Raghuram Rajan's Note Advising Against Demonetisation Should Be Made Public: Montek Singh Ahluwalia

Karan Thapar interviews Montek Singh Ahluwalia, former deputy chairman of the Planning Commission, about demonetisation, GST and the overall state of the Indian economy.

Karan Thapar: Hello and welcome to very special interview with the former deputy chairman of the Planning Commission, Montek Singh Ahluwalia. Over the next 45 minutes, I should talk to Mr Ahluwalia about the state of the economy, about demonetisation and GST, about the government’s plans to recapitalise banks, to boost employment and growth, and of course about Friday’s upgrade by Moody’s.


KT: Mr Ahluwalia, let’s start with demonetisation, which earlier this month marked its first anniversary on the 8th. In an essay on his blog, put up the night before, the finance minister said this is watershed moment in the history of the Indian economy, and then he added that this has ended India’s traditional chalta hai attitude about corruption. How do you respond to that boost?

Montek Singh Ahluwalia: Well, I mean, you know, the finance minister is obviously keen to present the most positive picture he can think of. I wouldn’t have called it quite that dramatic a development.

KT: Not a watershed?

MSA: I don’t think so. I mean, np look. It’s been highly, it’s probably been the most discussed initiative of the government, of any government for a very long time. Primarily because it was, in some sense, a very bold move, because after all, you’re taking out 86% of the currency, and that’s not a marginal change.  But you know, I go along with the general assessment that  it’s been quite disruptive, probably more disruptive than the government itself imagined. It’s had a negative impact, particularly on the informal sector, which was the most cash dependent. The negative effect is probably now over, so whatever the costs, they are behind us. Whether it affected corruption or not, I have my doubts. Because, you know, I don’t think that if you just take away a lot of money and hand back new money, that affects corruption. It’s very important to affect corruption, but you need to make some systemic changes that will do that.

KT: So you are saying two very important things. First of all, you don’t believe this is a watershed moment, and secondly, you don’t believe it has changed the traditional chalta hai attitude of the Indian people to corruption. Neither of those claims, do you accept.

MSA: Well I don’t know what he means by the chalta hai attitude, and I am not judging the attitude of people at large.

KT: I think what he means is that the Indian people tended to accept corruption as a fait accompli –

MSA: Oh that was given.

KT: You don’t believe that’s altered?

MSA: By the way, if it has focused people’s attention on the importance of corruption, I mean that’s certainly a good thing. Whether it has changed all the basic attitudes towards corruption, I have not seen any evidence of that – I mean I hope, I welcome anything that does.

KT: But there is no evidence that you have seen?

MSA: Yes, I don’t think I’ve seen it.

KT: Let me put to you three big, major gains the government claims demonetisation has delivered. I will put them one by one. To begin with, the finance minister has said that the unaccounted money in the economy has now been placed in banks, and once the government identifies what proportion is black, it will tax it, perhaps penalise it and then there will be a huge gain for the exchequer. And then separately, Surit Bhalla, now a member of the Prime Minister’s Economic Advisory Council, says that the gain in the first year could be as large as 2.5 lakh crore and then after that, there could be a gain of 1.5 lakh crore, annually, in perpetuity. Do you accept that or do you think that this is a) unverified and b) possibly exaggerated?

MSA: Well I have not gone into Surjit’s numbers in any great detail. Let me say that it’s very clear that virtually all the money that was lying around and was demonetised, has actually been brought into the banks again. That claim is certainly correct. Now the argument – or what used to be the argument – that if it was black, it just wouldn’t come back… Clearly, it has come back. Probably you can call that as a form of laundering. What the government is now saying is that we will trace the deposits made and then work out which bits were black etc. Good luck!

Also read: The Vast Difference Between What Demonetisation Achieved and How it was Perceived

KT: Do you think that’s going to be easy or possible to do?

MSA: You know what I have seen of the numbers, I mean anything is possible if you do devote an entire army to it. But the truth of the matter is that the numbers of deposits that they would have to check are huge, given the staff that we have.

KT: So it’s a humongous task?

MSA: Yes, and the other problem is that most of the people who have deposited the money, most of them will have good explanations as to the accounts.

KT: So it will be contested in courts as well?

MSA: Oh almost certainly, and let me say that you know, if it’s been, I have no doubt, by the way, that there was a lot of cash that represented income – accumulation from untaxed income. I have no doubts about it.

KT: But detecting it is –

MSA: But the fact is that it has got laundered through multiple sources. Each of these chaps could easily claim that this is agricultural income.

KT: Let me put certain things to you, said by a man who possibly in a sense is your successor, he is now vice chairman of NITI Aayog, Rajeev Kumar. Two weeks ago he said to me big data analytics and new modern technology would make detecting what element of this money is black relatively easy, and relatively speedy. Does that sort of technology, does that sort of big data analytics actually exist, or is he simply putting up a brave face?

MSA: Well, to be honest I don’t know what technology exists to detect these things, and I am sure that you know you can use better technology. But the bottom line in all this is that is somebody claims that he deposited a lot of money which was an accumulated savings from from agricultural income, which is free of tax – it’s not going to be very easy to establish that this wasn’t, unless you put the burden of proof on the individual. Okay now if you do that, there will be a very large number of people who will claim to be harassed. And probably for every genuine person in possession of black money, you’ll be pursuing a large number of people.

Regardless of what our cash to GDP ratio is or might become, India's system encourages corruption. Credit: Reuters

A poster at a store. Credit: Reuters

KT: So not only is this a difficult task, not only will it end up being contested in court, not only will it take a long time, but it will also add to the harassment, often harassment, of innocent people.

MSA: That’s the danger I worry about. Let me say there is nothing wrong in my view, of tax people pursuing individuals when there is a credible case to be made that they’ve obviously hidden money. I mean you cannot run a tax system unless you do that. But if you adopt a process in which a large numbers of people become subject to this kind of an inquiry, there is an obvious danger of harassment.

KT: Let me put to you the second major gain the government claims has followed. They say after demonetisation, the cash to GDP ratio has fallen from 11.3% to 9.7%. Separately, the finance minister in this essay on his blog has said that the reduction of currency in circulation is of the order of 3.89 lakh crore. And the Business Standard has said that year on year, digital transactions have increased by 41%. Now, do you see that as a substantial gain or just a gain no more?

MSA: Well look, on the question of the cash transactions, my understanding is that there was a huge, there was a big decline, and as the cash has come back into the banks, there will be a process of remonetisation. So some of the cash will be pulled out and we need to give it a little more time, to work out how much has the cash to GDP ratio actually gone down.

KT: There can I just interrupt you and give you the facts, I believe the value of digital transactions, I am talking about value–

MSA: That’s a separate issue.

KT: – in November, when demonetisation, happened was 94 lakh crore, it went up to 149 in March and it has come down, as of the 29th of October, to 97-98. So from 94 to 98 – that is exactly the change.

MSA: Yes I’ve seen those numbers and let me put it this way, I think an increase in digital transactions is a good thing. There was an underlying trend and government policy for several years has been to establish an infrastructure that would make more of this possible. So some of this would have happened anyway, but I think what you are really saying is that during the period when there was a monetary shock, a cash shock, the digital transactions shot up, as you would expect.

KT: And then declined.

MSA: Remember when remonetisation happened, remember depositing money in the banks was not the same thing as remonetisation, because when you went to withdraw the money there wasn’t enough money.

KT: Absolutely. But what about the –

MSA: So you need to allow it some time.

KT: But what about the change in cash to GDP? That ratio has gone down from 11.3 to 9.7. Is that significant?

MSA: No but that assumes that all the cash that people wanted has now been taken out of the banks and held by them. So, some of this, for example, if this is cyclical, and you have a lot of businesses that have traditionally cash dependent, the need for cash might increase a little later, you don’t know.

KT: So the 9.7 could creep up to 10 or even 11.

MSA: Could go up.

KT: The third –

MSA: By the way, I think there is one other point we should make. The assumption that good economies need to have a very low cash to GDP ratio, is not borne out by the statistics. I mean there are some incredibly good economies that have a high cash to GDP ratio.

KT: Japan at 19.4.

MSA: Ya. So I think what’s happening is, the debate is focusing on very precise things and you can pull out whatever numbers you like to make it look –

KT: You’re making an important point that I will spell out for the audience. You’re saying that the mere fact that the cash to GDP ratio has gone down doesn’t necessarily mean that the economy has become cleaner or that corruption or black money has stopped. Because a country like Japan has a 19.4% cash to GDP ratio and it is one of the cleanest in the world, Nigeria, on the other hand, which has a cash to GDP ratio 1.55, is probably one of the most corrupt in the world. So the government is using this set of statistics to draw a conclusion that doesn’t necessarily stand up.

MSA: Well I think that is the correct assessment that if you’re going to be using any comparison, focus on it and see what the cross-country position is, and the cross-country position does not suggest that merely because the cash to GDP ratio has gone down, that there’s a huge improvement in other dimensions.

Also read: Seven Little Lies the Government is Still Peddling About Demonetisation

KT: The third gain that the government claims has flowed out of demonetisation is that the number of individuals now paying tax has shot up. They claim this year – and this is Mr Jaitley who said it – that the figure has gone up, it has increased by 56 lakhs. He pointed out that last year, it had only increased by 22 lakhs, which means it has gone up by an additional 150%. Separately, The Indian Express claims – and I assume that there figure is correct – that if you add to this people who paid tax but didn’t file the returns, as well as people who filed IT returns but didn’t pay tax, then the increase is not 56 lakhs but 1.32 crore. In your eyes is that a) attributable to demonetisation or b) is it a big gain?

MSA: Well I wouldn’t know if it is attributable to demonetisation, again, the numbers filing income tax is expected to rise anyway. You make a comparison with last year, I have seen under comparisons about previous years; the key thing is that the numbers added, who are now filing returns, are they filing small incomes or large incomes?

KT: It seems, pretty small incomes.

MSA: It is a pretty good thing by the way, for people to file returns, I would I would call that, in any ‘ticking’ exercise, the fact that more Indians are filing returns is a good thing. But to expect that this would lead to a huge increase in revenue may be a little–

KT: It may not lead to a huge increase in revenue in the first year, but as the economy improves, and as growth picks up, these people who have declared themselves as income tax payees, will be paying more and more, and so in future years there could be a sizeable increase.

MSA: You know my feeling is that that is going to depend on how, on the signalling system in the future and what sort of incentive structure is put in place and how much people then want to–

KT: So there are question marks there?

MSA: That is not just connected with demonetisation. I mean there is a whole slew of things connected with tax reform, which have been on the agenda and on which progress is being made. And that’s what you should focus on.

KT: And you can’t credit demonetisation for it?

MSA: Yeah, I mean, look India is going to be a greater economy five years down the road, but to attribute all that to demonetisation would be a big mistake.

KT: Now there are two other objectives the prime minister outlined when he announced demonetisation on the 8th of November last year, which, to be honest, the government hardly talks about today. They were tackling counterfeit currency and tackling terrorist funding. In the essay the finance minister put up on his blog, all he said was that stone pelting in Kashmir and Naxalite extremism had reduced, his words were “reduced”. And secondly he said that the detection of counterfeit money had almost doubled, and again “almost doubled” is what he said. And my question is does that sort of language suggest significant gain, or is it, in fact, the clever use of the language to cover up for the fact that not much has happened?

MSA: Well I wouldn’t want to pronounce on that, in the sense that – my feeling, by the way, is that I don’t believe that demonetisation had any significant effect on counterfeit currency, because people who are counterfeiting currency will counterfeit the new currency. So maybe therefore for a short period, you will have an impact, but the fundamental problem will recur. So I don’t think that’s terribly important. And I guess the terrorist financing issue was also connected with counterfeit currency, in the belief that they are financed by counterfeit currency. So there may have been a shock, but counterfeit notes, they’re already, it’s already evident that they are there.

KT: Both will suffer but pick and carry on thereafter?

MSA: That’s what I think, yes.

KT: Now, you mentioned right in the very beginning the impact of demonetisation on the formal economy and we actually know that quite well: growth has come down, jobs have been lost, demand has fallen. But it’s the impact on the unorganised or unofficial sector we know less about. And yet it represents 45% of GDP, upto 80% of employment. You talked briefly about it in the beginning. Tell me, from your assessment, how badly damaged is it, and secondly, how little do we know of that damage?

MSA: Well, the short answer is that we don’t really know how badly damaged, but we do know that it must have been much more badly damaged than the formal sector. I mean for two very important reasons. One is that the informal sector was cash dependent. So if you give a big jolt to cash, their activity would be hit. You know in the very short run, like if it was something that was sorted out in a week, the problem would have been quickly taken care of because within the informal sector there are credit arrangements. But you know, it took more than six months for it to get anywhere close to normal. So a six-month disruption of the informal sector would’ve been a very serious disruption. Now I can’t say in terms of percentage, but you know, a lot of people talk about 20%, 25% lower economic activity. Now if that is so, that’s quite substantial.

KT: And this is something we still have to find out the full facts about.

MSA: Yes

KT: This is a horror story that we still can’t tell how horrible it could be.

MSA: (Laughs) It’s a good use of the word horror, but, I mean, the statistical people have clarified that all they have captured is what the data on the formal sector said.

KT: And we extrapolate it.

MSA: And yes, they’ve assumed–

KT: But the extrapolation may not hold, if the informal sector was disproportionately adversely hit.

MSA: I mean, clearly, the formal sector’s hit, the informal sector’s hit by extrapolation is also hit. But if the informal sector’s hit is more, then we are understating the extent of loss.

The RBI’s role

KT: Now in the book he published this summer, the former governor of the RBI Raghuram Rajan has made it clear that he had advised the government, when he was the governor, against demonetisation. In fact, either in the book or one of his interviews, he said he had actually given a formal note where he pointed out that the short-term cost would always outweigh, and considerably outweigh, any long-term gains. And yet they disregarded that advice – and it is their prerogative to disregard advice – and went ahead. Would you say that to reject the advice of a man as eminent as Raghuram Rajan was a silly mistake?

MSA: Well look, for governments, the eminence of the person giving advice should not be a guarantee that the advice is taken. But personally I think the best thing would be to publish that note. I mean if the note was given, this matter has gone before the standing committee in parliament, to weigh exactly what the governor said and to look back on was he right. I mean the best thing would be to put the note in the public domain and let everybody judge for themselves.

KT: So that we know how good the advice was and what sort of argument or basis it was grounded on.

MSA: Yes. I mean there is no reason not to, in the sense that there is no secrecy issue involved, he said he gave a note. The government rejected or disregarded it, subsequently the Reserve Bank board is supposed to have advised the go ahead and do it. For example I don’t know whether the Reserve Bank board was actually briefed on the note which the governor gave to the government.

KT: Would that not have been a part of the records of the Reserve Bank as well?

MSA: I have no idea, but I would assume that –

KT: Which brings me to a second point that is being made about the Reserve Bank. This time about its governor, Urjit Patel. Many people are critical of the Reserve Bank’s handling of demonetisation, starting with the fact that at the government’s suggestion, within 24 hours they recommended demonetisation, then they changed rules and regulations multiple times, and finally, for at least nine months, they withheld the details of the amount of money coming in. Now people say that all of this, collectively, has damaged the credibility and reputation of the RBI. Would you agree with that comment?

MSA: Well you know, I think it’s extremely important to maintain the credibility of the RBI, so I don’t want to add to criticism. As you say, if the RBI did it under the direction of the government, they probably didn’t have any alternative.

KT: You mean they were coerced?

MSA: Well I mean if you are doing something, that’s what you said, that at the direction of the government–

KT: At the suggestion, at the suggestion, but that may be a direction too–

MSA: In my view, the best way to encourage a public, an informed public debate on this is that the note that was put out by the governor–

KT: Raghuram Rajan

MSA: Should be made public. And I think personally, as an individual, that the board paper, on the basis of which the RBI board made the recommendation, should also be made public. I mean that’s the only way of really working out, ex-post–

Reserve Bank of India (RBI) Governor Raghuram Rajan delivers a lecture at Tata Institute of Fundamental Research (TIFR) in Mumbai, June 20, 2016. Credit: Reuters/Danish Siddiqui/Files

Former Reserve Bank of India (RBI) Governor Raghuram Rajan delivers a lecture at Tata Institute of Fundamental Research (TIFR) in Mumbai, June 20, 2016. Credit: Reuters/Danish Siddiqui/Files

KT: But do you think the RBI acquitted itself credibly or has its reputation, perhaps its independence, come into question?

MSA: No that’s too strong a phrase. I mean look, in the end the RBI is not a separate, sovereign body, so I mean, if the government in all its wisdom has decided that this is a major national objective, I don’t think that the RBI would be expected not to do it.

KT: So the governor and his board could not have turned around and said when the government suggested demonetisation, no we’re not going to recommend it?

MSA: I would say they couldn’t. They could not do that.

KT: So the criticism that’s been made of the RBI, you’re saying is somewhat exaggerated or maybe even unfounded.

MSA: I am not sure what criticism is being made.

KT: Basically that they buckled under, they should have rejected it. Secondly, they should’ve prepared better for it. Thirdly, they should’ve been, they should’ve been more forthcoming, with details.

Also read: As India’s Economy Simmers, What Will the RBI Do?

MSA: The last point is very crucial, I don’t know what–

KT: You’re talking about being prepared better.

MSA: Preparedness. See my impression, from the public statement that Raghuram Rajan made, is that, if it is to be done, you better prepare for it and I assume that meant get all the currency ready, I mean it was very clear–

KT: And that did not happen under Urjit Patel.

MSA: Well I wouldn’t call it Urjit Patel, it wouldn’t have happened under anybody because you need more time to get that done.

KT: And what about the–

MSA: I think there is another factor here and that is that the ATMs were disabled for a while, because you took away x number of Rs 1000 notes–

KT: The size of the notes was the problem–

MSA: You replace them with Rs 2,000 notes, took a long time, but the Rs 2,000 notes were a different size, so the, whatever the dispensers–

KT: Again, you are saying that this should have been foreseen.

MSA: Ideally it should have been foreseen, yes.

KT: What about the fact that the RBI deliberately withheld the details of the amount of money that’s come in, and even now, the figure that’s been given, which suggests that practically 99% has come back, is still considered a preliminary figure, because they haven’t taken on what board what has been deposited with co-operative banks, the money that’s in Bhutan and Nepal – and possibly the Supreme Court may permit some other people to put money in. That case is still being heard.

MSA: But you know my view is that once the demonetisation is done, how soon you get this information, it’s important for breaking news or television or whatever, but if the RBI is not really sure, if the RBI wants to do more careful counting, I don’t think that a problem.

KT: So again you don’t criticise them on that count as others do.

MSA: No, obviously it would have been nicer, had they done it faster, but I don’t think that this makes a huge difference. Because it makes a difference only in judging whether they were adequately prepared. But that’s a second-order thing, once it’s done, yes you know whether you decide that six months later of one year later, we are hopefully not going to have another one–

KT: So your real criticism of the RBI is to do with the fact that it wasn’t properly prepared, although you’re not blaming Urjit Patel in particular. You don’t think the RBI had the capacity, could even in a democracy have morally up stood against the government if the government wants to do it. So you don’t criticise them for that.

MSA: No no, I am absolutely clear about this, that if the government wanted to demonetise, I don’t think that the RBI, it’s not my understanding that the RBI could actually hold it up. And frankly, under the rules as I remember them, the governor of the RBI is obliged to follow a direction of the government.


KT: Let’s then at this point, move beyond demonetisation to GST, which is another subject which is very much in the news at the moment. Now, there have been concerns about at least four elements or aspects of GST. The number of rates, the way items fit into those rates, the fact that small businesses in particular have a very cumbersome procedure to fulfil, and then the functioning or the efficiency of the GST network. And admittedly, in the last four and a half months, the government has made many alterations, it’s made many changes and amendments, to cater to these concerns. Today, four and a half months after its roll out, how do you view GST?

MSA: That’s a tough one. I mean look, I have always been in favour, as indeed practically all economists have been, in making the switch to the GST. But I said when it happened, the way it was being done, it would not be an ideal GST. We must also be realistic, that you never get the ideal. So you always get, a little bit of progress, and then there are glitches. Now having said that, number one – the number of rates, I mean there are just far too many. And a kind of puristic approach, which of course never exists anywhere, is that a few exemptions one rate, I would say not an unreasonable approach would be a few exceptions, I mean zero and then maybe two rates, and perhaps sort of a cess which is not a rebatable thing, which is not something you take credit for, for a few sin items. That would have been a very good system. Instead, we have got five rates, or six rates, I mean that’s–

KT: And a zero, and a cess.

MSA: And the second, if you are going to do that, the idea that the same type of commodity, with marginal variations attracts different rates is simply absurd.

KT: Although that they are correcting, they are correcting it with regard to restaurants, they haven’t corrected it with regard to hotels. But they have corrected it with regard to one.

MSA: Well but I don’t know, for example, barfis with cashew versus barfis without cashews; different rates for shoes, if they are above 500, rather than less than 500. I mean that’s just ludicrous, frankly.

A boy riding a motorcycle gestures as he passes a hoarding in favour of the implementation of the Goods and Services Tax (GST) at a street in New Delhi, June 30, 2017. Credit: Reuters/Adnan Abidi/Files

A boy riding a motorcycle gestures as he passes a hoarding in favour of the implementation of the Goods and Services Tax (GST) at a street in New Delhi, June 30, 2017. Credit: Reuters/Adnan Abidi/Files

KT: Can I put to you the argument that Mr Jaitley might make in his defence, it’s one that he’s made many times on television. He says for instance, “The reason why you couldn’t have a single rate, or even two rates, is because hawai chappals can’t be taxed at the same rate as a Mercedes car”. And secondly, he says, food, and other items that the poor require, either have to be zero rated, or have to be kept at a minimal 5%. That’s why you have multiplicity spread.

MSA: See see, I appreciate that the progressivity argument always comes in. But let me say that, you know, if you have a zero, and two rates in the middle, and a sin rate at the top, you can fit the Mercedes and the chappals and food into this spectrum. At the margin, let’s look at it this way, at the margin, by moving some commodities from a higher rate to a lower rate, you increase the overall degree of progressivity. You don’t have to ensure that every commodity is differentiated from every other, depending on the income level of the person most likely consume it. It’s basically wrong. Now, let me say, finance ministry officials, and I assume that these are things that these officials advised on, they agree that there are too many rates. This whole thing became difficult as I understand it because the GST Council, which includes lots of state finance ministers, wouldn’t agree.

KT: And one of the reasons they wouldn’t agree and again this is one that Mr Jaitley has expressed, perhaps on their behalf, is that otherwise, you would have ended up with inflation. Goods were to become either more expensive, and therefore more costly, or, cheaper, which would have meant loss of revenue. And he wanted to make sure that the inflationary impact was minimal, which is why you needed to spread the rate, so that things could be fitted in, roughly where they were.

MSA: I don’t buy that at all, for the following reason. You know, inflation is not the instant change in price at a given point, it’s the rate of inflation over time. So by balancing rates, some becoming more expensive, some becoming less expensive, the, if you like the consumer basket, would not be affected one way or the other. So that’s not a problem, and over time there is no reason why inflation would be higher, once you fix the appropriate rate structure.

Also read: Gradual Tax Reform Would Have Been More Effective Than a Shock GST

KT: Okay, Rahul Gandhi, earlier this month has actually said, we need a single rate GST, and that rate should be 8%. The BJP have ridiculed him for that suggestion, on the grounds that 8% would mean, that you’d be selling Mercedes cars at 8% and you’d also be costing food for the poor, sorry, 18%, not 8, that’s my mistake. Do you think a single GST of 18% is practicable?

MSA: I don’t know exactly what Mr Gandhi said, but you know, I am quite sure that in the Congress, the view always was that there should be some exempted rates. So nobody ever said that there should be no zero-rated thing. Secondly, it was always the assumption that sin taxes, in other words, items that are only consumed by the rich, they would have an extra duty on them, which would not be rebated. It would not be rebated–

KT: So you’re saying that with exemptions, and with a sin tax, a single 18% rate could be practicable.

MSA: Actually if you ask me, from the numbers that I have seen, if you did some zeroes and a sin tax, 15% single would be practicable. You know, I think Arvind Subramanium had calculated what he called the revenue neutral rate, that is if you do a single rate, and I think, that something like 15%. You know the Congress had earlier on, Mr Chidambram had made the point, that why don’t we build in 18% as a ceiling, in the constitutional amendment itself. Now, when you look back on it, what it would have done is that it would have prevented the temptation to put some rates down, in compensating for others that are pushed up. But I think we would not have had a 28% rate, basically.

A double blow?

KT: Now, talking together, about demonetisation and GST, and we’ve covered both of those, Rahul Gandhi famously said that these two together were a commando-style double attack on the economy. Leave aside his colourful language, but do you think that the two together, the way they’ve happened, have adversely affected the economy? Because that’s something the government contests – at best it says this temporary and reversible.

MSA: No, there’s no question that each of these; demonetisation as I said earlier, definitely had short-term negative effects and those negative effects were more than what the government anticipated. GST, we knew during the transition would have some disruptive effects, but the long-term effect I feel is definitely favourable. Now, when you say together, they were not actually done together, they were done in a quick sequence. So, during that period, clearly there was a negative effect. How else to have done it – I don’t know for example whether I would have recommended delaying GST indefinitely, but if they delayed it, maybe by another two months–

KT: Well they could have delayed it up to September–

MSA: Up to September 1, they could have been better prepared. You know some of the problems that we’ve seen–

KT: Was lack of preparation.

MSA: I always give credit to a tax authority that admits it made a mistake, because there is, we’ve had many examples of tax authorities–

KT: The government hasn’t admitted the mistake, but it has corrected the mistake.

MSA: They’ve corrected the mistake. But it does mean that the number of corrections, it does mean, that if there had been a little bit more thought, some of these would not have been a problem.

KT: So something you’re saying by implication is that by insisting on unrolling GST in July rather than September, they were less prepared than they should have been, and some of the advanced thinking that should have happened, didn’t happen.

MSA: I think that is certainly true, and it’s just not the rate structure, I think some of these other things about, you know, matching invoices, which has been a humongous problem, particularly for the smaller people. And that was unnecessary–

KT: And yet the interesting thing is today, the day we are doing the interview, Friday, Moody’s has actually upgraded India, and in doing so, two of the things it cited as positive developments was demonetisation and GST. So in the eyes of Moody, and that upgrade is something that the government is particularly proud of, these are not minus factors, these are positive factors that have encouraged them, to do the upgrade.

MSA: I have not seen the Moody. I am aware that they have done a one notch upgrade, which, by the way, is to be welcome. And I think it’s overdue. The truth of the matter is the Indian economy for the last several years has been second only to China in terms of its growth rate, and pretty stable. So frankly that upgrade was overdue, necessary, I am glad it happened.

KT: What about the fact that they cited specifically demonetisation and GST?

MSA: I don’t know, I haven’t read exactly what they have said, but if they cited GST, I think that certainly is a relevant factor. In the sense, most people expect that there will be a transitional cost, obviously managing the transitional cost is something we should be doing, but you know, after the transitional costs, benefits flow in, so Moody’s would be right in saying that now that the GST is done, the constitutional amendment is done, problems are being fixed, perhaps, three to four months later, you’ll have a much better system. And I think that is fair.

State of the economy

KT: Let’s then at this point, and with this background, talk about the state of the economy today. Now since March 2016, GDP growth has fallen from 9.1 to 5.7%. In a similar period of time, manufacturing has declined from 10.8 to 7.9, construction from 5 to 1.7, whilst the value of stalled projects have gone the other way round, it’s increased from 10.7 lakh crore to 13.2. And you know better than me that gross fixed capital formation is languishing at a fairly poor 30% and bank credit growth is barely above 5%. Taken all together, what does this tell you about the state of the economy?

MSA: Well, these are– By the way, 30% should not be called poor, it’s just poorer than what it was, and it’s poorer maybe than what we need, if we want to get to 8%. Very few countries have 30% gross fixed capital formation, or whatever–

KT: But it was pretty close to 38 a couple of years ago.

MSA: Yes. So what has happened is that there is a deterioration, and while this 30% is perfectly okay if the objective is to grow at 6.5%, it is certainly not okay if the objective is to grow at 8%.

Also read: Even the Optimism of Official Economists Cannot Ignore the Warning Signs

KT: So what does all of this suggest about the state of the economy?

MSA: I think it is quite clear that we are going through more than just a short term, in other words a one or two year, a weakening of the growth forces in the economy, okay. Add to that the problems that the banks are facing, I mean that’s an important one. And really if we want to get back to high growth, and remember Moody’s and companies are not looking at growth rates, they are looking at the stability. So when they upgrade, what they, mean is, they think that the macroeconomics is stable. Now you can be very stable with a 6% growth rate and you’ll gain some upgrades, and you will not actually get the target growth rate, the growth in the employment that you want, and that’s really the weakest part of the system.

Growth is not where it should be, it’s below the average that has been for the last 15 years. We shouldn’t be too worried about the 5.7 of the last quarter. I am quite sure that’s going to come up, because that is a temporary disruption. But come up to what? I mean, the NCAER, which I think two days ago brought out their forecast, you can see what’s happening. RBI projected, a couple of months ago, 6.7% growth for the current year. That’s significantly lower than what is being talked about. NCAER, looking at more recent data, have projected growth at 6.2%. Now you know, if you get 6.2 in the fourth year of the government, there’s really one year left to make up a five-year average. Doesn’t give you, doesn’t put you in a position, where the government can confidently say that we will be at 8% in the fifth year of the government. And yet, you know, when the government came in, the target I mean, Mr Jaitley himself said, we are aiming at 8-10%.

KT: They are going to miss their target sizeably.

MSA: Absolutely.


KT: One of the key concerns is in fact jobs. Clearly, people say India is not creating the number of jobs it needs to create, and now, post demonetisation and post GST, jobs are actually being lost. The Centre for Monitoring the Indian Economy has estimated that between January and March, 1.5 million jobs were lost because of demonetisation and they’ve now recently added that in fact a further 400,000 could have been lost by August. Separately, newspaper reports about critical industries like leather, textiles, hosiery suggest that perhaps tens of thousands or maybe even a hundred thousand jobs have been lost because of GST. How worried are you about the employment and job situation?

MSA: No I think there is very good reason for being very worried on that score. You know, the GST, as I said, the disruptive effect of the GST has been most felt by the smaller enterprises. Now you know some of this could be said to be a situation where the smaller enterprises have been engaging in tax arbitrage, not paying their taxes, so they are not really that keen to adopt the new system. But many actually want to adopt the new system, but it’s been made very difficult–

KT: And Mr Modi has assured them that there will be no investigation or revenge for the past.

MSA: Which is a very good step, by the way, I mean it is absolutely essential for the enterprises that come in, into the tax net, not to have their past records–

KT: But come back to jobs and employment, how worried are you about that?

MSA: But wait wait, before you come to that, I think, on the GST, the negative, the potentially negative impact of the GST on small-scale enterprises and exports, the Guwahati session of the GST Council made a very important change, that is the matching of invoices, which was a huge problem, has been sort of postponed, up to the end of March. If they start matching from April 1, we’ll have another mess. So I don’t think–

KT: So that should be just dropped altogether?

MSA: I think it should be dropped altogether. I mean, this is a bureaucratic nightmare. I don’t think people realise what is happening is that if I am a producer and I have bought inputs, and the invoice that I have got for my input says that taxes are being paid on it, and then I have to pay a certain amount of tax, I claim credit for the tax that is being paid and pay the difference. But the matching invoice system holds that I can only do that if the other fellow has uploaded his invoice and shown that he has paid tax.

KT: Which he may or may not have–

MSA: No, and that is not my problem. What is happening is that almost half your exports come from the small guy. You know, these chaps, if you are denying them the tax return, the refund of tax which is their right, you are creating a huge working capital squeeze on them, which is a mess.

Labourers work at the construction site of a highway bridge on the outskirts of Jammu August 31, 2013. Credit: Reuters/Mukesh Gupta/Files

Labourers work at the construction site of a highway bridge on the outskirts of Jammu August 31, 2013. Credit: Reuters/Mukesh Gupta/Files

KT: And does this, in fact, connect, with the fact that jobs are now being lost? Because some of the people whose jobs are disappearing are exporters, industries like textiles have lost jobs, the diamond industry has lost jobs, hosiery, knitwear, leather, have all lost jobs.

MSA: I will say that you know, if you are an exporter, you need to be putting in export bids in advance, you need to be making offers, to supply stuff. And when you’re making offers, if you don’t know what’s going to be the tax treatment on inputs, you’re obviously going to be very hesitant, and let me say that, successful exporters will be quite happy to wait a bit, rather than expand. And that’s what causes–

KT: So all of this is adding to the problem that the employment sector is under. This is another reason why jobs are not being created, or jobs are being lost.

MSA: Absolutely, these are precisely the sectors that are labour intensive: garment, leather, shoes etc. And you know this is the sector which is already suffering, from the rigidity of labour laws.

KT: One last question on this. It’s often said that we need to create some 12 million jobs a year for India’s demographic dividend to actually have jobs and to function as a dividend rather than as a problem. By some estimates, we may not be creating more than 5-6 million, which is 50% of what we need to create. How worried are you by this developing problem?

MSA: You know, this aggregate number is extremely misleading, in the sense that I don’t think that the problem in India, is that we are not creating enough jobs. We are not creating enough quality jobs. We always create second rate, third rate jobs which don’t pay very much. The people of India are not interested anymore in the kind of jobs that are daily labour, casual labour, insecure etc.

KT: They want secure jobs.

MSA: They want more secure jobs. Now hopefully they don’t want permanent employment, but they want secure jobs, more or less in the formal sector. I mean today, two-thirds of the jobs created in the formal sector, in the last four or five years, have been contractual jobs and not sort of, properly protected jobs.

Also read: How to ‘Skill India’ When the Jobs Are Bad

KT: So we need to move the economy to a position where secure jobs have been created, rather than the casual daily-wage labour jobs.

MSA: And those jobs, the numbers are very small, 12 million is a huge number.

KT: But even the casual daily wage labour jobs did suffer, a) under demonetisation and b) possibly under GST as well.

MSA: Probably less under GST.

KT: Okay, but there is sort of double whammy. A) we are not creating the kind of jobs we need to create and b) the sort of jobs that are available, which may not be the right sort, which may not be the desired sort, are also being affected by demonetisation at least. That has to pick up.

MSA: You see demonetisation is now over. I mean, I – people can quarrel about that, but my suspicion is that the disruptive effect of demonetisation–

KT: Is over.

MSA: Is now over. I mean, maybe–

KT: At the moment we are going through the disruptive effect of GST.

MSA: And GST, unlike demonetisation, I mean, everybody thinks that GST is a good thing. And secondly, we have got to make it work. I mean, it’s there.

KT: And when it does, this problem will be taken care of.

MSA: What I am saying though is that at the moment, the Guwahati meeting identified a problem, for which they get full marks. And they just postponed it to the end of March – that is totally wrong.

KT: And all that critical point, which is this need to match invoices which has hit exporters particularly hard, they need to actually drop that requirement altogether, rather than postpone it.

MSA: Absolutely. See look the modern technology actually says that look, if I am telling you that I have got an invoice from this guy, saying he has paid his tax, you check whether he has, and if he hasn’t, clobber him, don’t deny me the benefit.

Bank recapitalisation and road-building programme

KT: That’s a perfectly good point, let’s come to the last part of this interview. I want to talk to you about the effort the government is making to tackle the problem they face of declining growth, employment that is not rising sufficiently, investment that is not picking up. Now the government has recently suggested a two-pronged strategy. One, a massive recapitalisation of banks, of something like 2.11 lakh crore over two years, side by side with a massive road building programme of nearly 7 lakh crore, to build 84,000 km of roads, in five years. First of all, is this the right response to the problem?

MSA: Well I think both recapitalisation and road building are good things to do. The question is always in the details, exactly how are we doing then. But there is no doubt that we do need a huge improvement in logistics. And I would say that it’s railways and roads that we need to be working on. So these are both things that require a huge investment.

KT: Let’s come to these two one by one. I’ll begin by asking you a couple of questions about the recapitalisation of banks. It’s a quantum of 2.11 lakh crore over two years, the Business Standard has recently, published on it’s front page, that the government intends to ask the RBI for a special dividend to part-fund this 2.11 lakh crore. Now, given, that this year anyway the annual dividend that the RBI gives fell by more than 50%, falling from 65,000 crore last year to just about 30,000 crore. Is it justified for the government, to on top of that demand, ask a special dividend.

MSA: Well, I haven’t really gone into what the scope is for the RBI to give more of a dividend. So I don’t know the answer to that question. I mean there has been a view which I think the Economic Survey, at one stage, had put out: that the RBI has much larger reserves than any central bank actually has. So the idea of giving a dividend was more like kind of shifting, using, taking out from the reserves in the form of a dividend. It’s not as if it would be out of their current profits.

KT: Do you think this is a good idea, assuming the assumption is correct, that they have more reserves than the other large banks?

MSA: To be honest, I haven’t really thought about that sufficiently. But let me put it this way. You need to recapitalise the banks, and the whole business of RBI dividends etc. is simply a way of trying to avoid, making it look as if you increased the fiscal deficit. The truth is, if you integrate the accounts of the RBI and the government, it doesn’t make any difference. I mean that’s just, it has the same effect, it simply means that it won’t show up in the fiscal deficit.

Also read: Explained – The Great Indian Bank Recapitalisation Push

KT: You brought me in fact to this question of whether the recapitalisation will affect the fiscal deficit or not. We now know, because the government has said so, that off the 2.11 lakh crore, 1.35 lakh crore will actually be government bonds. And the government has said that these bonds, and whether they affect the fiscal deficit or not, depends upon the character of the bonds. Others say that since they are going to add to government debt, it is a bit silly to claim it won’t add to fiscal deficit, because it is only an accountancy technique that will keep it out of the fiscal deficit. What’s your feeling, should it be accepted as part of the fiscal deficit, or should the government resort to accountancy, to ensure it’s not?

MSA: Well, this is a complicated question. But let me, first, there’s no question that it will increase the government’s debt. What that means, whether it increases the fiscal deficit or not, that’s the jugglery. There’s a difference between our accounting system and what is caledl the IMF’s accounting system.

KT: A point that Arvind Subramanian also made.

MSA: Okay, now in our accounting system it would clearly be a part of the fiscal deficit. See in the IMF’s accounting system, it could be treated as a capital transaction, that is, you are increasing the debt but you are acquiring an asset. So it sort of, if you, borrow in order to say, subsidise something, then you are not acquiring an asset. But if you do this borrowing in order to acquire a financial asset in a profit-making organisation, the IMF treats it below the line. But you know that logic would require you not to treat disinvestment as above the line. So the real choice, from the IMF’s point of view, and I need to be, I mean I am just giving you my off the cuff sort of, recollection. If you want to benefit from the IMF flexibility, that would allow you to treat this as below the line, you must stop treating the proceeds of investment as above the line. You can’t do both.

KT: Absolutely. That’s a very good point you’re making. That if you want to be logically consistent, you can’t do both. Isn’t that the second point, and I want to put it to you. Up till now, India had always followed its own traditional convention of accounting. Now suddenly because of this recapitalisation, if we were to follow the IMF’s pattern of accounting, and jettison out – won’t it look strange? And secondly, previous recapitalisations have actually added to the fiscal deficit, if now this one doesn’t, won’t that also look strange?

MSA: Well, by the way, this thing has been around for some time. In the sense that three years ago, towards the end of the UPA government, I had recommended that we should switch the accounting system and adopt IMF accounting. It’s a pity that we didn’t do it then, because if we had done it, then this would not have been a problem. But doing it then, it did involve giving up treating receipts from disinvestment as a revenue.

KT: Now if you do it, it will sort out your problem with recapitalisation, but it will create a problem in terms of receipts from disinvestment.

MSA: I don’t know how big the receipts are expected to be.

KT: Well this year the government is claiming, according to Friday’s papers, that they will fulfil the target – which I think is roughly Rs 74,000 crore.

MSA: But, exactly, I don’t know how much of that is being subscribed to by government entities or not, that’s the issue really.

KT: Let me come to something else. Mr Jaitley has also said that the second step after the recapitalisation of banks will be what he calls far-reaching reforms to ensure that bank management don’t run up such NPA’s again. Many people say that in fact, those reforms should have preceded recapitalisation, rather than follow.

MSA: Well, you know, I wouldn’t make too… Sequencing of reforms is always a good idea. But if they accompany it, that would be a pretty good thing. The idea of doing the reforms first and delaying the recapitalisation, you can, consider that, but to my mind, if you are really seriously doing the reforms, there’s no reason to delay the recapitalisation. The question that I am not clear about is that what are these reforms?

KT: That hasn’t been spelt out.

MSA: Yeah, and I mean there’s a huge, professionally, there are huge differences –

KT: And since the details of the reforms haven’t been spelt out, we also don’t know whether the reforms will be sufficient. And whether they will work in ensuring that we don’t build up these kinds of NPAs again. That’s still a question mark.

MSA: Yes, that’s absolutely true.

KT: Coming to the road building programme, we are talking about building some 84,000 km of roads over a five-year period for a cost that is almost Rs 7 lakh crore. Mr Chidambaram has said, in his Indian Express column, that several steps have to be taken before road building can even start. He’s talking about things such as preparing for the DPR for each road, environment clearance, acquire land, bid out the project, tie up financing, fix the toll and then actual road construction works. Which suggests to me, and he’s put it pretty clearly himself, that nothing is likely to start, in a meaningful way, for at least another 18 months. So it won’t have any impact on growth and employment for quite a while to come.

MSA: No, this is probably true. Look, increasing public investment is humongously difficult, in the sense that the processes involved are such that a short-term impact, via an increase in expenditure, is very difficult to achieve. Because even on existing projects, you cannot suddenly speed up the rate of construction, because you have to mobilise –

KT: So the benefits that will accrue to the economy, from this road building programme, are not likely to happen in any significant way during the duration of this government.

MSA: Well, say towards the latter half of 2019–

KT: But the latter half of 2019 is after the elections, because the elections happen in May.

MSA: Yeah, I am not making a comment on whether it can be done before it, but, you know, something can be done, but these large numbers are five- and seven-year programmes. They are not programmes for the next year.

Bullet trains

KT: Before I end the interview, there is one other subject I want to raise with you because it’s been in the news, it’s been discussed and I’d like your opinion, as a highly-regarded economist. And that’s the bullet train. Economists are divided over whether it’s a good idea, or whether it’s a foolish one. Some say, in a country where 30% live below the poverty line, and where already, there are major concerns about the safety of the existing railway network, this is a mistaken priority. Others say, given your target to grow at 8% and given your ambitions for the sort of country you want to be, it’s a very wise, futuristic investment. Where do you stand on this issue?

MSA: Well, there is no question by the way that the bullet train is going to be, essentially, an experiment between Mumbai and Ahmedabad. That’s not going to have a huge impact on growth. Railways, we need massive investment, and that has to be essentially non-bullet train type. The scope for doing something there is enormous, because quite frankly, we are running on tracks that should have been replaced a long time ago. And every railway minister that I am aware of has actually said so. So the priority for railways has to be all these things.

KT: Not the bullet train?

MSA: Well, these things are the real priority. I would say that the bullet train, you know, this was discussed during the last years of the UPA, because the original decision to explore this was taken in the UPA government. You know, I was persuaded by the point that a large country like India needs some technology demonstrators, that is to say, if we, start this bullet train thing now, it won’t come into operation before 2025. And by 2025, the economy will be in a different position. So I don’t object to the bullet train idea, you do need a technology demonstrator, the portion of the railways, that handles that, will become a very high-grade portion – and you have to start somewhere.

Credit: PTI

KT: Two other quick questions, and I’ll ask you for slightly shorter answers because we are somewhat running out of time, on the bullet train. The prime minister has made a lot of the fact that we have got a loan from Japan of $13.5 billion, which is Rs 88,000 crore, for a 50-year period, repayable at a 0.1% interest rate. Critics have pointed out that given that the Tokyo Interbank offer rate is 0.06%, and given that Japanese government bonds barely make a yield of 0.04, actually in Japanese terms, an interest rate of 0.1% is a pretty lucrative rate. So is the prime minister’s description, that this is virtually a free loan, a mistaken or misleading one?

MSA: Well, Japanese, the interest rates that you’re talking about are short-term interest rates. We don’t know what the long-term interest rates were. So if you have a 50-year loan, at 0.1%, I think you have to classify it as a relatively low-interest rate. The real problem there is that we don’t know what the exchange rate of the yen is going to be vis-a-vis the rupee.

KT: Are you therefore worried about the second problem, which is that the rupee could depreciate against the yen, in such a way that when you have to start repaying in 50 years, it may not be 88,000, it could be closer, as Bishwajit Bhattcharyya has said in an article for The Wire, it could be closer to 300,000.

MSA: Well, the exchange rate risk is always a problem, in all foreign borrowing. And it becomes more of a problem when you are doing a 50-year thing. But no, let me put it this way. I don’t think it’s the interest rate that matters. I mean, the key thing is – this is a very expensive project, the bullet train. It is probably going to be heavily subsidised because you know, the costs of the bullet train are the same here as they are in Japan. In Japan, at their level of per capita income, they are willing to pay in order to save two or three hours –

KT: Will people be willing to do that here?

MSA: – based on their income. Well, people will be willing to pay based on our income, and that will be much less, so it’ll guarantee to be a loss-making operation. Having said that, I still think that as a technology demonstrator, if you were to chart out a course for Indian Railways, it is not unreasonable to say, let’s have one bullet train, knowing that it is going to be loss making. Because it will start in 2025, probably, it’s only by 2035 that we will have worked out all the glitches, and you know, by then, we need some part of our railways capable of handling this technology.

KT: What about the danger of the rupee depreciating against the yen, do you minimise that?

MSA: That depends on how you manage the economy. I mean, if you manage the economy well. Look, over the longer period, the rupee should actually, you could argue, the rupee might be expected to appreciate. But if you don’t manage the economy well, you could have a real problem.

KT: My last question. Given that India is sitting on reserves that are just about $400 billion. They were 400 billion a week ago, they have come down slightly now. Should India be paying for the bullet train itself, rather than accepting a loan, even at an interest rate of 0.1%?

MSA: No definitely not. I mean if you are going to do this kind of thing, it is a good idea to take a loan. I would not be… By the way, the reserves have got nothing to do with pay, the reserves are not there in order to pay for projects, they are there in order to help manage the currency. And $400 billion, is not, in my view, a comfortable level of reserves for an open economy which has a lot of foreign capital coming in. I mean you have to allow for the possibility, if there is a short-term deterioration in expectations, quite a lot of money may go out.

Ease of Doing Business

KT: A last question, how do you view the fact that in three years, India’s ranking on the World Bank ‘Ease of Doing Business’ has jumped from 140 to 100? Do you take this as a sign that the problems on the ground have been sorted out, or do you believe this is an appearance and perhaps more cosmetic, that the reality maybe different. Which of the two?

MSA: You need to go into which components. Two things you need to look at, one is, you need to go into which components of the index have actually shown an improvement – and I have not done that. Secondly, you have to check how much of this improvement is because others have deteriorated, you remember this is not an absolute mark of how you are performing.

KT: It’s a ranking.

MSA: It’s a ranking. And I don’t know who are the 30 countries we have now overtaken. And we don’t know how much higher than us they were, so when you allow for all this, the real question you’re asking is – how much have we improved? Now my guess is that we must have improved a bit, and that’s a good thing.

KT: Around critical things like construction permits, we are still 181 out of 190. In terms of enforcing contracts, we are 164. In terms of starting a business we are 156, in terms of registration of property we are 154, so there are real problems on the ground that still haven’t been sorted out.

MSA: My own guess is that in this system of metrics, the fact that we’ve put in place GST would count very positively, even though we know that in the short run, it may be creating a problem. And there is nothing wrong with that, the GST, long term, is a good thing. So you could have such an improvement. And yet people say, “I don’t see the improvement on the ground.”

Watch: World Bank Rankings – The Myths and Realities of Doing Business in India

KT: It’s possible for your ranking to improve, and even your score, and yet for people to complain that, “On the ground, I can’t see it.” That’s not a contradiction?

MSA: Not a contradiction, but you know I wouldn’t necessarily try to deny that there will be some improvement. For example, the number of forms, you know, I believe that the number of forms that exporters have to fill has been reduced, it could probably be reduced even further. So, there must be some things. But you know, most people–

KT: Will this have a major impact on FDI and foreign investors?

MSA: No, I don’t– I mean, look, FDI was coming in anyway. Over the years, I mean, it was not, when we opened up the economy, FDI was about $200 million, and it slowly began to build up.

KT: So this is not going to lead to a spurt in FDI. Is it not going to lead to a qualitative change in the way foreign investors view India as a destination?

MSA: Well, foreign investors view India in terms of the reality, and if the reality is improving, it must be improving in some states, that would be reflected. I don’t think any foreign investor decides something, by asking, “By the way how are they doing on the index?” I mean this is really for breaking news, it is a composite measure for everything, it is not an input into what a serious investor thinks about when they put money on the ground.

KT: Montek Singh Ahluwalia, a pleasure talking to you.

MSA: Nice talking to you, Karan.

Karan Thapar is a senior journalist and television commentator.