Hello and welcome to this special discussion on The Wire on demonetisation. The devastating effects of demonetisation are still with us. Although the period of demonetisation and replacement of notes is nearly 50% over as per RBI’s submission before the parliamentary standing committee. They have claimed that 60% of the money, which was withdrawn, has been replaced. But they are still not giving us the exact amount that has come back and they are also not telling us when full normalcy will be restored, in the sense [when] withdrawals without restrictions will be allowed.
To discuss the effects of demonetisation on the economy in view of the union budget, which is coming up on February 1, and before that there is an economic survey which will have to capture whatever has happened to the economy post demonetisation and the last six months of the financial year – we have with us former professor of JNU Arun Kumar, who was with us sometime ago to discuss demonetisation and he has done extensive work on black money and the black economy. And, he is also coming out with a monograph on the current situation [and] where the black economy is headed post demonetisation. You’ll have that monograph very soon in the market.
Welcome to our show, Professor Arun Kumar.
Please tell us, how do you see the economy behaving? Now the government is going to do a budget and a lot of people are saying with what data are they going to do a budget because nobody has studied or quantified the effects of demonetisation, the loss of output which we are getting from various associations – trade associations, manufacture associations. How do you see this developing?
The situation as was anticipated has led to recessionary conditions deepening in the economy. Why? Because investment has declined and for that the data from CMI suggests that investment already before October is declining because capacity utilisation was very low and post demonetisation, as capacity utilisation has fallen further, their data shows that actually investment has gone down further.
Similarly, unemployment in the unorganised sector and therefore unemployment also in the organised sector where the demand was short, that has also increased. Banking system is in a crisis because it is likely that their NPAs are going to increase. They’re unable to lend out, whereas they actually got deposits so their costs have risen. So in other words, if banking is in a crisis, if your investments are declining, if unemployment is rising then that is what recession is all about.
The recessionary conditions have been deepening for now more than a month-and-a-half because initially you could have reversed it but now that the decline in investment has taken place, decline in employment has taken place, it means demand will not rise very quickly, expectations will not…
So you don’t buy the V-shaped recovery theory being trotted out by the government economists?
Correct, and what the government has done it has tried to produce data on index of industrial production, on various other things. But there are lacunae in all that because the government had allowed the old currency to be used for certain purposes. So for instance, for buying petrol and therefore petrol consumption rose; everybody filled up diesel and petrol consumption. Similarly, it allowed medicines to be bought with the old currency. So pharmaceuticals did well. Similarly, for certain other kinds of goods.
But the point is that the index of industrial production largely represents the organised sector and not the unorganised sector. And therefore the data for the unorganised sector is not captured by this. Because of this problem what will happen is that when the actual data comes out then you’ll find there is a revision in the index of industrial production, etc.
So my suspicion is, at this point, the government does not have data on which to plan for the next year because all budgets depend on what has happened and now what is likely to happen. And what has happened up to October is not representative of what is happening in the year.
So what do you project from? Do you project from the seven months’ data or do you project from the nine months’ data? Because the two months’ data that came out up to December end was vastly different from that which was the earlier seven months. So what should the projection be done from? So that’s why budget formulation will have deep trouble and the chief statistician has come out saying we don’t know the effect of demonetisation. Even the RBI has said that. So therefore, what should the government project from?
Basically you’re making your Budget in the dark…
Yes, in the dark. Also, the economic survey which comes out, that also has to make some estimate about it—
Suppose you are writing the economic survey, I know you have been traditionally writing an alternate economics survey, if you were writing the economic survey for this financial year, what would be your broad numbers?
So my suspicion is that already the GDP in the two months after November 8 that have elapsed already is in the negative territory because the anecdotal reports from the various surveys like the State Bank of India survey, Punjab, Haryana, Delhi Chamber of Commerce [PHD Chamber of Commerce] and Industry, the manufacturers association suggests, for this period there is at least 30-40% drop. Like for instance, the Punjab, Haryana, Delhi Chamber of Commerce survey showed that 80% businesses were showing a decline in their sales.
The State Bank survey also showed that…
For the first week of January, they showed that also. But the manufacturers association showed a much larger fall than what the State Bank of India is showing. So in other words, all these surveys are pointing to that. Also the reports coming from the field, whether from the construction industry, whether from the real estate, whether from plantation industry, whether the fish market in Kolkata being not so crowded as earlier, whether from the farming sector that farmers are not able to sell their produce—all this is pointing to a negative growth rather than a positive growth at the moment.
The rate of growth would be close to zero or negative because the first seven months were good, so you have to average over the seven months, plus the two months. So therefore, the rate of growth till now would be zero. But the point is what do you project on?
If you project on the seven months earlier, then it would be a positive seven percent. But that is not the situation in the last two, three months. The last two, three months have been negative growth. Now if you project from that for the budget, there’ll be a completely different kind of a budget projection.
And the question is, what do you do now to take care of this? So therefore, the budget is in a pincer. The pincer is that if they try to boost the economy, given that their rate of growth has turned negative, tax collection would not be as buoyant as expected, and therefore the fiscal deficit will rise. If the fiscal deficit rises, then the credit agencies will downgrade you. If you don’t allow the fiscal deficit to rise, then you cannot boost expenditures on capital items and on social sector, which is needed to get the economy out of the recessionary phase.
Therefore, the budget is in a pincer: should it increase expenditures or should it not increase expenditures? That’s why this is a very difficult task for the finance minister at this point – how to plan for the next year, on what basis to plan.
If you were making the budget, what GDP estimate would you take for [the year] 2017-18?
The nominal GDP is important and the nominal GDP implies the rate of inflation plus the real rate of growth. The real rate of growth is probably close to negative at this point of time. The wholesale price index is going at about 3.5% or thereabouts. In other words, the nominal GDP would be rising at zero at this point of time. So therefore, in a sense, it’s flat.
Rather than what the expectations earlier were that it’ll be 12% or 10% rate of growth of nominal GDP, so all your revenue calculations will turn out to be incorrect. Because, if you assume 10%-12% rate of growth whereas it turns out to be 0%, then your revenue projections will be wrong. In which case, during the year, you will have to cut back on capital expenditures and social sector expenditures to meet your fiscal deficit target because the government has been watching this because of the credit rating agencies.
In other words, budget making is in a huge crisis at this point. It’s a nightmare for the finance ministry.
But tell me Arun, the stock market seems to be suggesting, at least over the last four days, that consumption is kind of slowly coming back. Not fully back yet but some segments are showing consumption coming back and the stock market seems to be discounting this as it does for the future consumption. Today it’s nearly back to the pre-demonetisation level, a little below that. How do you read that?
My suspicion is because of the increase in the fed rate, the foreign investment, the FII and the FPI that has been withdrawn. To compensate for that, what the government has probably done is ask LIC and others to enter the market in a big way. They want support for the market. The rise in the stock market is because of that rather than because of the demand…
I must add to what you’re saying, which I learnt from some analysts in Mumbai. Because so much deposit has come into the banks, a lot of these deposits are going into mutual funds. Because they’re sitting in savings account, getting just about 4% or less. So the banks are selling to depositors the idea of pushing them into various mutual funds. Banks are earning a fee income on that.
That, of course, would be happening. But I think, more importantly, it’s the financial institutions which have been asked to keep the market buoyed up. But that cannot last for very long because the expectation is that the fed rate will rise further, more foreign funds will go out and they will begin to have an effect. So usually what has happened at the time of the budget is that the institutional investors have been asked to invest more so that they market remains buoyed.
My own suspicion is that it’s not because suddenly consumption has revived. Because if unemployment is as large as it is, and as the reports from early January are that businesses have been affected by 30-40% and the PHD Chamber of Commerce suggests that in north India 88 or 80% businesses were affected – if such a large amount of impact is there then consumption cannot suddenly revive.
How do you respond to finance minister Arun Jaitley’s assertion that GDP growth is back to normal because the revenues are growing as per the budgeted figures, roughly 14-16%?
Revenues were already rising quite substantially. If you notice up to the October period, then direct taxes were rising very rapidly, indirect taxes were rising very rapidly…
You’re saying revenues need not always indicate buoyancy and growth…
Yes, also, they can be for other reasons. For instance, why petroleum goods revenue has risen very rapidly is because you allowed old notes to be used. Similarly, for pharmaceuticals you allowed old notes to be used for medicines so people bought 3-4 months of medicines; people filled their tanks whereas usually they would have filled up maybe a quarter of the tank or so. Now they are filling up their full tank up to the period of November and December.
People bought forward.
People bought forward and similarly, industry, with its old currency, would have bought forward. Therefore, there would be a certain degree of buoyancy in that but that’s only one of. As soon as that period is over, there would be a decline. Therefore, in fact, a greater decline would take place so the data for that will come now and that data may suggest that we’ll average it out over the period of five months from November to March, then the buoyancy is not as high…
It’s interesting you’re saying that because some researchers in Bombay also told me the same thing that people bought raw materials six months ahead so now they will not buy in January until March-April. So this period’s data is very critical.
Correct. So the full figures have to come out and as the chief statistician and the RBI have said, we’re unable to estimate the effect of demonetisation on the GDP growth. Though if they are not able to give the figures then how would the budget get planned? Because the Budget has to plan for revenue, it has to plan for expenditure, and the buoyancy of taxes is very important then to be able to estimate it.
Secondly, what new policies? The prime minister has already announced several things whether it be on housing or whether it be on banking in his December 31 speech. Now you have to accommodate those also. So therefore there will be additional expenditures…
There is talk of universal basic income to be given to a large number of people, covering 90%-95% of the population…
There, my own take would be that already the demonetisation has sort of critically affected the economy. There is a lot of uncertainty and if you introduce such a major scheme without really adequate preparation then that scheme would maybe be very difficult to implement given the current circumstances. It could be another disruption.
I think it’s a good idea; we must give to the poor, we must have a negative tax in a sense for the poor; it’s a very positive thing. But to do that we must plan ahead. We must identify who are the poor, where will all the money go, how will we deliver that money.
There is also talk among some economists that this universal basic income would come from collapsing some existing welfare schemes, withdrawing them and giving them as basic income. So that will be a disruption. When you withdraw one set of schemes and…
Try to force it onto another. Because you see, what has happened is that people are adjusted to whatever they were getting in terms of the various schemes. Now those will stop. But when will the new schemes start, how soon would it be possible to do that, how would the identification take place – all that might take time so in between there could be a lot of disruption. Design is very important and implementation is always a problem in India given the leaky bureaucracy…
Specially this government, the way its demonetisation has happened. A similar experience could also occur if not done properly.
Professor Arun Kumar, there are questions from our viewers. Tirtha Deep is asking: is the decrease in GDP possible due to demonetisation, and how?
The reason why demonetisation might lead to a decrease in GDP is because cash is needed for circulation, especially in the unorganised sector. Unorganised sector is around 40% of the GDP. Reports seem to be suggesting that almost 80% of these units have faced problems and some reports suggest that maybe up to 50% of decline in output has taken place and massive layoff has taken place. If 40% of GDP faces 50% decline, that’s straightaway a 20% decline.
Suppose the organised sector hasn’t declined at all, which also is very doubtful, then that would lead to a negative rate of growth of the economy. If the organised sector has also declined in this period, as a result of the fact that demand has declined from the unorganised sector and discretionary demand has been postponed, then the decline could be even greater. That would be the answer.
There is another question from Arun Emmadi. Arun Emmadi wants to know, will the government/RBI, this is interesting, reveal the amount of black money unearthed due to demonetisation officially. So he’s asking will the government reveal or RBI reveal. What is your sense?
They will give figures. Ultimately, they will give figures. They have to give to the parliament, the parliamentary committees, so on and so forth. Ultimately, these figures will come out but from the reports that are already coming out it appears that 95-97% of the old notes have come back.
Now old notes coming back doesn’t mean that black income has been unearthed. Some of it may have been black cash but for that you have to prove that whatever has been deposited is black income. That means the income tax department has to issue notices, and then these people will have to file their returns which will be in October this year. Then those returns will be scrutinized, which will mean next year.
Even if some black income can be identified from these old notes deposited, that will not be until 2019 that tax will come. In other words, this budget will not get the benefit of most of that.
I want to add one more thing here, Mr. Arun Kumar. I spoke to one member of parliament who was part of the standing committee where the RBI governor and his team had appeared a couple of days ago. This member of parliament asked him very pointedly: why are you taking so long to figure out how much money has come back when on December 10 you had said 80% had come back? So from December 10 until now, why can’t you count the remaining 20%?
His answer was interesting; he says it’s getting delayed because RBI is trying to figure out the exact quantum of counterfeit notes that have come in. Because while accepting these deposits, they were not checking for counterfeit.
Well some banks were but not all banks were. And, if RBI’s own data is accurate you know about 400 crores then you multiply that by about 30 because they don’t catch everything. That would be about 10,000 crores. But 10,000 crores in 15 lakh crores is very negligible.
But you had predicted that 96% of the money would come back and it has come back.
In other words, this counterfeit cannot be the main reason why you can’t count it. Broadly you can count it. But I think they’re fudging it because they don’t want to announce that such…
Maybe they’re using that counterfeit reason just to delay. It’s wrong to say that the amount of counterfeit is way larger than whatever anticipated earlier.
There’s another question from Soumyo Jyoti Adhikary: can we expect tax reforms in the budget? What kind of tax reforms?
This Budget is going to be a very populist budget because all the problems of demonetisation that have come, which have affected the poor people, elections are important, elections are coming – UP, Punjab etc. – so they’d want to make it very populist. Therefore, they would announce certain tax concessions.
But the problem that would arise is in a situation where you are in a recessionary condition, the tax revenue would be lower, and if you now further lower it then how would you meet your expenditure targets? Especially because the government would announce things, many sops to many sections of population as the prime minister did on December 31. So I think the budgetary deficit would tend to go up.
In the end, what will happen is that when the year closes, you’ll find that many of these targets have not been met and that is what UPA II used to do where over five years they cut the total planned expenditure by about 6.5 lakh crores. Every year, there is about 1 lakh crore cut because you projected a high revenue figure, you projected a high expenditure figure. Those revenue figures didn’t come out right and therefore you cut back on the planned expenditure.
So something like that could happen which would mean that the government would not deliver on the schemes that it is promising to deliver.
There’s another question from Faiz Tajuddin; he’s asking what’s your estimate regarding unorganised sector workers being laid off. Can they be absorbed by the organised players because the informal sector is getting formalised? Is that transition possible? It’s a very critical, important question.
The report seems to suggest that unorganised sector which produces 40% of the output, a large number of that is agriculture. But what is in services and what is in secondary sector, that maybe about 40-50% also. There the report seems to be suggesting that at least 40% decline in output, which would translate directly into 40% of the people laid off.
Now this is a residuous sector. It is a residuous sector because the organised sector is very highly capital intensive; it’s not employing people. So the organised private sector employment has increased from 7.5 million to 9.5 million over 25 years in spite of massive investment in it, which is negligible because the workforce has increased from 250 million to 450 million. So only two million out of the 200 million have got absorbed in this kind of a situation.
Today, you are in a situation where this organised sector, which is also suffering, is suddenly not going to be able to absorb it. Formalised does not mean that you convert unorganised into organised sector. Formalisation only means registration with the government. But that doesn’t mean jobs get created. Therefore, it’s not possible that the unorganised sector workers will suddenly start getting absorbed in the organised sector because that’s not happened in the last 27 years. It is in fact the opposite: because the organised sector is not creating enough jobs that’s why people are going to the unorganised sector.
That’s why only two million additional jobs in the organised sector and 198 million additional jobs in the unorganised sector over the last twenty-five years.
Even the formalisation process is not so easy…
And, it’s according to the definition. Either you have ten or more people with power or 20 or more people without power. If you’re less than that then you don’t get formalised. So it’s not as if it’s an automatic formalisation. Having a bank account does not mean you’ve become a part of the formal economy.
Exactly, yes. There’s another question, Professor Arun Kumar, from Ritvik Khare: he said that Arun Kumar said credit rating agencies will downgrade us. But there has been a trend in the credit rating agencies to give higher ratings, as clients often switch over to other credit rating agencies for favourable reviews. So can’t India play one credit rating agency against another?
Certainly you can try and play but the point is no credit rating agency would like to be actually losing its credibility, that it upgrades you whereas actually the economy is tending to go into a recession. Therefore, in a sense, you can’t play at this point of time when the economy is actually in dire straits. This possibility which could have been there in normal times, but even in normal times we haven’t been able to play one against the other. Therefore, in this situation where the economy is weakening, to play one against the other would be very difficult, in my judgment.
There’s a last question which as an economist you can’t answer this; you have to use your political reading. In spite of demonetisation, how is it that in the Gujarat panchayat elections and other places BJP has won? How do you understand the pulse of the Indian voter, he’s asking.
The point is that Mr. Modi has high credibility. People really believe that he’s trying to tackle the black economy. It’s only with time that people are realising that that’s not really happening and therefore, anger seems to be building up whether its amongst farmers or whether its amongst the…
So you’re saying that Modi has political capital but he’s…
Slowly losing that political capital. And, the other thing is that Mr. Modi has tried to project the image of a Robin Hood by doing all this, saying that I’ll take from the black money wallahs and give to the poor. That really worked. That hasn’t happened but that worked with the poor people.
Thirdly, poor people automatically don’t get mobilised. They have to be mobilised by some social forces or some political forces. Now, even our political class actually was quite afraid that if we oppose this move then we’d be branded as being a black money wallah, hai na? So they didn’t want to be branded. So it’s only slowly that people are realising within the political class or the others that this move has actually devastated the economy. As that spreads, it will have a political repercussion also. But in India, poor people automatically don’t mobilise themselves.
So it will be a real nightmare for Finance Minister Mr. Arun Jaitley as he goes to into this Budget.
Thank you very much, Professor Arun Kumar, for talking to us. That’s all we have for now.