<http://www.business-standard.com/…/search/…/prem-shankar-jha>

http://www.business-standard.com/…/why-demonetisation-is-gr…

Why demonetisation is greatest blunder by a govt in 69 years of free Nation.

For one, everyone seems to have forgotten that if new notes are of a
different size, ATMs won’t work.

December 30, the deadline
<http://www.business-standard.com/search?type=news&q=Deadline>
Murderer of democratic institutions (Modi) set for completing his exercise in DEMON demonetisation
<http://www.business-standard.com/search…>has
come and gone, and there is now no room to doubt that it was the single greatest blunder
<http://www.business-standard.com/search?type=news&q=Blunder>that
any government has made in the 69 years that Nation has been free. On
November 8,Modi demonetised 20 billion bank notes, accounting for 86 per
cent of the cash in circulation in the Indian economy. But only a
fraction of the new currency notes needed to replace them had been
printed. As if this was not inept enough ‘somebody’, that is to say
everybody from Modi to the head of the Reserve Bank, ‘forgot’ that if
the new notes were of a different size from the old, the ATMs would not
work. The result was that, like a car engine run without lubricating
oil, the economy simply seized up.

The impact on the economy has not only been catastrophic but highly
unequal. Those with bank accounts and credit cards were merely
inconvenienced. Those who earn and spend mostly, or entirely in cash,
found themselves rendered penniless overnight. These were the poor of
India.

Banks still account for only a little over 30 percent of total credit
extended in the country. The balance comes from moneylenders who deal
in cash. That credit collapsed. In terms of value the proportion of
transactions that has been digitized is also about the same. But this
figure is deceptive because in numbers around 90 percent of
transactions still take place in cash. This entire segment – the lion’s
share—of the economy is now paralysed.

The fewer are the
transactions in the economy, the lower is the income they generate.
There is now a consensus among economists and bankers, therefore, that
the GDP will shrink in the second half of this fiscal year. Shortly
after the demonetisation
<http://www.business-standard.com/search…>Goldman
Sachs slashed its growth estimate for the second half of the year by
1.6 percent and predicted that the GDP would grow by 6.8 percent. This
was 0.8 per cent below its original estimate. Deutsche bank similarly
estimated that the annual growth would be around 6.5 percent. But the
most pessimistic estimate was that of Ambit Capital which forecast that
the economy would actually shrink in the remainder of the year, and
bring theannual growth rate down to only 3.5 percent for the year.

Anecdotal evidence suggests that Ambit’s estimate is likely to prove
closest to the mark. 90 percent of India’s more than 300 million
non-agricultural unorganized labour is paid daily or weekly in cash.

To pay them their employers have to have that cash first. The
government’s severe weekly withdrawal limits have made it virtually
impossible to pay these workers in the new legal tender. So far
employers were paying the in old notes and asking them to convert these
into the new money.

But this loophole has been shrinking and will shut on December 30.

As a result, Mazdoor Nakas—casual labour markets– where many of these
workers congregate every morning in the search for work, now receive a
trickle of hopeful aspirants, as the news has spread that their
employers, mostly in the construction, do not have the cash with which
to pay them.

There is a swelling reverse stream of migrant
workers returning to their home villages, where the cash they have
managed to save before the calamity will last longer than in the city.
Sectoral information from organized industry for the month of November
was bleak: a 20 percent fall in auto sales, 35 to 40 per cent in two
wheelers, 63 per cent in tractors.

But the most severe crunch has
taken place in the rural areas, where nearly all transactions are in
cash and there are far fewer banks. The
demonetisation
<http://www.business-standard.com/search…>occurred
just as farmers in north India in particular were selling their Kharif crop
and making their purchases for the Rabi. There is some preliminary
which suggest that the area sown with Rabi crops has therefore shrunk
but the full impact upon the Rabi will only be known as the crop ripens.
What is certain is that farmers all over India have minimized their
purchases of non-essential goods. This will killthe fillip that the
bumper Kharif
harvest would have given to the consumer goods industries.

Modi has sought to reassure the people that this is only a short term,
and necessary pain that the people have to suffer, to cleanse the black
money of corruption and black money. Once it is over the economy will
not only revive, but emerge stronger than ever. This is wishful
thinking.

For the sharp cut in spending that has taken place
will last for the entire time, now estimated at up to six months more,
that it will take for all the old notes to be replaced. During all this
time spending will remain constrained so income growth will fall too.
This means that the decline in consumer spending will persist.

This will force manufacturers to cut production in order to clear their
unsold stocks. That will cause a second round of reduction of orders
and retrenchment of employees, so another contraction in income and
expenditure. The economy will therefore continue to glide downwards till
it bottoms out. Left on its own the economy is likely to take another
two years to recover. By hen 2019 will have come and gone, and so will
Modi.

If Modi wishes to revive the economy quickly enough to recoup his
party’s political fortunes, he will have to give it a huge jolt, not unlike
the electric shock given to patients suffering a cardiac arrest. The only
way in which he can do that is through a huge cut in interest rates. By
this I do not mean a cut of 50 or even 100 basis points in policy
rates. I mean a slew of changes in various policy rates that will bring
the lending rates of the commercial banks lend to investors of five to
seven percent below the banks down to at most five per cent; that is six
to seven percent below that rates that had prevailed before
demonetisation.

A cut of this magnitude will enable India’s dying infrastructure and real
estate companies to refinance their debt and thereby halve their
interest costs. This alone will enable a large proportion of these
companies to pull out of the red and take up many of the Rs 8,80,000
crore worth of ‘stalled’ projects that they abandoned when interest
rates began to rise, and industrial growth to sink, six years ago.

A halving of bank lending rates will also revive the real estate sector
as millions of home buyers will once more be able to meet their monthly
installment payments, and give a huge fillip to the sale of consumer
durables that account for more than a quarter of manufacturing output.

But how will Modi bring interest rates down so sharply now , when
neither he nor his predecessor were able to persuade the RBI to do so
earlier, and when he has formally ceded the entire power to set them to
the RBI and its newly created monetary policy committee?

The
latter contains economists who, one presumes , are more sensitive to
economic growth issues than the bankers of the RBI, but even they will
be bound by the now official diktat of ‘inflation targeting’.

Inflation targeting requires central banks to keep lending rates in the
economy above the rate of inflation at all times. Its purpose is not
economic growth but financial stability, because doing so reassures all
our country people, and particularly foreign, holders of Iour country’s
money that Modi will not allow the value of their savings and
investment to depreciate. Advocates of inflation targeting claim that
growth will automatically pick up when prices and exchange rates
stabilize, but they are unable to describe the chain of cause and effect
that will make this happen. There is also very little evidence in the
experience of other countries that had adopted inflation targeting, to
buttress this claim.

On the contrary, South Korea’s two-decade
long surge to prosperity took place in the midst of a 21percent annual
rate of inflation and a continuous devaluation of the won to counteract
its impact upon external competitiveness.

In our country
inflation targeting, which has been the informal mantra of the RBI since
2006, has bestowed the kiss of death on industry, infrastructure,
construction, and therefore employment. This is because it does not
distinguish between inflation caused by an excess of demand in the
economy, which high rates can bring down, and one cause by shortages of
supply, whether of food grains, industrial raw materials ( usually a
reflection of rising global commodity prices), or labour which, by
curbing production, they can only intensify.

India’s cost of living index is sticky, and has diverged further and
further from the wholesale price index of inflation that the government
used earlier, because ever since 2007, its CPI inflation has reflected
local and global shortages, and not the state of domestic demand.
Judged by the latter, which is reflected both by the wholesale price
index and the GDP deflator, the true rate of demand inflation in the
country was zero or negative even before Modi exploded his
demonetisation
<http://www.business-standard.com/search…>
bombshell.

In our country inflation targeting will play a useful role if it keeps
interest rates two to three percent above the rate of demand inflation.

By that yardstick today even a five percent long term rate of interest
would be on the high side. So bringing commercial bank lending rates
down to this level is the minimum that Modi should do.

—
Peace Is Doable