Demonetisation update 36- loss of sense of humour and more

Manish Sabharwal wrote:

I’d like to make the case that demonetisation made India a better habitat for formal job creation for five reasons: Rs 18 lakh crore new lending capacity, 7.9 crore new monthly digital transactions, 3 lakh crore new financial savings, 2 per cent lower interest rates, and permanent damage to our sense of humour about the rule of law (1.5 lakh people deposited Rs 5 lakh crore, that is, 0.00011 per cent of India’s population deposited 33 per cent of total cash demonetised). Let’s look at each in more detail.

Rs 18 lakh crore new lending capacity

Without equity capital for banks and better governance in banks and demand for loans, it is a problem and not the answer.

7.9 crore new monthly digital transactions

So what? What does it mean? More revenues for the government and capricious taxmen? Again, without tax governance changes, is it good or bad? May be, even bad.

See this for example. Mohandas Pai had tweeted it.

3 lakh crore new financial savings

What exactly is it? People now put money in banks? Will some of it not be withdrawn for consumption purposes? Further, it is a duplication. He has already mentioned new lending capacity.

In any case, the overall household financial savings rate has been declining.​ We have to wait for 2016-17 data to see the overall stock and ratio of financial savings.​

2% lower interest rates

One, banks are yet to lower rates meaningfully for borrowers.  But, two, they have been lowered for savers and depositors. That is actually a negative. Three, loan demand is a function of investment demand which is only peripherally linked to lower interest rates.

The last one is probably the best – loss of sense of humour.

But, has it also come with a permanent damage to our logical  analytical capabilities?

I fail to understand the oft-repeated assertion that India has a ‘wages’ problem and not ‘jobs’ problem. Well, it has a ‘wages’ problem (they are too low and with too little worker protection, health and job security benefits) because its economy creates such low-quality and low-wage jobs.

As Manish writes,

But if our problem is wages then India needs the higher productivity that comes from structural change: Formalisation, industrialisation, urbanisation, skilling and deep financial markets.

He is partially or mostly right here. India needs to create more jobs in the formal sectors with worker protection provisions. But, were such follow-up measures thought of or did demonetisation trigger thinking along those lines?

Gulzar Natarajan and I argued for the need for such thinking. We wrote that demonetisation could be such a ‘breakout’ moment. But, the evidence that the Government is thinking along those lines is missing.

TJS George channels Kaushik Basu here and it is a worth thinking about:

A bigger worry than the demonetisation itself is the failure to recognise that it was a mistake. That is what is getting investors and businessmen worried about future policy decisions.


What went wrong with GST? – a useful discussion

Friend #1

I think Jaitley is being unfairly blamed for the plethora of rates. Every State Government had a pet commodity on which it didn’t want a reduction in rates. Partly it was fear a reduction in revenues and partly it was political. The GST rate on AC restaurant was a classic case of being politically correct and fiscally stupid. There was a built in revenue buoyancy in that the Idly at the Taj was always going to be a good deal more expensive than the street corner Udupi restaurant. The AC non AC distinction was thus unnecessary for GST purposes. It was Chidambaram who introduced a higher Service tax for AC restaurant in his 2013 budget. Now, rationalising the tax structure for restaurant service would have reinforced the image of ‘suit boot ki sarkar’ which this Govt wanted to avoid. Moreover in the interest of federal consensus the Centre humoured each State Government on its pet peeve. This was a conscious political decision for which the FM
alone can not be blamed. That said, the CBEC had its own axe to grind.

They didn’t want an altogether simpler tax structure. Jaitley couldn’t or didn’t have the gumption to overrule his officials who were constantly painting a picture of fiscal collapse.

My reactions:

But, somewhere, the buck (or, is it actually a bug, in this instance?) has to stop. Yes, States were reluctant participants for many reasons. Partly, it was about revenues for the State and partly it was about rent for the officials. Someone – and it has to be logically the leader of the whole initiative – should have risen above all these considerations and arguments and seen the big picture and have used all his rhetorical and logical skills to persuade them to go with a simpler structure from day one so that compliance is encouraged and incentivised.

Given that states were given 5-years of revenue loss compensation, then he assumes even greater moral right to articulate and ‘impose’ a vision of the above nature.

I am repeating myself: policymaking is also entrepreneurship. One must take one’s chances, at least from time to time. The GST called for such an entrepreneurship.

It has to be said that the government had proven itself to be poor in the execution of GST and the Demonetisation exercise. Of course, the latter is opposed even conceptually by many. That is a different issue.

Against this, they have a good one in the PMJDY. So, the score line is 1-2 in their favour.

Friend #1 responded:

(2) Viewing it purely through the management spectrum, this is what occurs to me on GST and demonetisation. On GST, it is principally the ‘treason of the clerks’ (to use a phrase made famous by Jagdish Bhagwati). The bureaucracy set up this Government nicely, to take a mighty fall. I mean how else can you explain a GST rate structure that had something like 13 rates? I am including those different ‘GST compensation cess’ rates for specific commodities, to the many basic rates of GST, in this context. For the bureaucracy the motive was fighting to stay relevant in the post GST regime. In the medium to long term the CBEC and the VAT administration at the State level would be rendered redundant (my guess is about 90% of the staff would not be needed). On the  other hand, you could argue with equal force that the top manager (PM/FM) knew that there would be resistance from the bureaucracy (or subordinates) but he might have thought that giving the clerks the impression that they are setting it up to fail might have secured better cooperation than doing something that would have invited complete recalcitrance. The odd civil servant can be made to fall in line. But if the whole system digs its heels in and refuses to move, there is not much that even the most powerful CEO can do in such a situation. The course correction that we are seeing now is perhaps part of that process.

On demonetisation, there were two issues. One was the obvious mistake- not realising in advance that ATMs are not calibrated to handle currency denominations of completely different dimensions to the existing ones. In every strategic decision you cannot factor in all possible consequences. There will always be the ‘unknown unknowns! The ATM problem falls under this category. But not ramping up production of new currency notes is total managerial failure. We now know from news reports that have surfaced in recent times that preparations had started in early April or May or perhaps July. It is possible that everyone along the chain went through the motions thinking that this won’t happen. Only Modi knew otherwise.

Friend #2

XXX gives much more credit to the bureaucracy than it deserves. We often think that Ministers are easy fodder for the wily bureaucrats. Trust me, it is rarely the case. I have been involved in the process of bringing VAT to the States a decade back. People do not remember it now, but the process had similar hiccups. Since it was at the State level, the media glare was not so much. Moreover, there were different experiences in different States, ranging from excellent to shoddy.

Different tax rates is quite normal in the multi-partisan polity like ours. As Sampath himself admits, every State had a pet peeve. Insisting on a single tax rate at that point, or even on 18% ceiling would have been a deal-breaker. Jaitley knew that, as also the Congress. Top Congress mandarins never wanted GST, but had to give in to the political realities. Jaitley deserves great credit for using his deep connections to fool the Congress mandarins to push the Constitutional Amendment through. Nobody else could have managed that.

The mistake was committed at the implementation level by keeping CBEC in the driver’s seat. CBEC had no experience in handling the small traders, who constitute 90% numbers but only 5% value, whereas the States had great experience in dealing with the small traders. Small things like using the Excise codes instead of the VAT codes have created so much confusion at the ground level that could have been avoided if Adhia had used the State officials more than the CBEC mandarins. Even the earlier insistence on monthly returns, and then the mismatch in quarterly and monthly returns is due to CBEC’s ignorance of VAT procedures.

All in all, it is a good thing if mistakes are being pointed out and being quickly addressed. Rahul Gandhi has woken up late as usual, but his party fully cooperated in passing the Constitutional Amendment.

Final remarks from me:

If you do not read Indira Rajaraman on India’s fiscal policies – whether on  GST or on demonetisation – you are missing something. Her recent article in MINT (published on Nov. 3) can be a case study for management students, for budding bureaucrats and for economists. It is a very important article. I cannot say it often enough and loudly enough. Just a sample here:

I still maintain that the principal reason why GST reduced economic activity had to do with the reporting modalities, not the brambly rate structure. But the rate structure was and continues to be a problem. It has undermined the very principles on which the tax reform process was built seamlessly across successive governments at the Centre, the most fundamental of which was simplification….

…. Any tax reform has to facilitate business in order to secure revenue and willing compliance. Such a configuration for the GST is still possible if the reporting frequency is shifted to quarterly for all, and voucher matching is restricted to IGST transactions.

The highlighted sentence is what I have been calling as ‘policy entrepreneurship’. What is the point of introducing a single tax if the objective was not to create a single market and facilitate better and more economic activity. It boggles and disturbs the mind to find that no one inside the government seems to have thought of that angle at all. Did they think that it would happen automatically and that they could simply pile on their burdens?

Indira Rajaraman’s article is an indirect indictment of the jump in the ‘Ease of Doing Business’ rankings for India. On that topic, read the column by Shankkar Aiyar.

Why I don’t agree with Kevin Rudd

Kevin Rudd has a piece on the rise of China for ‘Project Syndicate’. I disagree with him for the following reasons:

(1) I am, by nature, a contrarian.

(2) The current consensus on China being the global model on everything from democracy to market economics to trade openness to gender equality is so risible that it does not behove intelligent people to join the bandwagon.

(3) China has become more indebted than the West before it has become half as prosperous as the West.

(4) Asia is still short of vital resources such as water. China is no exception.

(5) The dominance of the West (in the aggregate) is only 200 years old whereas Asia (India and China) dominated for nearly Eighteen centuries. There is plenty of time for mean reversion to happen.

Central bankers in the dock

Today, central banks are under attack for all of these reasons: for missing their inflation targets, for failing to maintain financial stability, for failing to restore stability in transparent ways, and for not adequately taking into account the global repercussions of their policies. Dissatisfied by their performance, politicians are seeking to reassert control…..

….What central banks can do to head off threats to their independence is become more transparent. They can announce the votes of individual board members on all policy-relevant matters and release minutes without undue delay. They can hold more press conferences and be less platitudinous in explaining their policies. They can avoid pontificating on questions remote from their mandates. They can acknowledge the right of politicians to define the goals the central bank is tasked with achieving.

And to shape the views of those politicians, they can better explain why cooperation with fiscal authorities and foreign central banks is in the public interest. They can publish more detailed financial accounts, including on their individual security transactions and counterparties.

Above all, they can avoid intervening in parliamentary politics, as the European Central Bank did when it hastened the fall of Silvio Berlusconi’s government in Italy in 2011. Then they can keep their heads down and hope for the best. [Link]

That was from Barry Eichengreen in a recent (Nov. 10, 2017) piece for ‘Project Syndicate’. All emphasis mine.

Wait for my column coming Tuesday as well, for I am adding my voice to the attack on central bankers. Of course, my voice is not a recent addition to the chorus against the remit of central banks.

Trump in Vietnam on India

India is celebrating the 70th anniversary of its independence. It is a sovereign democracy, as well as — think of this — over 1 billion people. It’s the largest democracy in the world. (Applause.) Since India opened its economy, it has achieved astounding growth and a new world of opportunity for its expanding middle class. And Prime Minister Modi has been working to bring that vast country, and all of its people, together as one. And he is working at it very, very successfully, indeed. [Link]

In this context, two tweets by Chris Balding deserve mention.

First tweet:

What do you think China’s model is if not “nationalism, protectionism, unilateralism & xenophobia”?

Caroline Freund @CarolineFreund

If Trump’s retreat into nationalism, protectionism, unilateralism & xenophobia continues, China’s model could win.

This is the second tweet:

I’m not about to say yet that Trump got Beijing to open up bank ownership, but if it comes out Trump admin played a role, will everyone who said he was played please step forward? No one? Anyone at all? [Link]

You have to believe this story because it appeared in ‘South China Morning Post’:

Chinese officials pay homage to tree planted by Xi Jinping as Communist Party chiefs get in touch with their roots.

Let me close with Ely Ratner’s tweet:

I’d like to see more reporting on the absurdity of Xi’s major speeches, contrasting his rhetoric about openness and globalization with the actual situation in China.


Irrational exuberance revisited

Most people had heard of these sentences and even repeated it scores of times:

But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?

But, we have rarely heard this sentence quoted:

We should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.

They were both part of the same speech that Alan Greenspan delivered at the American Enterprise Institute in 1996. I saw these in a good blog post at the Institutional Risk Analyst website.

Indeed, one should look at Christopher Whalen’s post on ‘Loss Given Default’ as a possible metric of market overvaluation.

My colleagues at Lumen Capital in Singapore sent me this very thought-provoking table:

US market valuation


Steph Pomboy has this chart too:

Domestic stock market cap as percentage of pvt. sector GDP


We are still debating if there is a uniform asset bubble or not! Even if we do not have a uniform (or, universal or global) asset bubble, when the U.S. stock market crashes (not IF), all asset classes will be correlated.

Bloomberg overcompensates for this good and important story with this one – a horribly bad headline. I felt that it was a rather strange headline to offer to readers and I am pleased to note that someone else concurs.

Trump’s first annniversary

As of the start of October, federal red tape scorekeeper Wayne Crews found that Mr. Trump was off to an historic beginning. Mr. Crews measures the number of pages of new and proposed rules spewing forth from Washington. Last month he reported:

The Federal Register stands at 45,678 pages. Last year at this time, Barack Obama’s Federal Register stood at 67,900 pages. (Obama’s 2016 Federal Register set an all- time-record: 97,110 pages). Compared to Obama at this time last year, Trump’s page count is down 32 percent so far in his first year.

It took a few years for Ronald Reagan to achieve his ultimate, one-third reduction in Federal Register pages following Jimmy Carter’s then-record Federal Register. So by this metric, Trump is moving much faster.

By many measures, including graciousness and dignity, Mr. Trump is no Ronald Reagan. But this is the first time since Reagan left Washington nearly 29 years ago that a U.S. President has mounted a vigorous effort to tame the federal bureaucracy. The Trump campaign for expanded economic liberty should give all Americans reason to be hopeful. [Link]

We are unlikely to read this in any commentary on the first anniversary of Trump Presidency. Hence, posting it here.