2016 was a roller-coaster year: Financial Express December 30, 2016

When one looks back at 2016, there are stories that get etched in the mind, and just like the Billboard chart of top 10, there can be one drawn up for major economic upheavals in the last almost 365 days.

When one looks back at 2016, there are stories that get etched in the mind, and just like the Billboard chart of top 10, there can be one drawn up for major economic upheavals in the last almost 365 days. The year was full of surprises, and it was not just a case of Bob Dylan getting the Nobel Prize in Literature. If words like “Mama, wipe the blood off of my face, I can’t see through it anymore, I need someone to talk to in a new hiding place, Feel like I’m looking at heaven’s door” are literature, then Donald Trump is also pro-free trade.

The countdown begins from 10, where the Yellen-Draghi combination kept the markets guessing almost by habit—the former for increasing rates and the latter to continue doing everything to ensure liquidity is there. We know both the objectives will be met, but then the market needs something to drive them forward, or rather back. Right?

At the ninth spot was the eternal flame of GST which almost appeared to be seeing the cliched light of the day. The interesting part of any crucial Bill in India is that the Opposition opposes it vociferously when on the other side, but fights hard for it when in power. Nobody knew what irked the Opposition, but the Bill got passed and the rates have been agreed on. It is a typical Indian compromise with several exemptions and an array of rates that makes everyone happy. But much like the ‘bad penny’, it surely will come back to haunt us next year as states feel taking in GST and demonetisation at the same time is stressful.

Eighth is the phenomenon of inflation which has come down after almost three years. With the CPI inflation being at less than 5%, everyone is taking credit for it. The government says it has brought inflation down, while RBI feels vindicated that its stance has helped to break the back of inflation. But how exactly was this accomplished when inflation was driven by bad weather and a poor harvest? When the crop fails, the weather is responsible for inflation. But when the weather is good and the crop thrives and brings down price, all of us take credit for it. Not bad for a deal.

Seven, the rockstar Raghuram Rajan had his share of controversy whether or not he wanted it. It was almost assumed that he would get an extension after a three-year term, and when that did not happen, the media was abuzz with its own speculation, which is always the case with RBI governors. Parallels are drawn to independent governors and not-so independent governors. Somehow, we want excitement whenever it is succession in central banks. We never ask ourselves whether we question the big owners and CEOs who run companies in which we work. We are always complaint, but we want RBI to work independently from the government? A contradiction here, really.

he sixth position goes to the investment activity. We have had several measures taken to revive investment. It started with clearing projects and then all those fancy slogans which energised the markets for a day after their announcement—Swachh Bharat, Make-in-India, Start-up India, Digital India and Smart Cities etc. All of them germinated several articles and discussions, besides proliferating conferences and seminars involving lunches and dinners, to show how the economy would be galvanised. Everybody who was ‘a somebody’ had something powerful to say. But the investment rate has been falling continuously till September and does not look likely to recover any time soon. Where are those investments dude?

Fifth, banking sector continued to blow hot and cold on its own performance. PSBs said last year that the NPA issue would be behind all of us and confined to the history books by March 2016. But their numbers and those for provisioning and profits are getting more difficult to comprehend by the day, and the date has been pushed forward to March 2017. The Bankruptcy Code is to be the magic wand now. But didn’t we have all DRTs, ARCILs and their like before?

At the fourth position is the most critical variable of interest rates. We all want rates to come down to spur growth at a time when no one wants to invest not because cost is high but there is little demand. The monetary policy can now be called the interest rate policy as it has been reduced to a single variable policy—or maybe three if we add CRR and SLR. All the experts or those with such pretensions are always arguing on business channels that RBI should lower rates (as if the central bank is not aware of the same). Such reductions have not led to any increase in credit and the tyranny of the status quo continues.

The third position goes to the Brexit drama. No one expected it and once people voted in favour of ‘exit’, the formula of 51% was questioned. Then it was claimed the young and old had different views, and several people did not understand what they were voting for. But now there is a possibility of an IT-exit (Italy) and Fr-exit (France). It surely looks as if the idea is compelling. We need to see how these ideas develop in 2017.

At two is the triumph of Trump, which could have been in the first slot. Everyone said Trump had no chance. The Economist argued that he was a bad choice. The markets got jittery as the voting day advanced, and this spectre took the indices down and the dollar weakened. But once he won, it was an about turn. More spending and lower taxes helps the US economy, right, which will strengthen the dollar, which is what the Dow Jones showed.

The mother of all events was the grand design of demonetisation. Or rather, what has been called remonetisation, as old notes get replaced with the new, even though holding money becomes easier with the R2,000 note making an appearance. The coloured notes add glamour to the monetary system and the designers need special mention of bringing in variety within the same denomination which is legal tender. The mention of ‘Swachh Bharat’ on the notes smacks of irony—it is now a clean India, you see. We learnt a lot about banking as it was less known that ATMs need to be recalibrated and that printing currency requires paper, ink and time.

However, we have to think big, and the inconvenience caused is quite small as we have now gone in for a transformational change where everyone will be using mobile phones to transact even in villages where there is no electricity. This will be efficient and make all our lives better.

But wasn’t the scheme to target black money? Yes, in the next round after December 31, the taxman will be in action and those who have something to hide should need to worry.
Otherwise, don’t worry, be happy; and have a happy new year.

Demonetisation gains: Right move but efficacy depends on follow up on basic objectives: Financial Express 28 Dec 2016

The demonetisation exercise is probably the largest venture undertaken by any government to remove high denomination currency and replace it over a period of time, depending on the requirement.

The demonetisation exercise is probably the largest venture undertaken by any government to remove high denomination currency and replace it over a period of time, depending on the requirement. It has evoked a lot of emotion on both sides.

While the stated objective was attacking black money, this has gotten fine-tuned along the way, and has become changing the way we transact business. This, it is hoped, will check the growth of the black economy in the future. There are however no clear conclusions that can be drawn; at best, there are conjectures based on logical reasoning. Let us look at some of the questions for which answers may be sought.

Will the economy be affected? The answer is “yes”, though one is not sure of the extent with estimates ranging from 0.5-3% of the GDP. That there will be lower growth is certain as the services sector has countered some irrecoverable loss of output in Q3. For manufacturing, in case of durable goods and automobiles there could be some recovery in demand when conditions stabilise, though for FMCG products, the loss would be permanent. A slowdown in the real estate and construction business has negative backward linkages, too.

Similarly, farmers have had to resort to distress sale for horticulture products due to the currency crunch that has affected their income though output per se has been higher. Overall, the fact that we are a cash-based economy does indicate that there will be a deep gash in the consumption balloon and it would take time—maybe even one or two quarters—to get back to normal.

How about black money? To begin with, there were discussions on how much money would stay out of the system and hence get impounded. However, with various amnesty schemes at different levels of taxation, almost all the currency should come back and one may never know how much black-cash was in the system. The guess now is as to how much will actually get taxed at 50% and 85% which will accrue as tax revenue for the government. But one thing is certain. All black money in these denominations will get out of circulation and enter the white stream. Therefore, the ‘most negative effect’ will still be ‘positive’ as all money enters the taxable stream in future, which is also a major achievement.

Will a new black economy develop? One cannot be sure about it, because a black economy develops basically when two parties in a transaction agree to game the system. As long as there is cash, transactions can always take place outside the system, and markets involving property, forex and gold are those which engender such money. There is no guarantee that future transactions will all be through the regular channels as the problem is not addressed by demonetisation which does away with old notes and replaces with new.

Hence, while demonetisation can thwart the existing stock of black money residing in cash, future flows can be controlled only by having strong systems in place. Human intervention in any transaction which involves regulation and permissions—like real estate—will always be prone to the creation of such money.

How will the so-called transformational objective of changing the payments systems pan out? At present, an increase in use of cards and e-wallets has been seen. But this is more out of compulsion, and curiously, the value of transactions is low. Hence, it is not really indicative of people switching over. Also, the argument that there is less cash being used in the system is more because there are limited supplies and not that people are demanding less money.

Cash is held for three reasons: transactions, precautionary and speculative. If people have to go digital for transactions, they need to be incentivised and not penalised. Further, we need to address the question as to why do people hold money for precautionary purposes. It is always for emergencies, and when there are no alternatives offered, which is the case when one has to get admitted to non-The government has addressed, to a large extent, the speculative aspect of holding money by taking such businesses online. Hence, the stock market, which up to the1990s was cash-based, had been made clean by introduction of dematerialisation and online trading. But the same does not hold for dabba trading or real estate transactions which are difficult to monitor. The clue is to rationalise duties and taxes and ensure that bribes do not have to be paid for the system to work.

How will the banks look back at this ordeal? Banks have been proactive in meeting the 60-odd amendments made in the last 50 days or so. They would be wary of the Jan-Dhan accounts—opening more of these was a target earlier—which have become a reason they could be questuioned by the taxman. While going digital is pragmatic, the cost for the same has to be borne by someone. This is a typical catch-22 situation, one where we have to incentive people to go digital but by doing so have someone else bear the cost. Ideally, it should come from budgetary allocation. Otherwise, it will be onerous for banks.

Hence, the three-months period following the end of the exchange scheme will gradually provide clues about what all has been achieved. Gains from taxing the revealed black money will be a one-shot flow, but to ensure that tax collections increase over a larger base, systems have to be changed and rates rationalised. For example, even today, for registration of property, one has to go through agents and pay one’s way through the office as alternatives do not exist. The same holds true for any dealing with government departments with tiers of bureaucracy.

Transaction behaviour is more complex and will evolve over a longer period of time given the expanse of the nation and the limited access for all to technology. The advantages have to be driven home convincingly to bring about such change. Hence, while demonetisation could be the right move, its efficacy would depend on how we follow up on the basic objectives and not just move on to another agenda. While this is the Indian habit, given the performance of this government, it looks likely to be different this time.government hospitals, the transformation will never really take place,

Tim Harford doesn’t disappoint readers with his latest book ‘Messy’: Book Review: Financial express December 25, 2016

Tim Harford joins the popular mood that’s gaining momentum, of being more chaotic, less fast, of being more discordant with the times we live in

Messy’ is the propagation of the dictum that when things are in disorder, they make you work the best. While all of us like to walk the known path, messiness brings out the best in you, as it forces you to innovate. This is the basic thrust of Tim Harford in this book, quite appropriately titled Messy, which we in India would call jugaad.

When you pick up any book by Harford, starting from Undercover Economist to Adapt, you expect to read unique approaches to common issues, with a lot of psychology and reality thrown in. He does not disappoint the reader in his latest book too. The section on ‘life’ is appealing and very typical of Harford where he gets into the finer points of online dating and makes some very pertinent points. For instance, he argues that when an algorithm concludes that two people are matched and they team up successfully, the mechanism often acts as a placebo rather than correctly identifying a true match. But it works, as both sides believe that their match is the
best just because the computer said so.

There is another section on ‘automation’ where Harford takes us through the dangers of having things automated in life, as we cease to think and leave everything to technology. But what when technology fails? Here, he gives an example of a plane flying across the Atlantic that is on auto pilot mode for most of the time, thus making the crew redundant. This ‘Air France’ Airbus flight develops a snag, which makes it lose height, and the pilots are unable to figure out what to do. None of their responses are right and the plane crashes into the ocean. It is the humdrum of being dependent on technology that comes in the way in which we think and respond.

In the same context, Harford shows how ‘creativity’ is engendered by chaos and gives examples of musicians who come up with great performances under adversity, which is what we see in our own lives. Therefore, we need some sort of disruption to ensure that we become more creative. He believes that some of the best ideas germinate from a crisis—howsoever small it may be, even something like the keys of a piano malfunctioning.

The author takes us through the process of drawing up ‘incentives’ for human beings, as there is always a tendency to game the system. Bus drivers who have to meet targets measured in terms of ‘being on time’ could skip some stops or change their routes to ensure that they do so. Ambulances may change their way if they realise that they are not able to reach the patient in the pre-defined time limit. Hence, there is a thin line between providing incentives and the same becoming a perverse incentive. A glaring example is the famous assignation of risk weights under Basel II, which gave lower risk weights to less risky assets. Banks took advantage here and invested heavily in Greek bonds, which offered high rates, as they were really of junk status, but were still considered to be government bonds and had lower risk weight attached.

The takeaway here is that once we have targets, it makes the participants concerned look for distortion. By making such investments, banks were able to do well with the Federal Reserve stress tests. Volkswagen was able to cheat through all the emission tests—a goal for all automobile manufacturers—but ultimately got caught. Therefore, every time there is a scheme of incentives, it is essential to ensure that they do not degenerate into perverse incentives.

At another level, Harford also looks into the relationship between output from employees and the quality of the ‘workspace’. Steve Jobs, for instance, liked the idea of serendipitous interactions, where workers almost get forced to meet each other without any planning while probably walking to the coffee machine. Further, Harford’s research shows that workers like places where they have a say in its layout. Hence, if they are allowed to choose the décor, which could be as simple as arrangement of plants and paintings, they would feel empowered. But if these basic choices are decided by the superiors, which happens in most organisations, it’s a sign of disempowerment and workers feel less attached to the company they work with.

Another attribute picked up and deliberated upon is ‘winning’, where the author gives the story of then German general Erwin Rommel, who always managed to outwit the allies because of his uncanny way of surprising them every time. At the business level, he speaks of Jeff Bezos of Amazon and Donald Trump in politics, though the narrative is more on the latter. The approach of Amazon to retailing is an amazing story that involved several calculated risks being taken to ensure that the company stayed ahead even though there were several reverses, especially when its ‘third party tie-ups’ flopped. But the brand Amazon stands for power and strength.

In this book, Harford emphasises how there are close connections between creativity and mess, and unexpected changes in plans or unfamiliar people and events generate both new ideas and opportunities.

Using real-life examples, he is able to illustrate how messiness helps in bringing about better solutions and backs his arguments with psychoanalysis. At the end of the day, it is the human mind that matters. His belief is that people think harder when they face uncomfortable situations and are able to come up with better ideas and solutions. If the reader looks back at almost all products or services that have made a difference, he/she will realise that it is a case of making the most from an opportunity that resides in the chaos that envelopes us today. This is the message to be taken from this book.

A tale of two demonetisations: Business Line December 21, 2016

India’s systems seem to be holding up better than Venezuela’s, despite the logistical chaos in both countries

Narendra Modi of India and Nicolas Maduro of Venezuela will both be remembered for embarking on audacious campaigns aimed at demonetisation of their large denomination currencies. India is the largest democracy in the world while Venezuela is socialist, but for all purposes fairly autocratic. Hence the demonetisation exercise has been carried out in two different kinds of regimes.

We went in for this move on November 8 with almost immediate effect though several took advantage of having access to old notes till midnight. In the case of Venezuela it was announced on December 11, and was to kick in after 72 hours with the exchange window being kept open for 10 days. The withdrawal now stands till January 2 as it has been realised that, like in India, the supply of new notes has not kept pace with the demand. But unlike our case where the environment has been peaceful, the Venezuelan experience has been marked by a great deal of dissatisfaction resulting in violence.

Tango and cash

The Venezuela story goes as follows. It is one of the worst performing Latin American nations with hyperinflation. The IMF forecasts that it would cross 1500 per cent next year. The official currency exchange rate is one bolivar for 10 US cents, though the black market rate is 2 cents. The reason for demonetisation is to quash the operations of the mafia by blocking the border to Columbia which is the route for such money. At another level it has been alleged that such currency was being used to buy goods that had controlled prices which was responsible for hyperinflation, though there are not too many buyers for this argument. Almost 50 per cent of the cash in circulation is to be removed and replaced with higher denomination currency which can go up to 20,000 bolivars.

The Indian tale is more organised. The Government was absolutely keen on unearthing black money, and in the last two years started the exercise by addressing Swiss bank accounts while simultaneously starting Jan Dhan to equip all with bank accounts. An income declaration scheme which ended in September has been followed up with demonetisation which has removed all old ₹500 and ₹1,000 notes which are to be replaced with new ₹500 and ₹2,000 notes.

Immediate effect

While demonetisation was instantaneous, the people were given a longer window of 50 days for changing notes. Along the way the Government also revealed that the aim of demonetisation was to make India cashless and hence added transformational objective that went beyond black money. Efforts are on now to ensure that this infrastructure is created to ensure this transformation in the coming months.

While terror funding was part of the initial announcement there has been no move to impose any embargo on movement between India and Pakistan, unlike in the Venezuela case. We are getting rid of 86 per cent of the currency in the system, and hence the exercise is much bigger in scope.

In the case of Venezuela, economic compulsions have also been a driver as hyperinflation is not sustainable. But in our case there are no economic factors that have driven the move; they are moral and ethical issues. India is the one of the best performing economies in the world which is virtually in a take-off state and has low inflation to the extent that interest rates have been lowered steadily during the year. Besides, inflation has always tended to be more on the costs side and less on the demand front.

A commonality in the two cases is the implementation of the schemes where supplies of new currency have just not been adequate. The problems start from availability of paper to printing and distribution of currency to the banks which can stock their branches and ATMs with the same.

While the aspiration was to return to normalcy in 50 days to begin with, it is now accepted that given the logistical issues, we could be 50 per cent of the way through by year end. For Venezuela which has just embarked on this adventure, it could take longer given that the systems are much weaker than in India. The pain is likely to be deeper at the ground level there, while in our case there have been temporary economic distortions which will get corrected by the first quarter of FY18.

Interestingly, the reaction of the public has been very different in these two countries. In our case, people have understood the broader goal of black money and possible redistribution through effective government spending or transfers and have borne their travails with patience. While this may be waning, life has been peaceful notwithstanding some cases of death in queues due to non-availability of money. But clearly, there has been no protest from the masses so far which is creditable as these deaths have not been politicised, which normally occurs when issues like religion or caste are involved.

Mature reaction

This was a concern put forward by the Supreme Court when it observed that supplies of currency had to be segmented to eschew a social upheaval. It does appear that the country is mature; it realises that the malaise of black money is deep-rooted and has to be removed, and that the inconvenience is worth the trouble. As can be seen after 40 days, we appear to be moving towards normalcy, albeit at a very slow pace.

In Venezuela, conditions have not been peaceful. Violence has erupted in less than a week’s time with the people rioting and attacking banks and ATMs and causing a lot of destruction. This is probably why the government has extended the withdrawal date. The message behind the reason for demonetisation has not been clearly explained unlike in our case where there has been a proactive campaign to make people aware of the motivation for the same.

It does appear that these two examples will serve as paradigms for countries planning to attack the malaise of black money and other ills such as drug money through demonetisation. These two stories highlight what should be done before embarking on such an exercise and, more importantly, underline the challenges faced on the way that have to be addressed.

This may just be an interesting experiment to be considered for several other countries in 2017 with the dos and don’ts being known now.

Demonetisation money must not be used to cushion the deficit ... Financial Express December 13, 2016

Money, it’s a crime Share it fairly but don’t take a slice of my pie Money, so they say Is the root of all evil today’- Pink Floyd, ‘Money

The demonetisation plan has three dimensions, with each one superseding the other with time. It started as being a part of the crusade against black money and counterfeit currency. This could be termed as the ‘adagio’ of the musical piece. It was followed by the ‘andante’ or the quest for changing the way in which we transact business where the elegance of digital transactions was extolled. As we end with the ‘allegro’ the questions now are centred on what do we do with the goodies that are collected?

The scheme, it was assumed, would at the end of the day catch the black money holders and put them in a spot.

The first stage was to ensure that a strong due diligence process was followed when taking in cash as deposits with banks. This would, finally, leave those who could not justify the same with currency that was worthless. Once out of the system, RBI could reassess its balance sheet. When currency disappears, then the size of the liabilities contracts and this could be interpreted as a transfer of a surplus to the government. The pundits had argued that amount, Rs 3-4 lakh crore, that would be left can give the government ammunition to fight various battles of development. The purists (including ex-RBI Governors) were against this move, even though the government made no such potential claim on these amounts. It was, hence, more of an intellectual speculation.

The party has apparently been dented by two factors. First, the pace of conversion of old notes to deposits has been very brisk and it appears that there may, after all, not be much left for balance sheet adjustments. Second, RBI, in its recent post-policy press meet, has made it clear that these amounts will not leave the balance sheet though they would cease to be legal tender. This, sort of, puts to rest the controversy over what happens to money left in the system.

The other route of getting money for the government is in questioning, investigating and penalising what enters the banking system. This was not a part of the original plan, as the demonetisation measure was taken just after the formal income declaration scheme came to an end. But once it was noticed that people were gaming the system by backdating bills on jewellery or transferring funds to other peoples’ Jan-Dhan accounts by giving them a part of the money in exchange, the government has thought of ways of identifying and taxing them with a fine.

This Robin Hood scenario would be played out in two ways. The first is to encourage people whose accounts have been used not to return the money to those who have deposited their money, which will be poetic justice.

The second is to tax the deposits that cannot be ‘justified’. This is done by first giving a chance for voluntary disclosure where one pays 50%. If one does not declare the same, but gets caught subsequently when the IT/Intelligence department catches them then the punitive charges could go up to 90% with possible penal action. The calculators are out in guessing the collections and estimates range from Rs 50,000 crore to Rs 150,000 crore. Assuming the final number is somewhere in between, what can be done?
One option is to transfer all this money to the Jan-Dhan accounts, which was a promise made by the government when talking of black money. But with over 25 crore such accounts in operation, an amount of Rs 6,000 per account would be very small. Also, it will not be possible to sift through the misused accounts and the regular ones to lower the targeted group. But this is an option.

The second would be to be fair and compensate all account holders who deposited cash in their accounts with clean money, meaning thereby those that have not been taxed. The sum total could be transferred equally into these accounts which is a way of compensating the country for the trouble they have been through for no fault of theirs. This will be a fair way out much in the Rawlsian spirit.

Both these options should be seriously considered as government’s stance on the November 8, was that this exercise was a nod to transfer funds from the ‘criminal rich’ to the poor.

Yet another route is to transfer the funds to the budget and then use them for spending on specific purposes like roads, rural electricity, urban infrastructure, health, education. This will indirectly add to the welfare of the people in the medium run. But at any rate the money should not be used to cushion the deficit to 3.5% this year, and make up for failure in disinvestment or any other collections.

Another alternative is to use these funds to fully recapitalise public sector banks which are short of funds. The proceeds of demonetisation could be used for compensating banks for the trouble they have taken—though the non-PSBs would be left out.

Which is a better way of using this money? Using it for projects which includes bank capitalisation looks more appealing and logical and would be looked at positively by the global community, especially the rating agencies. Transferring funds to the bank accounts of the masses may be problematic as it looks like bestowing largess and is analogous to ‘subsides’ and ‘waivers’ of loans. But a call has to be taken on whether or not the government considers this transfer as being a commitment made earlier to the people. A more serious impediment would be to address the concerns of the Election Commission which will observe such transfers as being done to curry favour in the upcoming elections.

It would definitely be prudent for the plan to be cast right away to decide on the use of the additional revenue garnered from this scheme. Besides improving transparency it would also clearly spell out the stance of the government on sharing the proceeds with the people of India.

Is demonetisation going to pay off?: Business Line December 5, 2016

The impact on future black money generation and the extent to which scrapped currencies do not return are crucial metrics

How can one judge the success of the demonetisation or rather re-monetisation programme of the Government? The stated purpose of such a scheme, when it was announced, was that it was that it was a bold attempt to eliminate black money besides countering the phenomenon of counterfeit currency. As time went by, other objectives were also spelt out. These included more ideological issues such as why there should be cash in the system when there were cards and e-wallets available. The scheme was also intended to transform the way in which we conduct our lives where we adapt to technology rapidly.

Hence, such a scheme cannot be evaluated in the short term as some of the goals specified are transformational and will take time to materialise. But there could still be yardsticks drawn up for evaluation.

Rejecting bad money

First, there is the hope that a large part of the currency in high denomination notes which aggregates around ₹14.25 lakh crore would not enter the banking system, thus making it redundant. The amount that disappears from the system can be the first metric for evaluating the scheme. Presently, around ₹8 lakh crore has gone back as deposits and there are still 30 days left for the doors to close. Will 10 per cent or 20 per cent or 30 per cent not returning to the system be a measure of success? A ratio of 20-30 per cent seems a fair number that can be targeted to justify this vast exercise.

Second, the Government has also stated that any suspicious transactions when converting cash to bank deposits through the Jan Dhan programme or any other means would attract tax plus penalty-cum-fine which can vary across the spectrum. Such identification will clearly earn revenue for the Government.

Hence every ₹1-lakh crore of identified black deposits could earn the Government a bonus of at least ₹50,000 crore revenue. Any success here will reflect on the alacrity with which the Government has plugged loopholes that were being exploited by holders of black money.

Visible effects

Third, the Government has spoken of a window of 50 days ending December 30 to restore normalcy, which is fairly aggressive. Insofar as the currency crunch that prevails in the system is quite stark, currency should be available at all branches and ATMs in the country by this date. Often the queues outside these points are used to vindicate the success of the distribution system which, however, can be misleading as lines tend to get shorter when limited currency is available. An objective measure would be the time taken to revoke all the curbs that have been placed by the Reserve Bank of India on withdrawal of currency from banks. Any delay in such announcements would mean the system is not yet ready with the required amount of currency which was promised.

Fourth, it has been agreed almost unanimously that the economic growth process would get retarded in Q3 of the year, thus affecting overall growth for the fiscal. One metric to judge the re-monetisation scheme would be the speed with which GDP growth recovers and moves upwards. If Q4 growth is lower than Q3, quite clearly the scheme has debilitated growth, which was not in the plan. If things do normalise, Q4 should be the turning point after the expected drop in Q3.

Fifth, the sector that is host to black money is real estate. While there are arguments on both sides as to how this sector is affected by downplaying the role of cash in transactions, the litmus test would be whether or not real estate prices come down. The RBI or NHB price indices would provide some clue to whether there has been any moderation in the prices of property in the country.

Sixth, the volume of cash holdings should come down in case the broader goal is satiated. Hence, over a period of 6 to 12 months, the ratio of currency to GDP should come down from the present level of around 12 per cent. If we are speaking of global norms, it should be halved to begin with. In case households and businesses go back to holding similar amounts of currency, then the transformational objective would get vitiated. It would also mean that we do require such sums of currency for the three classical purposes put forward by monetarists — transactional, precautionary and speculative.

A new black economy?

Seventh, as the main objective was to target black money and eliminate it to the extent that it resided in cash, a question to be posed is whether or not it will lead to the creation of a new black economy considering that high denomination notes of ₹2,000 become easier to hold. Here it will be hard to devise a metric because the extent of such holdings is known only ex-post.

But it will probably take 5 to 10 years for such an economy to come up; however, it can be delayed by more stringent tax laws. This is where the tax system must be tightened so that slippages are eliminated.

The benefits from this scheme are important considering there are considerable costs the country has been subjected to — some that can be measured and others that cannot. The most tangible cost is the loss of GDP and 50 bps cut in the GDP growth rate would amount to around ₹70,000 crore. If the loss on an annual basis is higher, then the cost for the economy will increase proportionately. There are also intangible costs such as time spent by households and businesspersons to deal with the new situation.

Another cost in the economic sense has been the wide distortion caused in the markets which include stocks and GSecs in particular. Yields have become volatile as the RBI grapples with the excess liquidity problem in the system that cannot be supported by their holdings of government paper.

Banks have borne the brunt of higher costs in the execution of this programme such as late hours, reconciliation, overtime, recalibration of ATMs, security and so on, which would be considerable even as some cannot be quantified. The icing has been the recent 100 per cent incremental CRR.

Hence, the success of this scheme can be evaluated in stages and a complete picture will be seen after probably a year when customer habits can be reassessed. Hopefully, the gains will outweigh the costs at the end of the day when the system is largely cleaned up. The challenge then would be to ensure that a new black economy does not get generated.

Women power" Book Review Financial Express 4th December 2016

Role of women in the corporate world and how positions of power are easily accessible

Women in the corporate world’ is a much spoken about subject; and there are several examples of those who have transcended the traditional barriers, which are both physical, as well as psychological, to reach positions of power and recognition. Several media houses do go a step ahead by giving awards or ranking them in terms of success or power. The RBI is one institution that has had several women rise to the top positions from within, and Deepali Pant Joshi is one such example. Given her experience in the journey up the ladder, she is in a very good position to provide women with some guidelines on how to maneuver their way in corporate life and break the glass ceiling that has been institutionalised in our setting.

In this book, she addresses three specific issues that make for interesting reading. The first is the role of women in corporate governance and business ethics, where she lays out the blueprint for women who can contribute to the same. She takes the reader through the finer points of the constitution of board of directors and their responsibilities that can be taken on by women. Here, she makes an interesting comparison between the barriers faced by women in Asia and Europe based on five parameters, such as prevalence of double burden, existence of female role models, performance model, family support services and basic reluctance to promote oneself. By overcoming these impediments, women have an opportunity to make a difference. The important thing is to take this challenge head-on.

She then takes us through the issue of sustainability and the glass ceiling. Her insights here are meaningful. Women have a major challenge in convincing boards that companies should not compromise on sustainability to further profits, as preservation of environment is critical for future growth and development. Having a policy in place and making sure the management is accountable for the same through implementation will be something that has to be pursued by women in power. Technology may have to be reworked, but would be worth the cost and effort. This is one area where she argues women should focus on, as this will be a win-win situation for all constituents of the ecosystem.

On the subject of glass ceiling, she explains in detail the challenges that women face at home, as well as prejudices in office, which have to be overcome. They do have to contend with inherent biases such as job segregation, absence of not having an old boys network to support them, gender discrimination, and physiological needs.

The last section on leadership styles of men and women is probably the best and hence reserved for the end. She takes us through different approaches of women in management, from being transformational to situation-based to more participative. The choice may not be consciously made and will be based on the existing circumstances. The constant feeling of being a woman in a man’s world is a challenge and moving over to mainstream activity requires a different approach. Women otherwise get confined to conventional, softer roles like HR, training and communications.

This book by Joshi is very different from her earlier take on financial inclusion and governance, which was more her domain expertise while working with the RBI. Governance is probably the only common factor in both these books, which is significant today, as it is the distinguishing factor between companies. Joshi does provide guidance, as well as options to women who are ambitious. There is hard work involved and compromises to be made, but the final result will be satisfying. The message really is that women on boards should take more responsibility and leverage their superior skills to carve a niche and should seize opportunities along the way, besides honing their skills.
The author also cautions that women need to know how to handle power, as it can be their downfall if not used in a judicious manner. The system provides the opportunities and women need to only grasp them. And she believes that as a gender, women are more than up to this challenge.

Demonetisation: For banks, agony of surplus liquidity higher than ecstasy of rising deposits: Financial Express December 1, 2016

A lot has been conjectured of the ‘good’ that will happen. However, the reality has struck now when there is excess liquidity with banks and few avenues for deployment.

The scheme of exchanging old currency for deposits came as a breath of fresh air for banks, which saw their deposits soaring as households and business rushed to convert old currency after November 8. This has led to a sharp increase in bank deposits in an environment where bank credit is not growing rapidly.

A lot has been conjectured of the ‘good’ that will happen. However, the reality has struck now when there is excess liquidity with banks and few avenues for deployment. Much like the process of demonetisation, the situation appears more reactionary rather than planned, and banks find themselves in a tight spot.

There was ecstasy with deposits rising just at beginning of the busy season. Consumerism had shown strong signs in the period leading to Diwali and the good times were to come along supported by banks, which were running tight on deposits. In fact, RBI has been supplying funds through OMOs all through, and it is against this background that banks became ecstatic as deposits rolled in. Most households were in a panic mode and were just keen on getting rid of old notes safely and, hence, most of this money went into savings deposits.

The consequences were significant. First, banks automatically started lowering the deposits rates as they no longer had to wait for RBI to announce changes in the repo rate. This also meant that the lending rates could be reduced without a prod, which was a win-win situation for the system. The transmission mechanism became smooth under the compulsion of market forces. In fact, some sections of the market believed that RBI need not lower the repo rate in the December policy, as circumstances have already delivered the result unobtrusively. Banks were also pepped up as the G-Sec yields had crashed with the 10-years paper going down to 6.3% with sentiment providing a guidance of sub-6%. This meant there were capital gains to be had, which would prop up income and banks would be better able to manage provisioning for their NPAs.

Hence, while the first announcement of RBI spoke of around R5 lakh crore of deposits accruing to the system, the government spoke of R10 lakh crore by the end of December. These goodies definitely made banks less touchy about the inconvenience that they had to
go through.

The initial pain was in terms of dealing with the system and the public. Currency notes had to be brought and replenished in all branches and ATMs, which are still work in progress, but given the grand resilience of the Indian public, empty ATMs and branches devoid of cash no longer stir any umbrage. The nation carries on, keeping in mind the big picture. Bankers have worked overtime without any further compensation to make this work, which will be seen right through December and even in the succeeding months when all the numbers have to be reconciled. But this pain is minimal compared to what lies ahead.

The system does not have the capability of absorbing this much of money. We are in a situation where there are not many takers for credit as growth has just about started and got thwarted with the move of demonetisation. Producing units are struggling to make their business move ahead, facing a liquidity crunch, and hence production has gotten stalled in both manufacturing and services sectors. Retail loans have, by far, been the most buoyant with mortgages picking up during the year. Here an impasse has been witnessed as households are working out ways of meeting their payments, given the high cash component in such purchases. Further, there is expectation that home prices would come down once the system regularises, which, in effect, means that it makes sense to postpone purchases. Hence, demand for credit is low, and banks have a challenge of deployment.

The alternative is to go to the G-Sec market. But with the government sticking to the fiscal target, there will be no additional paper in the primary segment. Hence, the secondary market has been the target for banks. This led to the yields coming down sharply. But given that banks have been paying a minimum of 4% interest on deposits, a positive net return is what they would have wanted. The reverse repo window has been used widely to park these funds where the return could go to 6.25%, which would just about cover their operating cost to assets ratio of 2-2.5%.

However, RBI has limited G-Secs in its balance sheet, which is around R7.5 lakh crore, and in case deposits do shoot up to R10 lakh crore, it would not be possible to satiate the market. One option is seeking recourse to MSS bonds (market stabilisation bonds), which have been used in the past when money supply increased mainly due to the influx of foreign currency in the system leading to sharp appreciation in currency. But given the quantum involved (between R5-10 lakh crore ultimately if the target is reached and cannot be used for lending), this would push up government debt substantially. In fact, it will also add directly to the fiscal deficit, which is not acceptable.

Therefore, RBI has come out with this new measure of locking in liquidity on an ex-post basis through 100% CRR for all deposits between September 16 and November 11—i.e. before the demonetisation. This is a sharp blow to the banking sector as it involves R3.2 lakh crore, on which the cost would be at least R12,800 crore (assuming all are savings deposits) on an annualised basis, which would increase in case part of this amount has gone into term deposits. The revenue earning would be nil on CRR balances and, hence, is an inferior option for banks, which were hitherto putting these funds at 6.25% in the reverse repo window, thus earning around R20,000 crore on an annualised basis.

So, banks will be less gung-ho about this entire exercise as the agony of surplus liquidity, which is now reckoned not on net funds available (deposits minus credit) but only incremental deposits, is higher than the ecstasy of rising deposits. This is over and above the pain gone through for 50 days in enabling a smooth transition from old notes to new ones, which does not receive any remuneration. On the whole, it does appear that this exercise will be a negative picture for banks in case it gets prolonged for long and is not reversed soon.

Book Review: Phasing Out Cash: Business World: 15-28 2016

In  India, there is relentless attempt at moving commercial transactions to the electronic mode with less use of currency. Interestingly, worldwide, there is a move for the same and the book The Curse of Cash by Kenneth Rogoff, who is known better as the author of This Time is Different, makes good reading.

Rogoff argues that cash can be dispensed with by conscious policies of the government and central banks, that this has been successfully done in Sweden and that there are several developed nations considering the same.

There are two reasons why the author has strong views against cash. First, excess currency helps to grow the black economy and second, having more cash comes in the way of effective monetary policy especially when there is recession, low inflation and the shadow of a financial crisis all at once.

Rogoff is not against cash per se, but only those of higher denomination. His aurgument is that households do not hold high value notes even for emergency purposes. Typically, the amount in the wallet is of smaller denominations and hence anything above 100 in the local currency can be discouraged. Several countries have put restrictions on the amount of cash that can be used for buying goods — €1,500 in Greece, €3,000 in Belgium and €1,000 in Italy. The European Central Bank (ECB) has decided to discontinue printing of €500 notes. The caveat, however, is that in order to protect the lower income groups, there must be universal financial inclusion to ensure access to free debit cards.

An argument put forward is that some companies use cash for making payments to illegal immigrant labour, which is against the law. And a more frivolous reason apparently is that this also spreads bacteria and poses a health concern for society at large!

But a more serious reason why we should have less cash lies in the realm of monetary economics. Rogoff cites the phenomenon of the financial crisis where central banks tried to lower interest rates to spur their economies. Ideally, they would have liked to go in for negative rates to ensure that no money was saved. But by doing so, there would have been a major demand for currency which would have created instability. Hence, central banks stuck to zero rates or only marginally negative rates. His point is that we should be targeting a higher inflation rate of 4 per cent instead of 2 per cent so as to have elbow room to lower policy rates well below zero.

Quite curiously, Rogoff also tells us that by doing so, central banks and hence governments will be losers because of lower seigniorage earned. The US government earned 0.4 per cent of GDP per year printing notes as it costs 12.3 cents to produce a $100 bill. Hong Kong and Russia earn above 1 per cent of GDP while Sweden which has almost switched over to electronic transactions has negative seigniorage.

How can we then dissuade the use of cash? Stamping currency notes or using magnetic strips are options to tax the ‘note’. Having expiry dates is another way out. A two currency system looks practical where electronic money can be tracked and can go at negative interest rates while a new currency would be declared and old one scrapped. There would be an exchange rate on a daily basis for this new currency which is linked with the electronic money!

Would this hold for all countries? Here Rogoff contends that the ‘black economy’ arguments hold for all countries though the support for monetary policy is more a developed nation’s syndrome. Emerging markets are trying to lower inflation rather than raise it and hence they would not come under this ambit. By phasing out cash in the developed countries, it will be easier for central banks to invoke negative interest rates when inflation is stuck at low levels in the face of a recession.

A point not touched by the author is the holding of say dollars by other nations given that it is an anchor currency and is normally held in larger denominations. Banning such notes would have practical issues. The book is nevertheless interesting and the RBI could borrow some ideas.

Will demonetisation boost RBI’s surplus? Financial Express 23rd November 2016

An issue being debated related to the demonetisation saga is the benefits accruing to the government. Much has been said about how RBI will gain and how, if this happens, the collateral benefit will accrue to the government through transfers of surpluses.

n issue being debated related to the demonetisation saga is the benefits accruing to the government. Much has been said about how RBI will gain and how, if this happens, the collateral benefit will accrue to the government through transfers of surpluses. Neither RBI nor the government has claimed this to be the logical conclusion, though there have been statements made that there will be a transfer of money from the private to the public sector. Evidently, there is merit in this argument though the transmission chain is unclear.

One way of resolving this issue is to go back to the accounts of RBI and see how the balance-sheet and income-expenditure statements would look like once money gets impounded. This is interesting because there would be a mix of balance-sheet items with income-expenditure entries. While the overall impact on the government balances would be positive with more income that can be taxed being revealed, the singular impact of currency being made ‘useless’ can be addressed through a partial equilibrium analysis where ceteris paribus conditions are made for other factors not changing. For FY16, the broad picture is shown in the accompanying graphic.

The RBI accounts are different from the corporate balance-sheet as, in the latter, one can find links between, say, long-term borrowings and fixed assets. But here, the assets are independent of the items in the liabilities listing. Forex investments are based on the reserves invested by RBI. The domestic investments are holdings of securities that are used for managing OMOs. Now when, say, R4,000 billion of currency disappears from the system (assuming this quantum is not revealed in either exchange of old notes or deposits during this 50-day window), the liabilities would come down to R28,429 billion. It looks unlikely that any of the assets can be reduced as they are held by distinct entities. Hence, government debt per se can’t come down. The adjustment has to be in the reserves which will go up as per the accounting standards followed by RBI. The other liabilities, the second-largest component including the currency and gold revaluation account (CGRA), is where unrealised gains from valuation of gold is capitalised rather than booked as income.

Therefore, the conclusion drawn here is that the balance-sheet per se may not really undergo a change in structure. A special reserve will have to be created to make the liabilities match with assets.

The other thought is whether the RBI surplus will increase on this score. To comprehend this impact, we need to look at the income and expenditure statement, which is provided in the accompanying graphic.

The income-expenditure statement reveals that the overall size of the income flows in FY16 is around Rs 808 billion, with income coming mainly from interest, which is on the investments made in domestic and foreign securities. Other income is mainly from exchange on forex transactions (R38 billion) and commission (R15 billion). None of these components could change because of impounding of currency as these investments and transactions are exogenous to this process.

The expenditure side is interesting. Out of the total expenditure of around R150 billion, establishment, agency charges (commission paid to banks for dealing with GSecs as well as underwriting fees) and printing charges account for 85%. Some of these may increase on account of printing of new notes, but will not come down. Hence, it is hard to conceive of a situation where the RBI surplus will increase on account of currency disappearing from the system as it is a cost already incurred. Any changes on account of a decline in currency holdings will be more of an accounting entry if it enters the income-expenditure statement and can’t be in the nature of money that can be used by the government to fund, say, a new road or bridge.

However, the future gains for the government would be better as more money comes into the tax fold. In fact, even within the current scheme, there could be several income tax notices sent which will result in a tax as well as penalty being imposed on the amounts deposited with banks. Further, by almost forcing households to migrate to alternative channels of payment at one stroke, future monitoring and tracking costs would come down and tax evasion to a large extent would be checked. Hence, administrative costs on tax collection would come down substantially with this move as compliance levels increase progressively. Better tax collections will have an indirect but positive impact on the fiscal deficit in future, another major gain to be had.

Hence, while the overall act of demonetisation will be positive for government finances, the precise phenomenon of disappearance of currency may not, on its own, be able to directly improve them, except in the accounting sense. The economic fabric will be cleaned up for sure, which is required given the depth to which the black economy has spread. This will also make it easier to run the administration and implement the GST next year when the major housekeeping exercise is accomplished.