Friday, November 18, 2016

Macro-economic effects of the Great Event

A lot of people have been talking about macro-economic effects of the Great Event. Some people think these are positive - others disagree.

The thing about macro-economics is that it is easier to track and evaluate progress against. Being composed of hard numbers, macro-economic effects are less woolly than social or empowerment based benefits.  If the macro-economic effects are adverse - bankers everywhere will discard the policies that triggered them like an old shoe.

I want to capture what I feel is the main dynamical aspects here. I am doing this because unless there is a positive movement along these aspects - the entire demonetization will fail in real economic terms.

1) Increase in bank deposits - This was something the various Indian banks were happy about. The demonetization would force cash out of private cash reserves and into bank accounts that are easier to track. This notion received support from both the RBI and private bankers in India. Even some international economists felt this was a likely positive outcome.

A lot of people on the development side also said that if India was "cashless" - people would be able to use their Aadhar number much more effectively to access GoI and state government benefit schemes. Combined with the biometric Aadhar identifier and a secure encryption system - one could really see the core of India's economic reality change rapidly.

That said - as the great poet said - Delhi hanuz dur ast.

On Quora - there was a very interesting thread that people participated in - and the main conclusion was that there isn't going to be a significant shift in the amount of money stored in banks. A number of new accounts are likely to be opened, but it is unlikely that they will be operated with large quantities of cash sitting around in them. The people with piles and piles of money will never go to a bank to store it as that would attract the attention of the tax authorities and the people with small piles of cash don't really like to use bank accounts for the reasons below - so even if they open an account it will just have some nominal amount of money for a few days and then it will be withdrawn once the notes are all exchanged.

The real limiters here stem from the fact that most ordinary people in India (who use cash only) don't go to banks because

  1. There are no banks close by. (true for most of India - though this may change as paytm type operations become more common). 
  2. When they go to banks - they feel that banks are biased against them (basically a trust issue - "they treat us like dogs because we are poor/low caste", "they make the account in the husband's name" etc...).
  3. They spend all their time working and don't have time to go to a bank. (this I feel is really true for the so-called "daily wagers" - who only get paid at the end of a long hard day after the banks have closed). 
  4. They are operating at subsistence level and living day to day and do not have any real savings. The money they "save" doesn't even pay for the trip to the bank. 
My personal sense is that the factors limiting the growth of bank deposits in India are unrelated to "black money" and more driven by cultural and economic factors.  India is economically and culturally in the same space that the US or Europe was during the Great Depression. 

2) Lowering of interest rates - This trend was anticipated and many were salivating over it. The basic logic here is that if the deposits rise - banks don't want to have money sit around and pay high interest on it. So they lower the interest rate and hope that people will borrow money and the difference between the interest rates for lending and deposits will be sufficient to support the banking operations.

I call this the "Brahmin's Pot" theory - after the famed Panchatantra tale of the Brahmin and his Dream.If the deposits go up and if there are people willing (and able) to take out loans and the new businesses the loans help start do well then there will be enough interest income coming into the banks to allow them to pay interest dividends to the depositors (or central bankers they actually borrow money from)... That is a lot of ifs and buts and a crucial component of this is that the economic slowdown caused by the cash flow problem not impede the growth of businesses created with the newly issued loans - otherwise the banks will simply be saddled with toxic debt and no dividends will ever come back to the people who deposited the money.

A key limiter here is that people in India don't have credit histories that are easily tracked. This makes lending a very risky affair, everything has to be collateralized in some way and that limits the rate at which people take out loans. Some people have said the system in India favors companies that borrow big sums of money and default on those loans, and this demonetization is actually just a fancy way of pulling wealth from the poor and shoving it into bad loans to the rich.  That may or may not be true - but merely lowering the interest rate does not have the same effect in India as it does in the US where credit-worthiness is a much more transparent affair. India does not have a personal credit scoring system.

3) Other stuff:  A number of other gray areas like "taxation increase" and "inflation" or "deflation" have been bandied about - but I don't see any way to really estimate which of those will actually occur.

Off topic - 

I saw this YouTube video - it really brightened up my day. I can say that things are going in the right direction in some parts of the world. I wish I could say the same about other places.


At 2:42 AM, Blogger Wise_Ass said...

Excellent explaination of various facets of the Great event by Bibek Debroy

At 5:16 AM, Blogger maverick said...

Dear Wise_Ass,

Thanks - I will look through it. Although I confess "Shyama Prasad Mukherjee Foundation" doesn't exactly shout out neutrality and I have never been able to listen to Ashok Malik without falling asleep mid-way through the conversation.

I hope I am clear about what I am saying in that post.

Unless the rising deposit rate prompts a significant increase in the actual lending (either via lower interest rates or larger loan amounts) - the economic decline created by the demonetization will not be reversed. The economic decline will overpower the cash inflow and unless GoI cooks its books the growth rate should decline. Now the decline may appear minimal as the revenue model in India is less sensitive to cash transactions but what the demonetization has basically done is increased the real taxation in the economy. This should increase inflation and create the same dynamics that we see when the Federal Reserve cranks up the inflation rate in the US. We are likely to see a recession in the Indian economy.

One metric to calculate is what fraction of the old 500/1000 Rs amount was recovered and how much tax was extracted from such recovery. That will tell us what the impact on the real corruption will be.

If I am a corrupt police officer the next time I catch you driving without a license I will demand twice the bribe I did earlier - you might have gotten away with slipping me a Rs 1000 note earlier, but now I need to make that back the Rs 1000 you gave me earlier - so I will need Rs. 2000 to look the other way - i.e. Rs. 1000 for this time and Rs. 1000 for the last time you paid me.

Alternatively if I am a big industrialist with a lot of Rs 1000 notes stuffed in my safe in Mauritius, I will need to take a much bigger bank loan with at the lower interest rates that recovery of your Rs 1000 and 500 notes creates. Once I get the loan I will default on it because you see I have to recover the amount I lost in my Mauritius vault.

Alternatively if I am the trustee of a major temple, I will take all my Rs 500 and Rs 1000 notes and put them into the hundi while removing all the Rs 100 and new Rs 500 and Rs 2000 notes I can. I will ask God for forgiveness afterwards, but then I am not going to be donating to the BJP MLA's campaign like I did last time - I relied on that man to at least tell me what his PM was going to do - that man didn't even do that!

Never underestimate the criminal mind. It will always find a way.

At 9:21 PM, Blogger Dustin T said...

It is an informative post.

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