Demonetisation of Rs. 500 and Rs. 1000 Notes in India and its possible effects

Demonetization of Rs. 500 an Rs 1000 Notes in India and its possible effects

This article has Five parts

Part-I

Benefits of this process

Direct Revenue to the Government

1)     If we look at the balance sheet of RBI¹, every single note issued by it is a liability (as RBI guarantees to pay the bearer specified amount as printed on the note). So, if by 30^th December any part of recalled currency notes of Rs. 500 and Rs. 1000 denomination does not return back to RBI (which, as per some estimates may be as high as 2-3 lakh crores) the unreturned portion of say, 2-3 lakh crores will vanish from liability portion of RBI’s balance sheet, as the guarantee of RBI to pay the bearer of note lapses. Therefore, RBI will have to show that amount as an extraordinary income in Profit & Loss accounts for FY17, which it could either pay as dividend to government of India or use it to re-capitalize some of its subsidiaries for infrastructure financing or use it for other purposes.

2)     It is sure and clearly visible from trends that despite threats of prosecution from tax authorities, people are flooding their savings and current accounts with money more than the specified limits. The higher deposits, if not backed by satisfactory explanation will attract penalties as high as 50-60%. Several businessmen will also try to justify the high cash collections on account of higher sales or revenue generation during FY16-17, this will also attract tax @10-30% + surcharges. All this process is going to earn the government a windfall of tax revenues.  Estimates vary from 1-3 lakh Crores.

3) The government is likely to generate 2-5 lakh crores of revenue in this process of demonetization. This amount is huge, if we see total fiscal deficit target for FY16-17 it is Rs. 5.33 lakh crores. Government might be in a situation to cement this gap up to 100% in one go. During last budget lots of notable economists criticized the government and finance minister due to its decision of fiscal contraction despite poor shape of infrastructure in the country.  Now, this decision gives room for fiscal expansion and increase planned expenditure and that without affecting inflationary forces, leaving room for RBI for monetary easing.  

1.   RBI-BalanceSheet-Page-144 https://rbidocs.rbi.org.in/rdocs/AnnualReport/PDFs/11P2E7FC90CC39794A068E24313AFE0D535F.PDF

Banking Sector Overhaul and Disinvestment

1)     Lots of undeclared money will come into the system, increasing liquidity.

2)     Banking sector will get a fresh dose life and blood due to high cash deposits. It can start another phase of lending to boost economy and generate employment. As hoarding cash has already been discouraged and technology is ripe for low cash/cashless economy more and more transactions will be routed through banking channels, creating more avenues for expansion of their business, opening of new branches, new offices, creating new jobs etc.

3)     Due to high deposits and that in the form of CASA (Current Account and Savings Account deposits), a source of low cost funds for banks, there is more money available for lending, this will increase the lending and NII (Net Interest Income). Banks will also be able to Write-off more and more NPAs and clean their Balance Sheets. This will tremendously impact their market valuations and government will be in a situation to proceed with Disinvestment plan at rather attractive share prices.

4)     Government had set a target of generating Rs. 56000 Cr. through disinvestment of public sector undertakings. As the share prices of government owned banks will increase, it will make it easier to meet the targets or overachieve it. As more money will go to government it will cement its budget deficit and bring it in a situation of a large fiscal expansion and that without even touching the inflationary forces.

5)     Under such favorable situations in banking industry, government may go for its long awaited plan of mergers and amalgamation in PSU banks to create larger than life, International size/standard banks in India, which are need of hour, as source of large scale finance is needed for infra projects and era of Development Financial Institutions is already over.

6)     The huge availability of CASA and increase in turnover and transactions in banks, banks could easily lower lending rates and banks will also be able to lower the interest rates on loans, which will stimulate agriculture and industry in the country. Cheap capital is one of the prerequisite for stimulating growth in an economy.

Economy and Financial Markets

1)  As rightly stated by Jean Dreze (Welfare Economist and former member of UPA’s National Advisory Council) that "Demonetization in a booming economy is like shooting at the tyres of a racing car," this decision is going to shave off a few percents (%) from the GDP growth numbers, may be 2%, as predicted by notable economist and former prime minister Manmohan Singh in his historic address to Rajya Sabha.

2)  Demonetization process directly sucks out the liquidity surplus from the market. Most of the transitions (60-70%) in India are cash based and you can’t transform a cash based economy into a cashless economy overnight. This decision has already impacted the transactions across the board. Ask any retailer/wholesaler/hotel owner/restaurant owner or any other business owner per se, if this decision by the government has impacted their business? ‘Ayes’ will be the most common answer.

3)  Overall demand has fallen as cash (especially change) has become a scarce ‘commodity’ to possess. Supply of cash in the market is lower, especially notes of lower denomination like Rs.100 and Rs.500 and Rs. 2000 is almost of no use, as nobody is willing to provide you change of Rs. 1900 for purchase of Rs. 100 goods. This is seriously going to impact the market and the booming economy. Financial markets, often called barometer of economy, has already indicated this trend in advance. So the big question arises why the government has shooted in its own foot just before the marathon? We will try to figure it out in part-2 of this article.

Cashless Economy

1)     The present situation has already led to surge in amount and volume of cashless transactions. More and more no. of people is switching over to online and cashless modes as no alternatives are accessible. Installation of POS terminals, use of mobile wallets like Paytm etc. have surged like anything. But how long this will continue? Once the new currency notes are available in the market, are people still going to use online means?

2)     To answer this question we should first see how new notes are being printed and being supplied. Total value of Rs. 2000 currency notes on order for printing is Rs. 7 lakh crore (50% of total recalled currency notes of Rs. 500 and Rs. 1000). This clearly suggests that the government wants to create an artificial deficiency of usable currency notes (change, Rs. 500, Rs. 100 and other smaller denomination) in the market to continue to promote its agenda of cashless transactions via mobile banking apps and cards as most of the transaction that happen on day to day basis are low value transactions. In coming days, even after demonetization is over, people will have to willingly or unwillingly switch over into cashless mode as government may secretly suck back the more currency notes of lower denomination from market via banking route.

3)     There are several benefits of a cashless economy or society. As, most of the transactions could be easily identified and traced, consumption pattern, demand, supply inflationary trends etc. could be identified, it helps the central bank/government to take more accurate decisions based on quantitative data of consumption and velocity of money. Transactions, turnover, tax liabilities etc. could easily be identified and measured. High speed mobile networks 3G/4G penetration is ever increasing, smart phone penetration has increased, technological awareness of people is increasing therefore time is ripe for proceeding towards this direction.

Poverty-Inflation-Subsidy Cycle

1)     India has developed a very unique problem especially in agriculture sector. If government keeps MSP (minimum support price) higher to help farmers earn higher income, it increases inflation, makes raw material costlier and make poor die of starvation or suffer due to malnutrition. If MSP is lower Farmers don't get enough money to meet their expenses and they suffer. Several farmers commit suicide everyday due to poor market rates and lower profit margins. Therefore government generally keeps the MSP higher to incentivize farmers and keeps the processed grains cheaper via subsidizing the finished products to support poor consumers. In this process the government bears high expenditure but has no other option but to continue with the trend. Problem is increasing day by day as income of lowest strata of population in not improving but MSPs have to be revised almost every year.  There are also political compulsions to do so.

2)     This problem has its roots in unequal distribution of wealth. Rich (especially tax evading rich) get money surplus as taxation process fail to absorb their surplus money as they are invisible to the system. They use this surplus money for consumption and sometimes even wastage. Their consumption creates artificial demand in the market, which on one hand drive economy but at other hand increases inflation. This inflation increases the cost of almost all factors of production. Therefore, inputs and labor cost become high but at the same time income of a poor farmer /salaried class or a micro/ small manufacturer does not increases with the same pace and their standard of living start deteriorating and government has to intervene by way of subsidizing the products. This leads to two way control of market at both ends input as well as output.

3)     Rising inflation also compelled the central bank to do monitory measures to suck out excess of liquidity from the market by increasing policy rates. But this too has becomes counter-productive as people who transact through black market remain mostly unaffected but doing business for poor/normal public becomes difficult. Economy slows down but inflation persists. RBI blames central government for fiscal measures and government blames RBI for monetary measures. This is what has been happening in India for decades. 

4)     The only possible long term solution to the above problem is to make the distribution of income more uniform if not equal, reducing the budgetary deficits and letting the prices to be controlled by market forces. Which neither the politics nor the welfare economics allows.  Demonetization process is likely to touch even this grey area in multiple ways:

a)     It has suck out excess liquidity from the market, especially the kind of liquidity surplus provided by the black money.

b)     It has led to more uniform distribution of wealth as some of the rich used poor for laundering their cash by employing them to exchange cash for them or getting it deposited in their bank accounts for some commission.

c)     Government may generate anything between 2-5 lakh crores in the process and use it to lend smaller sums to poor via more micro loans at minimal interest rates or on their benefit schemes or by other means or ways possible.

d)     Poor might not become rich in this process but large no. of rich will sure become poor in this process. This is likely to down the rich-poor income gap and lower wasteful consumption. 

.......to be continue, more  details to be covered in 2nd, 3rd, 4th and 5th part.

The MODI Phenomenon

The rise of so called Hindu Nationalist leader and India's principal opposition party BJP's PM in waiting Narendra Modi is unique in several ways. He is being loved and hated by people like no other leader in Indian Political History has been. Here is an attempt to understand some aspects of the phenomenal rise of his influence over the Indian people and society.

His Supporters: 

1. Die hard supporters: His supporters have some kind of blind faith in him and consider him as some kind of incarnation from heavens for resolving all the problems being faced by this country today. There is nothing wrong with his die-hard supporters; they think they are serving their mother nation by serving him. Patriotism factor has been effectively capitalized by Modi Machinery to create such an enormous supporter base which is even ready to kill or get killed for him.
2. Normal supporters: Frustrated with the incumbent govt. there are plenty of people who are ready to support him as an alternative to the existing. They have or don’t have any good idea about his role in 2002 incident but are of forgiving class having faith in change of hearts and souls.

His Opponents: 

1. Strong opponents: His past record of handling of Gujarat Carnage and the subsequent developments under his reign in Gujarat has created an equally fierce force against him which is even ready to go thermo-nuclear any day, to prevent him from acquiring the national stage.
2. Normal opponents: These are people having their normal choices and don’t think that Narendra Modi would offer anything different and due to normal, political or ideological preferences are opposed to him.

Neutral People: 

There is also an undecided class which can not be classified in any of the above categories, that is his supporters or opponents. This class has further divisions:

                                                                

 Category-1

1. A- These are people who have clear idea about his wrong and right deeds and having an overall negative outlook but yet confused and undermined.
2. B- These are people who have clear idea about his wrong and right deeds and having an overall positive outlook but yet confused and undetermined.
3. C- These are people who have clear idea about his wrong and right deeds and having no overall outlook yet

Category-2

1. D- These people have no idea about his wrong and right deeds and having an overall negative outlook but yet confused and undermined.
2. E- These people have no idea about his wrong and right deeds and having a positive outlook but yet confused and undetermined.
3. F- These are people who have no idea about his wrong and right deeds and having no overall outlook, confused and undetermined.

Now let’s move to strategy room of Modi and company and look how they are dealing with these separate classes of people and adopting different methodologies to convert them in their favor. 

Generally a multi polar/colored identity system is working in India to deal with such classification and diversification of people for example:

A Sonia Gandhi to lure Gandhi-Nehru supporter base, a Manmohan singh for clean image and representative of intellectual community, a Shinde as a representative of Dalits, a Antony to represent minority (Christian) interests, a Rahul Gandhi to represent the youth power, Salman Khursheed for Muslim representation etc. Each one among the above faces in top Congress leadership or the govt. serves different unique purposes and has created a multi colored and diverse power block. 

Similar diversification is also found in regional parties (but a miniature version) like Azam Khan, Mulayam and Akhilesh combination representing Muslim, Yadav and Youth aspirations.

BJP doesn’t has that luxury and that much diversified spectrum of leadership capable to represent the interest of each and every corner of the nation from Kashmir to Kaniyakumari and from Christians to Hindus, from Schedule tribe to Forward Brahmins and from a rural farmer to a world re-known economist. 

So! What alternative lies with the BJP? 

The answer lies in personality politics. Creation of a larger than life multi colored personality capable enough to represent each and every section of the society. The result is obvious the anointment of Narendra Modi as the face of the party. His multi colored personality and ability to strike chords with everyone else is doing miracles these days. 

His Personality 

His personality has evolved over time; one time considered an intolerant Hindu Fanatic and dogmatic persona, ready to eliminate a whole religious civilization any day soon, is today known for his works for uplifting the Gujarat from an economic, social and political turmoil to a fast developing, industrialized and rapidly urbanizing state. His performance of governance and administration got recognition world over, corruption free, business friendly and growth oriented polity has won him universal applauds.

For each section he has a different face, for Business community he is a modest reformer, enthusiast statesman and no nonsense politician capable enough to correct India’s credit rating and future outlook just from his little advances in opinion polls. For Middle class he is a dream merchant selling dreams of World class cities like GIFT, Wide roads, infrastructure and entertainment hubs, jobs, financial security etc. For Poor he is a poor Chiawalah turned Chief Minister having a firsthand experience of kind of life in slums and poverty. To some sections he is a backward caste leader who would make India’s first backward PM and end the dominance of Forward Caste at top. For youth he is the one, who would bring unprecedented economic growth and generate employment opportunities, a technology friendly leader who would turn the present lackluster administrative machinery into an effective one. He would make India corruption free and make us the superpower. He would attack Pakistan and end terrorism in the country. Different people have different definition of him, and different reasons to support him. 

Why he is so effective? 

The answer once again lies in psychology. He is a mass manipulator of a very unique breed. He understands where to hit hard and at what point of time. How to connect with locals anywhere in the country. He has very high diversity in terms of experience and is effectively using his huge experience base in dealing and converting people. 

Modi is not a new phenomenon in Indian Politics; he has been a nightmare for the congress party for at least last 15 years. Congress kept on ignoring him considering his regional limitations but he kept on evolving and evolving over time and acquired the present giant mass and size. There is no reason but the less than effective Gujarat Congress and ignorant central leadership of congress responsible for his present rise. 

Best Defence is offence ! 

This is the strategy presently being followed by Narendra Modi. 

He has pin pointed all the loop holes in ‘Congress Super Structure’ over the time and has ready to fire missiles in very high alert mode. I still wonder why Political Pundits never consider the timing of rise of NAMO. His timing of rise is spectacular especially with the sense that now congress is standing at one of the weakest point of its history of 125 years or so. His offensive campaigns, attacks on topics like Foreign policy, Defense preparedness, dealing with terrorism, economic policy, social cohesion, administrative efficiency, corruption, governance, leadership or anything else would seem more than justified to any rational being both in the theoretical and practical sense. 

Now consider his hyped, flawed statistics of Gujarat Development or his poor knowledge and understanding of History, Economics and International relation. This weakness can be easily felt if one pays attention to his rather frequent speeches at public rallies. The congress and other Modi baiters work 24x7 to pinch holes in his speeches and data he presents but at the end of the day there is hardly any impact over him or his audience. 

The impact assessment tells us a different story. His impact is far greater and intense than the parties and people opposed to him. What he actually does is to put a number of blames and accusations against his rivals. Though all his accusations are not always true to core or wells researched but are always in line with the public perception and general belief patterns. Right or wrong is not a question for him but the acceptability of his assertions, things are right as long as they appear true and acceptable.

He is conducting rallies after rallies in a very quick succession, everyday he has new set of facts, data, substance, claims, accusations and blames which keep busy the congress core team in research and data mining. By the time Congress comes with errors, omissions and factually correct answers, he has already made new statements in a new rally somewhere else and the discussion topic has shifted to the new controversy he just created and virtually there is no one available to buy congress research works of previous episodes. Even that research is made a subject of debate and discussion by the second and third line leadership of BJP causing frustration, helplessness and anger among Congress cadres and they end up abusing and baiting Modi in undemocratic fashion.

Though he may not be considered a class of a person, doing high quality politics but what surely he has mastered in is quantitative politics. Do what appeals to masses rather than having an appeal for limited no. of classes, it is also a time tested formula in Indian Polity Lalu Prashad did it in Bihar and Mamata didi did it in Bengal. A factually incorrect statement which appeals masses is preferable to a factually correct one but having limited audience. His speeches have humor, satires, mimicking, comments, jabs, fun, energy, enthusiasm, aggression or anything else needed for a perfect show. He has done to political speeches and rallies, what a 20-20 version of cricket has done to the one day and test cricket. 

We are living in a country where political parties have to convey to the rural and uneducated masses, every election, that Congress means Nehru and Gandhi and has a symbol of ‘hand’ and BJP means Atal and Advani and has a symbol of lotus. Recently a rural women, when asked, whom she is going to vote for, replied MODI and when asked what symbol she would press to vote him, she was clueless!! This might not be case for every Indian but the things worse if not worst.

Go to sub-urban/rural India, and ask people who are Manish Tiwari, Shashi Tharoor, Digvijay Singh, Rashid Alvi and Ajay Maken, or the Prakash Javedkar, Minakshi Leki, RaviShankar Prashad or the Nirmala Sita Ram and see what answer you get. These people only know or have good idea about top leadership like Sonia Gandhi, Rahul Gandhi, Manmohan Singh, Shinde, Chidambaram etc. or Advani, Modi, Sushma Swaraj, Jaitley etc. 

While the attack from BJP side is being led by top leadership like Rajnath Singh, Advani, Modi, Swaraj etc. the Congress is being defended by 2nd and 3rd level of leadership who are not even widely known faces. For some unknown reason the top leadership of congress is way too shy to face public which is doing more harm to Congress than any good. 

Possibilities of RJD-NDA Alliance

NDA alliance has ended in Bihar on the question of bigger role for Modi.

2. If elections happen today, there is more probability of a hung assembly, either with the JDU or the RJD emerging as single largest party. 

3. In any case (as of now) none of the three parties are in a condition to form a govt. on their own and almost zero possibility of any kind of alliance between them. 

4. There are rumors about JDU+Congress +/- LJP alliance in the state.

5. The recent inclination of Nitish Kumar towards Congress has increased the possibility of such an alliance; Congress has also softened its stand towards JDU. 

6. The presence of Congress in Bihar is almost negligible and would be of limited help to JDU, the base of LJP (a stand-less and agenda-less) party has also contracted. 

7. Still a pre-pool alliance would increase vote percentage, may provide them the needed thrust to win over the state again. 

8. After the NDA split the Main competing forces (for assembly) are JDU and RJD with BJP being at third position, so JDU has more threat from RJD than from BJP. 

9. Therefore the first Priority of Nitish would be to contain RJD.

10. Split with BJP and the Secularism rhetoric of JDU would certainly win JDU handsome amount of Muslim Votes and destabilize RJD's M-Y equation further, though there would be equal spill of upper caste votes but that won't go with RJD but with BJP which is a secondary threat.

11. With almost half of backward votes + newer Muslim votes + Maha-Dalit votes and a possible pre-pool alliance with Congress and LJP, the future looks rosy for JDU. 

12. If Congress ditches RJD in the same fashion as JDU ditched BJP what alternatives Lalu Prashad has ?

13. The first priority for Lalu Prashad is to gain power in order to keep his party alive, intact and united. 

14. In case congress ditches RJD and Muslim votes has to be shared with JDU, RJD has practically no alternative but to make an alliance with BJP for its survival. 

15. This may lead to further spill of Muslim votes but the addition of upper caste votes would compensate the loss and the alliance would certainly have higher vote percentage to seat conversion ratio. 

16. This kind of alliance would be the worst nightmare for JDU and its party chief Nitish Kumar. 

17. BJP in Bihar is more potent partner than the Congress and LJP combined, both quantitatively and qualitatively (as RJD, Congress and JDU share similar kind of vote bank). 

18. There is less to lose than to gain, if RJD comes under the ambit of NDA. 

Analysis :  

If we analyse the data of 2010 elections minutely, there were no significant gains in the percentage of votes for JDU and BJP. JDU got 22.61% of votes from an earlier figure of 20.46%, an increase of mere 2.15% but a significant increase of 27 seats while BJP getting 16.46% of votes from an earlier level of 15.65%, a mere 0.81% increase in vote% but a whopping 36 seats increment. 

What made this possible ? 

The answer is, 4.61% loss of RJD vote share. 

In First-past-the-post voting system, which is prevalent in our country, you are not always bound to perform, in case, if you are unable to perform or increase your vote share percentage, play negative politics, cut and divide the percentage votes share of your opponents, you'll still win with a very small margin. 

Check the 23.45% share of RJD in 2005 and 20.46% share of JDU in the same year, still the JDU has 34 more seats than RJD? 

In 2010 it was the loss of 4.61% of vote share of RJD which decreased its vote Share% to seat conversion ratio to 1.17 (1.17 seats for every one percent vote share) from earlier figure of 2.30 against a united and consolidated strength of JDU and BJP. 

Similarly, LJP, whose Maha-Dalit vote bank loss + Promising NDA govt. made it to loose 4.35% vote share and around 7 seats. 

Lets take an example to understand this Political Maths in a better way : 

Suppose there are three parties A, B and C with A and C, being an alliance partner. A is having 35% share, B having 40% vote share while the C having 25% vote share. 

1) As the A and C are having an alliance They'll surely win due to higher vote share. 

2) Now, the alliance breaks and all parties are competing with each other who will win ? 

The simple answer seems to be B (with highest 40% vote share)but the same is not universally true. The game rests with vote types. If B and C share similar kinds of votes (say of same or similar caste/religious groups ) 'A' will still manage to win. B having higher percentage of vote share would loose because C would cut short the height of B, lower than A, who would win with a very small margin of votes. 

Similar conditions exist in Bihar, after the NDA split, RJD =>JDU's vote share percentage, but JDU will gain newer Muslim votes and would diversify its portfolio with diverse kinds of votes ranging from MahaDalits to Backwards and even Muslims. The BJP would take away significant portion of upper caste votes and the Congress and LJP (if not in alliance with RJD) would eat some amount of  Muslim and Dalit votes respectively. As a result despite RJD is having highest vote share%, JDU will sweep elections and form the government. In case JDU enters in alliance with Congress and LJP its Vote share% to seat conversion ration would get further sharpened.

The Diversity of votes is a very important consideration for winning any election and that is the reason why Congress has ruled India 80% of time and party such as BJP having limited section of voters in limited geography always ends with disappointment. 

In Bihar, JDU is having widest portfolio of voters representing different castes and religions, ethnic and economic groups, which makes it strongest player in Bihar's politics. 

If RJD somehow makes and alliance with BJP, its diversity and strength would surpass that of JDU and all other parties putted together, as the BJP and RJD have unique vote-banks with almost nothing in common. So the diversity would increase the vote share% to seats conversion ratio by multiple folds.