pros and cons, etc.
For example, the government’s response after the deadline of Dec. 30 ended, has been rather disappointing. I had blogged on it recently. It was paternalistic. There is nothing about economic liberation. It is all about interference and intervention in the banking system through various subventions.
Usha Thorat, former Deputy Governor of RBI, wrote in ‘Indian Express’ that RBI has been found wanting in many areas -from communication, to catching the errant banking staff, etc. It was an impassioned plea.
A thought crossed my head:
How much of RBI’s pusillanimous behaviour is due to the manner in which the current Governor’s predecessor was sent out of the office. I am not questioning the government’s prerogative. But, the manner in which it was done must have sent an intimidating signal. I wrote as much then and perhaps, that has been vindicated.
So, no one speaks the truth to the government, including the RBI Governor. He does not tell the government that it is an impossible task to pull off, he issues circulars as the government demands and then retracts as the government faces flak, he does not report on the currency returned in a timely manner lest it embarrasses the government, he does not object when the government dictates which States receive the currency notes first, for political reasons, etc.
This is not at all a defence of recent RBI conduct post-currency swap announcement. But, it is entirely possible that someone who does not have the courage of his convictions is easily made to fall in line by the government’s behaviour. This government is as guilty of having brought this about as the RBI itself is. See the blog post that I had written on May 27, 2016 (‘Does the government deserve this?’). Perhaps, it does deserve this.
This morning, there are reports of more than 90% of the specified currency notes being returned to RBI. As is made out, it is not an indictment of the government decision. Not in a narrow sense. The government can still go after the deposits deemed suspect. But, it is an indictment of the banking system corruption. It is an indictment of the public sector ownership of Indian banks. It is an indictment of the government’s failure to recapitalise public sector banks and or use the opportunity of that exercise to consolidate them and to reverse nationalisation done more than 40 years ago in a different context. No one talks of recapitalisation of public sector banks in India anymore. That is a tragedy.
Mr. Gurumurthy has been in the forefront, speaking up for the government’s decision in several forums. Quite possible that he advised the government on the move. His article in ‘New Indian Express’ in June provides a strong hint of that possibility. I had blogged already on the relevant portion of his article that supports this belief.
In an article for THE HINDU, he wrote the following on the calculation of GDP:
Inflated asset prices to the extent realised by sale got accounted as part of income and included in GDP.
That is simply not true. All that was required was few key strokes to know that this is not how GDP is calculated. Just few sentences from few sites:
It’s true that GDP won’t see a direct increase from the value of a stock rising from $25 to $30. However, the seller of the stock will now own additional cash. That cash can be held or used to save, spend or invest. It’s likely that, at some point down the road, that extra cash will be used to purchase additional goods or services. This can grow GDP. A similar effect can be produced by any appreciating asset. … Real economic growth doesn’t result from more money changing hands. [Link]
See this one:
Business investment does not include the transfer of securities or tangible assets, such as real estate, furniture, or motor vehicles. Securities simply represent ownership or some other financial relationship but are not actual goods or services. Tangible assets that are resold are also not included in GDP, since this simply transfers ownership — it does not represent production. Investment in the economic sense means the production of real goods and services, not the transfer of ownership. [Link]
The Bureau of Economic Analysis has put out a simple primer on the calculation of GDP. Income from financial assets is taken into account but not from sale of financial assets. Or, for that matter, from other assets.
I am going to end the blog post here, deliberately, without providing a conclusion of sorts. Let us reach our own conclusions on the implications of the above.