Q1: RBI came out with a report saying that 99.3 per cent of the banned currency has come back. This has led to a debate where on one hand opposition is saying that demonetization hurt the economy by decreasing GDP and on the other hand government is claiming that it led to formalization of economy and more tax collection. After nearly two years, how do you see the demonetization exercise? Does the benefit of demonetization outweighs its negative affects?
A1: As I had said from day one, the economic costs of demonetization would be higher than the economic benefits. The data that has come out so far confirms that analytical prediction. I am not in position to evaluate the intangible benefits and costs of Demonetization.
Q2: Opposition leaders had predicted a GDP growth reduction of 2-3%, what do you think?
A2: I had forecast a GDP growth reduction of about 0.5% for the full year, with an absolute upper limit of 1% of GDP. I have formally estimated the loss in a working paper as 1.2% points in the two quarters following demonetization, ie a total loss of 0.6% of ful year GDP. This is very close to my original estimate.
Q3: Were there any benefits of demonetization?
A3: in my initial analysis I had identified three potential benefits of de-monetization. One the immobilization of black money held as cash. Two, the increased income tax compliance and reduction in tax evasion & bureaucratic corruption. Three the reduction in black money in real estate. I had written that we would have to wait for data to quantitatively evaluate each of these.
There are straws in the wind about increased formalization of transactions & financialization of savings but there’s insufficient data/ evidence to link them to demonetization.
Q4: What is your evaluation, given the data published in the RBI annual report and the data put out by the CBDT/Dept of Revenue?
A4: The RBI report shows that 0.7% of demonetized notes did not return to the RBI. This compares with a number of 1.8% during the demonetization of 1978. If this is taken as a measure of the immobilization of the black money held in cash, the performance was 60% less than last time. In my judgement this is due to the increase in corruption in the Public Sector Banks over 40 years and its demonstration effect on Private sector banks. In the absence of reliable data on corruption, it provides an estimate of the deterioration in public sector banks ie corruption was 60% higher in 2016 than it was 40 yrs earlier.
Part of cash was, however, deposited in 1,48,000 accounts, with an average deposit of Rs. 3.3 cr. Some of this will prove to be tax evasion subject to taxes & penalties. We don’t yet know how much!
Q5: What about the gains in Personal Income tax compliance?
A5: CBDT data shows that both the number of income tax declarations and income declared for tax have increased. Income tax buoyancy with respect to nominal GDP has increased from 1 in FY15 & FY16 to 2.45 in FY17. This is higher than the 1.5 seen earlier in FY14. GST was introduced in July 2017 and there was consequently a lot of uncertainty. This likely had a negative or negligible effect on income tax declaration in H1 of FY18. Its still unclear how demonetization and GST interacted jointly on income tax decelerations in H2 of FY18.
Q6: Has there been any effect on black money in the Real Estate sector.
A6: There was an expectation that one of the collateral benefits of demonetization would be the reduction of black money in real estate. The only data we have to indicate such reduction is the ~30% reduction in prices in Mumbai & Delhi markets post-demon. There were also some indication that the traditional black-white ratio in transactions has gone down. It’s not clear however how long lasting this effect was. There has however been a general effect on speeding up the digitization of the economy.
Q7: Indian Rupee has fallen to a new low after crisis in Turkey's Lira. What is the reason for weakening of Rupee when Indian economic is much stronger than Turkey?
A7: The most important driver of depreciation of EME currencies has been the appreciation of the US dollar against the index. There is also some apprehension about the effect of planned US interest rate rises on Emerging market economies dependent on capital inflows to finance deficits. Given our high dependence on oil imports, the impending imposition of Iran sanctions, its effect on trade deficit is also of some concern. As these are one-off factors, Rupee is likely to stabilize after some adjustment.
Q8: What is reason for FPI capital outflow? Is Indian market not as attractive?
A8: Historically short term movements in Exchange rate of rupee are linked to fluctuations in capital inflows. Besides the global factors mentioned above, fluctuations are also driven by expectations of political developments and politically driven Fiscal excess. It’s therefore very important for Govt to maintain it’s responsible fiscal stance during this period before the elections.
Q9: Fall in Rupee is expected to increase exports and imports. So what do you think overall what will be net impact on economy of fall in Rupee?
A9: The Sharp appreciation of the Real effective exchange rate (REER) of the rupee during 2017 was one of the factors, along with GST refund problem, for the slowing of export growth. The depreciation of the REER during 2018 has corrected much of the problem. It will therefor be a positive factor for export and help contain the current account deficit.
Q10: Moody's has said that due to increase in oil prices there is risk that India might not meet its fiscal deficit target for current fiscal? How do you see?
A10: Besides the global factors mentioned above, capital inflow fluctuations are also driven by expectations of political developments and politically driven Fiscal excess. It’s therefore very important for Govt to maintain it’s responsible fiscal stance during this period before the elections.
Q11: Current account deficit is also expected to widen this fiscal. Should it worry policy makers?
A11: Any rise of the Current Account Deficit above 2.5% of GDP always requires careful monitoring. However, to the extent it’s driven by oil price rises, it is usually followed by increased demand for imports from oil exporting countries & higher remittances from our citizens employed there. This is a lagged effect which should help moderate the rise.
Q12: Do you expect government curtailing its expenditure due to GST revenue being less than expectation, increase in oil subsidy (LPG and kerosene) and MSP. What will be its impact?
A12: With the decontrol of petrol and diesel prices, the direct effect of oil price rise on Govt deficit is limited. The rise in Kerosene subsidies is manageable. There will also be some offsetting increase in revenues, given the effect on oil prices on inflation. Govt expenditures are manageable as long as no major new schemes are introduced.
Q13: Do you see rise in inflation due to high fuel prices and MSP and as a result RBI hiking interest rates?
A13: Inflation has in fact moderated due to easing of food prices, though higher MSP may keep these prices from falling further. Average CPI inflation is likely to be between 4.5% & 5% during 2018-19. Good Monetary Policy is designed to moderate inflation, not to raise it, so I would be surprised if RBI raises real rates precipitously.
Q14: Is there any risk of government taking populist measure before 2019 Lok sabha elections?
A14: There is always such a risk before elections. But this Govt has already laid out its programs, among which the health insurance program is the most ambitious. I am hopeful that it will be phased in carefully without raising the fiscal deficit sharply before the election. There is also some concern about the potential rise if fiscal deficit of States!
Q15: What impact do you see of the ongoing trade threats being made by US on India?
A15: The sanctions associated with CAATSA and Iran sanctions are part of the external risk factors for India. The effects of the latter are already in the market & were discussed above. Uncertainty about the former will hopefully be resolved in the 2+2 dialogue.
Q16: How do you see the Indian economy in 2018-19
A16: The Indian economy is now firmly back on its medium term growth path. This expectation is based on the recovery of fixed investment during last four quarters, the restoration of private consumption to its trend, and the renewed hope on export front. GDP growth in 2018-19 is likely to be 7.5% +/- 0.25%.
Arvind Virmani, "Growth Prospect: Deceleration, Demonitization & GST " http://dravirmani.blogspot.com/2017/09/growth-prospects-deceleration.html
Arvind Virmani, "Deceleration, De-Monetization and GST: Growth Prospects and Policy Solutions," Working Paper No 2/2017, September 2017. GrowthDeceleration2017sep.docx .
Arvind Virmani, "Investment: Corporate India and Indian Households," Working Paper No. 1/2018, June 2018.
Data Appendix: Income Tax Collections
Year NomGdpGr IncTaxGr
2011 20 % 14 %
2012 16 % 18 %
2013 14 % 19 %
2014 13 % 20 %
2015 11 % 10 %
2016 10 % 11 %
2017 11 % 27 %
Data curtesy Nilesh Shah:
Note: A version of this interview by Praveen Bali, appeared in the with Asian Age((http://www.asianage.com/opinion/interview-of-the-week/020918/data-confirms-economic-cost-of-demo-was-higher-than-benefits.html ) , Deccan Herald.