Macro Q&A August 2018

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%.

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References:

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.

InvestmentFables2017.doc

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.

Current Economc Situation

Some Answers to Questions posed by Bloomberg on the Current Economic Situation:

Q1: We have rates tightening coming in the US, while ECB and BOJ are easing policies. How do you see these diverging monetary policies impacting the the rupee?

A1:The US$ has been appreciating against all currencies as result of higher growth expectations and expected rise in interest rates relative to Europe, Japan etc.. It has consequently appreciated by around 12% against the index, but only about 5% against the rupee. So the Rupee is quite comfortably placed.

Q2: What's your outlook on the rupee? Where do you see the rupee by the end of Dec. 2015? Also, pls mention the reasons that will be influencing the rupee in 2015?

A2: This depends on the further changes in the USD against the other currencies. However, one is reasonably confident that the USD appreciation against Rupee wont be larger than against the index. Though there is great uncertainty about oil prices, at some point in the next two years they will rise & have some impact on our CAD

Q3: On balance, how do you think the RBI will respond to evolving situation? 

Will it keep the rates high to defend the rupee amid financial markets volatility or due you think it will cut rates going forward to support growth?

A3: I cannot speculate on RBI's response. I believe that the relatively lower depreciation of the Rupee against the dollar, as indicated in A1, and the down trend in Indian inflation (through its effect on real exchange rates), provide additional leeway to cut Indian interest rates.

Q4: What's your outlook on the RBI's monetary policy? Do you think, it should cut rates now since CPI inflation has come down, while growth still remains tepid?

A1: The time for a rate cut arrived several months ago with the dramatic change in inflation trends. Every piece of new inflation data has reinforced my earlier conclusion that it is time to cut rates.

Q5: When do you think the RBI will start cutting rates? What is it that the RBI is waiting for to cut rates?

A5: The RBI seems to have three reasons for not cutting rates last month. A slow downward adjustment in inflation expectations, uncertainty about future inflation shocks and the need to avoid the discomfort of having to raise rates in next year or two after reducing them now. This view was supported by financial market participants who believe in Chicago-Wall street monetarist approach & the IMF. At some point the sharp downtrend in inflation will force them to change their view, resulting in monetary loosening

Q6: What's your outlook on the Indian economy in fiscal year to March 2016? What factors you think will be driving growth?

A6: I had forecast a 1% rise in the growth rate for 2014-15 (over 2013-14: ie 5.7%) with a margin of 0.25% on either side. The delay in loosening monetary policy will likely push growth to the lower end of my range of 5.45% to 5.95%). Growth in 2015-16 is still likely to reach the 6.5% to 7% range that I had given after the June 2014 budget, because of the structural reforms underway and the likely change in macro policy (macro twist) to tighter fiscal policy (lower Revenue deficit) and looser monetary policy (lower repo rates).

Q7: What's your outlook on the government's efforts to reduce the budget deficit? (do you think, it will succeed in containing budget deficit at 4.1% of the GDP in Fy15 and 3.6% in Fy16)?

A7: After the June budget I had said that despite the difficulty of attaining 4.1% FD, the FM would likely have to achieve it to establish credibility. This is still the most likely outcome. I also believe the FM will stick to the targets for next year. There are some voices that are urging a weakening of these targets to stimulate growth through higher investment. In my view this would be a serious mistake. The best way to stimulate investment is to reduce Revenue deficit to zero and use the space created to increase real infrastructure investment within these fiscal deficit targets.

Q8: How do you view the drop in global crude oil prices and how will it impact inflation, budget deficit and the cad in India?

A8: The decline in crude oil prices has clearly helped in reducing inflation, the CAD and oil related subsidies. But we shouldn't forget that it also indicates a lower than projected World growth & and growth of global demand. This is part of the reason for slower recovery of manufacturing sector world wide and in India, which is also reflected in  lower revenue growth.

Other Questions:

Q9: How much of a drag will the World economy be on the Indian Economy.

A9:   There are two aspects of this issue. One is that an analysis of the acceleration in the growth of the Indian economy and the World economy from the early 1990s and subsequently in the early 2000s and the negative impact of the Global financial crisis shows that in per capita terms India's economy slowed by about 3.6% while the World economy slowed by 1.2% (in per capita real growth). Thus at 2.4% or 2/3rd of the deceleration is due to domestic factors and can be reversed.
     Given the preceding boom and the continuing high investment in China the excess capacity in manufacturing and mining continues. This continues to put strong competitive pressure on manufacturing recovery in India and across the World (Ultra globalised sectors). However, there is scope within every sub-sector and industry to improve investment in and output of intermediate quality goods which are less globalised and less subject to global competition.

Q10: Some people have called for an easing of monetary policy, others have called for an easing of fiscal policy to increasing government expenditure on infrastructure. What do you think.

A10: In my view the best macro policy for India at this time is an easing of Monetary policy and a strict adherence to the fiscal deficits targets. In fact Government should go further and reduce the Revenue deficit further to zero, the original FRBM target for revenue deficits: In other words the government should shift its expenditures more sharply from subsidies and consumption/current expenditures to infrastructure investment, while sticking to fiscal deficit targets [ http://dravirmani.blogspot.in/2013/02/macro-pivot-rebalancing-of-indian.html , http://dravirmani.blogspot.in/2013/08/managing-indian-macro-pivot-twist.html ]
   As in the case of Indian States so is the case for different countries- One size does not fit all. What is the best policy for Europe, namely an increase in fiscal deficit through greater expenditure on infrastructure investment, is not the best policy for India. India needs monetary easing as real interest rates have increased sharply during the last 6 months or so because of a sharp decline in trend inflation [  http://www.btvin.com/videos/watch/10117/rajan-called-for-a-%27make-for-india%27-policy-over-%27make-in-india , http://www.youtube.com/watch?v=vL7voeGkMvQ&feature=youtu.be   ]

Growth, Exchange Rate & Expectations

 Q&A with Outlook (L Nayar)

Q1: Why there is such a marked change in perception about India's growth prospects and improvement in Indian currency since RBI governor Raghuram Rajan took over?

A1: these are two different questions with opposite answers.

 Q1a: Why there is a change in perception about India's growth prospects.

 A1a: Growth prospects have worsened as shown by the GDP data for the first quarter of 2013-14 (April-June). Consequently all forecasters, including the government related bodies, have reduced their forecast for 2013-14 by 1% point or more.

 Q1b: Why there is such a marked change in perception about India's currency and improvement in Indian currency since RBI governor Raghuram Rajan took over?

A1b: There are two reasons. The movement of the dollar above Rs65 was clearly due to pessimistic expectations, a problem that economist call overshooting. Raghuram Rajan the new RBI governor has, through his maiden speech on the first day of taking over at RBI, effectively used his global reputation to remove irrational fears and re-establish RBI credibility. This brought the dolrar below Rs65.  The further movements below this level are due to small positive developments on the external front, like a narrowing of the trade deficit and stabilisation of expectations about future fed actions.

Q2: Have the fundamentals changed in anyway or is it only a change in perception? If so will the change in perception including among private investors bring cheer to Indian economy?

A2: It is due to a change in perceptions of short term financial investors alone. There is little or no change in the perception of long term investors, and the decline in GDP growth coupled with marginal improvements in balance of trade have a negative effect on balance.

Q3: Can a single person - the RBI governor be the change agent or is it unwarranted expectation?

A3: The RBI Governor can only change perceptions regarding aspects that are covered by RBIs mandate and act within its own mandate, which is monetary stability. The governor can also play a more activist role in financial market reform, which will have a medium term effect on efficiency & growth. Raghu's speech gives an indication that he intends to play such a role to promote faster financial development. Beyond this the expectations are unwarranted.