MINISTRY OF FINANCE GOVERNMENT OF INDIA. Demonetisation. Module Contemporary Themes in India s Economic Development and the Economic Survey

Transcription

1 MINISTRY OF FINANCE GOVERNMENT OF INDIA Demonetisation Module 13.1 Contemporary Themes in India s Economic Development and the Economic Survey 1

2 Overview Objective and Background Costs and Benefits Markers of Success 2

3 Source: NDTV, DD 17/06/17 Demone-sa-on and other Metachallenges (Module 14) 3

4 Demonetization The Beginning 1. On 8 th November 2016 Prime Minister Narendra Modi announced that two of India s largest notes INR 500 and INR 1000 will cease to be legal tender except for a few purposes percent of cash in circulation (17.7 lakh crores) was rendered invalid, and these notes had to be deposited in banks by the 30 th of December 2016 (Go to Chart) 3. International example: only sudden demonetization under normal circumstances 4

5 25 Growth in average currency with public (%, yoy) Go back 5

6 Cash shortages for some time 6

7 To prevent/curb: Objectives of demonetization Accumulation of black money generated through income that was not declared to the tax authorities Corruption Currency counterfeiting Use of high denomination currency for terrorist activities Perhaps, most important was to signal a regime shift on tolerance for illicit activities and tax-noncompliance 7

8 Black money rendered useless 8

9 What is black money? Origin vs Function Function Transactions Store of value White Origin/nature Company pays employee salary in cash; payment and receipt are declared to tax authorities Household keeps savings in cash for emergencies Black Small enterprise pays for input in cash; neither declares the transaction to tax authorities Businessman hoards undeclared cash, with a view to distributing it to his candidate during elections 9

10 Cash-to-GDP ratio in India is quite high and higher than that for comparable countries India Log of GNIpc PPP*(Atlast Method Current $ 2015) Source: World Development Indicator; International Financial Statistics 10

11 Consumer transactions in India are predominantly carried out in cash Consumer Transactions Carried Out in Cash 100% 80% 60% 40% 20% 0% Volume Value 100% 98% 96% 94% 90% 86% 85% 69% 68% 57% 47% 45% 43% 38% Indonesia India Mexico South Africa China Japan Brazil 55% 48% 14% 11% United States United Kingdom Source: PricewaterhouseCoopers

12 Cash-to-GDP steadily rising over time, including high denomination notes 12

13 HDN used mostly for transactions purposes? Highest Denomina.on as propor.on of GDP per capita (2015) Lower Middle Income 5,000 5,000 Upper Middle Income 1,000 1,000 High Income ,000 1,00,000 1,000 1,000 5,00,000 1,00,000 1,000 5,00, , ,000 1,000 5,000 5, ,000 20, ,000 10,000 1,000 1,000 10, ,000 1, , Note: Numbers above bars are high denomination notes in Local Currency Units 13

14 Estimates of black money Estimates based on soil rates On one assumption: Rs. 7.3 lakh crores On another assumption: Rs. 3 lakh crore (~2 % of GDP) 14

15 Broader analytics of demonetization A money supply contraction but only of one type of money cash Go to chart A tax on unaccounted private wealth maintained in the form of cash black money A tax on savings outside the formal financial system 15

16 Growth in Average Currency with Public and Demand Deposits (%) Go back 16

17 Costs and Benefits Expected Effects (1/2) Money/ interest rate Sector Short-Run Long-Run Cash has declined sharply Bank deposits have increased sharply RBI's currency liabilities have fallen, liabilities to commercial banks have increased Broad money essentially unchanged Interest rates on cash will rise but other interest rates will decline Financial System Savings Increase Increase Unaccounted income/black money Formalization/digitalization Stock of black money will fall as holders get caught in the tax net Digital transactions have increased sharply Cash will recover but settle at a lower level Moderate increase in bank deposits RBI's balance sheet will shrink, if it declares outstanding notes will no longer be redeemed Money multiplier will rise as bank lending increases; broad money effects will depend on RBI response Loan rates should fall, as the durable increase in deposits creates new lending capacity Flow should decrease because of formalization Further increases 17

18 Costs and Benefits Expected Effects (2/2) Wealth Sector Short-Run Long-Run Real estate GDP Tax collections Credibility Private sector wealth will decline, to the extent that high denomination notes are not returned, while real estate prices fall Government/RBI's wealth will increase because unreturned cash will reduce liabilities Prices will decline, as wealth declines and cash shortages impede transactions Will decline, as demand (cash, private wealth) and supply (reduced liquidity and working capital) fall Cash-intensive sectors (agriculture, real estate, jewelry) likely to be affected more Will decline as growth slows, partially offset as tax net snares black money Prices could rise if evasion of stamp duty/capital gains tax becomes difficult Could be beneficial in the long run: greater formalization, less corruption Informal output could decline but recorded GDP would increase as economy is more formalized Increase, as formalization expands and compliance improves Will be strengthened if demonetization is accompanied by complementary measures. Will be undermined if remonetization is slow and if tax arbitrariness and harassment increase 18

19 Digitalization upward trend in digital transactions across all three types of consumers Digitally Excluded AEPS Total and Approved Transactions (Rs. Crore) Affluent Customers Credit Card + Debit Card + PPI (Rs. thousand crore) Total Transaction Approved Transactions Less Affluent Customers Rupay POS (Approved amount in crore) Rupay E-Com (Approved amount in crore) Nov Nov Nov Nov Nov Nov Dec Dec Dec Dec Dec Dec Jan Jan Jan Jan Nov Nov Nov Nov Nov Nov Dec Dec Dec Dec Dec Dec Jan Jan Jan Jan-17 Source: National Payments Corporation of India 19

20 Real estate prices fell as black money transactions reduce As black money in the economy reduces illicit transactions in the real estate sector, which used to be the key sector to evade taxes on property sales, prices fell Early signs are evident as weighted average of real estate prices in eight major cities shows a decline Year-on-Year Quarterly Growth Rate Real Estate Price Q Q Q Q Q Q Q Q Q Q Q Q4 Source: Knight Frank data and Survey calculations 20

21 Assessing the short-term macro-economic Impact Demonetisation is: An aggregate demand shock because it reduces the supply of money and private wealth An aggregate supply shockto the extent that cash is an input to production (for example, agriculture) An uncertainty shock for investors and consumers Impact on informal sector difficult to measure 21

22 What are the indicators? 32 Rabi Sowing for Wheat 10 Rabi Sowing for Gram th Oct 4th 11th 18th 27th Nov Nov Nov Nov 4th Dec 11th Dec 18th Dec Avg 5 yrs 30th Dec 8th Jan 15th Jan th Oct 4th 11th 18th 27th Nov Nov Nov Nov 4th Dec 11th Dec 18th Dec 30th Dec Avg 5 yrs 8th Jan 15th Jan Real Credit Growth (YoY, %) Growth in Indirect Taxes (YoY monthly & cumulative, %) Excise Service Non-Customs Indirect Tax Excise w/o ARM Service tax w/o ARM Growth in Automobile Sales (YoY, %) Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov Two wheelers Medium & Heavy Commercial Vehicles (RHS) -10 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov Jan-15 Passenger Cars (RHS) Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 22

23 The Quantity Theory of Money Theory MV = PY, where M refers to the money supply V is velocity, the rate at which money turns over P is the price level Y is real GDP If M, V either or, the nominal GDP (a negative impact on both price & real activity) For example, a reduction in cash in circulation (or cash in hand) implies that across the value chain of goods and services production, transactions that were in cash will either have to be on credit or not occur 23

24 Quantity Theory of Money Operationalization Two conceptual issues to be considered to operationalize this equation: Definition of money supply restricted convertibility between cash and bank deposits, separate analysis of the two needed Formal and informal economy had different effects we assume only the informal part of the economy affected by cash crunch however there are second-round effects on the formal economy workers in the informal economy may reduce their consumption in response to being laid off. 24

25 Assumptions for projecting currency with public Unreturned cash (assumed to be 10 percent of cash in circulation as of 8 th November) doesn t need to be replaced 75 percent of outstanding old high denomination notes continue to be used as legal tender till end-december Liquidity of Rs notes increases over time from 75 percent in November to 85 percent in December and 100 percent January onwards Velocity of small denomination notes unchanged 25

26 Assumptions for projecting currency with public Replenishment Cycle: November: Rs. 3.2 lakh crore replenished by 30 th November (72 percent Rs notes, 6 percent Rs. 500 and rest in small denominations December Rs. 2 lakh crore available in stock for disbursal in December (75 percent Rs notes and 25 percent Rs. 500) Rs. 0.5 lakh crore injected from RBI s reserve stock of money in December Rs. 1.4 lakh crore printed and injected in addition January onwards: Rs. 1.4 lakh crore printed and injected every month starting January (for December this is in addition to above figures) 26

27 Re-monetization timeline 120% Effective Currency in Circulation as a proportion of Estimated Transactions Demand 110% 100% 90% 80% 70% 60% Historic velocity change 95% confidence intervals 101% 100% 95% 93% 91% 88% 88% 84% 84% 82% 81% 79% 78% 75% 76% 73% 72% 70% 68% 65% 65% 62% 110% 103% 99% 8-Nov-16 End-Nov 2016 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 27

28 Real GDP Growth Forecasts (y-o-y %) Q1 Q2 Q3 Q

29 Excess liquidity increased sharply after demonetization but has not been eliminated even after 7 months... Rs thousand crore Liquidity Shortage Liquidity (Daily LAF) overly tight liquidity Jan Feb Mar Apr May Jun Jul Sep Oct Nov Dec Jan Feb Mar May Jun Jul Aug Sep Oct Dec Jan Feb Mar Apr May-17 overly tight liquidity Demonetisation Excess Liquidity

30 ..so that short-term rates still below policy rates Call below repo Demonetisation WACR Repo Rate Reverse Repo Rate Apr May Jun Jul Aug Sep Oct Dec Jan Feb Mar Apr 2017

31 Markers of Success Increased digitalization or a decrease in prominence of cash as a means of transactions Reduction in cash-gdp ratio as formal savings increase and black money falls Number of new income tax payers as well as the magnitude of reported and taxable income should go up over time 31

32 Maximizing LT gains and minimizing ST costs Faster remonetization will reduce the duration of currency crunch and enable faster economic recovery Re-establish internal convertibility of cash and money deposits to build confidence in the country s financial system Continued impetus to digitalization bearing in mind the trade-off between cash and digital transactions, and sensitive to those currently digitally deprived Eventually, digitalization should also be privately profitable to sustain the digitalization efforts. Cyber-security is another important aspect of this effort 32

33 Complement demonetization with measures to reduce incentives for tax evasion GST with broad coverage to include activities that are sources of black money creation land and other immovable property should be implemented Individual income tax rates and real estate stamp duties could be reduced Income tax net could be widened gradually and, consistent with constitutional arrangements, could progressively encompass all high incomes. (After all, black money does not make fine sectoral distinctions Timetable for reducing the corporate tax rate could be accelerated Tax administration could be improved to reduce discretion and improve accountability 33

34 MINISTRY OF FINANCE GOVERNMENT OF INDIA Exit and the Meta-challenges Facing the Indian Economy Module 13.2 Contemporary Themes in India s Economic Development and the Economic Survey.

35 The Chakravyuha Challenge of the Indian Economy (The Problem of Exit) 35

36 From Socialism without Entry to Capitalism/ Marketism without Exit The Indian economy has embraced the spirit of the market, dismantling the Licence-Quota-Permit Raj. But these were mostly restrictions on entry not exit. 36

37 37

38 The Theory A market economy requires free entry of new firms, ideas, and technologies so that factors of production are guided to most productive uses. But Exit must to entice resources away from inefficient deployment: Joseph Schumpeter: the gale of creative destruction. Problem in public and private sectors, and all economic sectors: Civil aviation, Agriculture, Welfare Schemes, Public sector banks & companies, Infrastructure, Discoms, Regulatory bodies, Labour, Small Savings 38

39 Magnitude of the problem Good firms don t grow large enough over time and bad ones stick around for too long. Average 40 year plant only 1.5 times larger than a new one in India. Thick tail of badly run firms. Average employment of old & new plants in India, Mexico & US Average employment of old & new plants in India, FY1999 & FY2010 Source: Hsieh and Klenow (2014). 39

40 Costs of Lack of Exit Fiscal Costs: Government supports inefficient firms/banksexplicit (bailouts) or implicit (loans). Economic Costs: Misallocation of resources. Hsieh and Klenow (2009) argue that when labour and capital are hypothetically relocated within firms to equalize marginal products to the extent observed in the US it leads to productivity gains of 40-60% in India. Debt and stressed assets overhang. Political costs: Perception of favouring the private sector. 40

41 Examples 41

42 1. Civil Aviation: Air India The erstwhile pride of India today has a negative price. Cumulative losses rising Air India Cumulative Losses since (Rs. billion)

43 2. Agriculture:Lack of Exit from Cereals Change in Acreage under Important Crops (Area in 000 Ha) Progression of Per Capital Income relative to Gujarat Haryana Maharashtra Punjab Tamil Nadu Uttar Pradesh

44 3. Policy persistence: Government Schemes 1 Distribution of centrally sponsored and central sector schemes by duration (in years) Duration of the scheme as of Vested interests create a market of their own. Number of CS+CSS schemes increased from about 900 in to about 1100 in Current government moving towards consolidation. No. of schemes in is around

45 4. Public Sector Banks: Bad Health Burdened by Non-performing Assets. RoA of most banks less than the norm of 1.5 % considered reasonable ( ). Most of these banks with small employment. Capital infusion between 2010 and 2016 above Rs. 1 lakh crore. Return on Assets (%) Total Employment (in 1000s) 45

46 5. Infrastructure Heavily indebted firms in power and telecom sectors. 46

47 Why no Exit? 47

48 Why no Exit? Interests Interests: Concentrated producer interests (farmers, trade unions) vis-à-vis dispersed consumer interests and unrepresented (because unborn) future interests. The former will have the incentive and the financial ability to mobilize more easily. 48

49 Why no Exit? Some Weak Institutions Weak Institutions: They hamper or increase costs of exit. Example: Debt Recovery Tribunals. Banks finding it hard to exit bad loans, private firms unable to exit bad balance sheets. Hence Larger recourse to DRTs but with dismal results. But, share of settled cases small and declining. 450 Backlog of Debt Recovery Tribunals (Rs crore) 350 Total Amount Disposed 250 Actual Amount Recovered Pending Amount

50 Why no Exit? Some Strong Institutions Strong Referee Institutions: Critical for democracy, but functioning a difficult balancing act so as to not impede calculated risk-taking. 4 Cs: Courts. Central Vigilance Commission. Central Bureau of Investigation Comptroller and Auditor General (CAG). 50

51 Why no Exit? Ideology Difficult to phase out entitlements. Sanctification of the Small Political difficulties: Perception of favouring the private sector. 51

52 Solutions Avoid exit through liberal entry: aviation and telecom. Direct policy action: bankruptcy law. Technology and JAM to bypass vested interests. Transparency: explicitly advertise the costs of bad programs like fertilizer subsidy. 52

53 India s Meta-challenges: The Precocious, Cleavaged Democracy 53

54 Overview Meta-challenges: Not about today but entire history India s Transformation-A Washington Consensus Economy But what are the underlying deeper challenges 54

55 Openness to Trade Trade to GDP ratio Trade to GDP and Log Population China India Trade to GDP MYS THA DEU JPA BRA IDN USA IND CHN Log Population 55

56 Openness to Foreign Capital Capital Inflow % of GDP (Average of 2011 to 2015) FDI Inflow in India FDI Inflows (USD Bn, LHS) FDI inflow as a % of GDP (RHS) CHL PER BRA BGR MYS UKR CHN POL MEX IDN IND ROM TUR ARG ZAF THA PHL RUS BGD VEN PAK :Q :Q :Q :Q :Q :Q :Q :Q :Q :Q :Q :Q :Q :Q :Q :Q :Q :Q

57 Size of Government: Macro Expenditure to GDP Ratio and Log GDP Per Capita Expenditure to GDP Ratio Taj Ken Cam Ban Gha Fra Fin Den Bel Atr Ita Hun Swe Gce Por Cro Slo Ukr IceNet Ecu Ger Nor Bol Ven MtaSpa PolSRP Cze Isr UK Bra CypJap Egy Can Bul Est Ire Tur ArgRus Lat Aus US Rom Lit Nzl Uzb SA Bot Uru Swi Geo Chn Col Vie Mex Ind Mal Mau Chi Par Per Tha Kaz Cos Kor Phi Indo Dom Ira Nig Lux Log GDP lpc_gdp Per Capita 57

58 Size of Government: Micro (Public Sector Enterprise Share of GNI) 24% 21% Sales 4% 3% Profit 18% 15% 12% 2% 1% 9% 6% 3% 0% China India Russia Brazil Indonesia South Africa 0% India Malaysia China Russia Brazil South Africa Indonesia 150% 125% 100% 75% 50% 25% 0% Assets China Malaysia India Russia Brazil Indonesia South Africa 55% 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Market Value Malaysia China Russia India Brazil Indonesia South Africa 58

59 Solid, Remarkable Growth Performance Since 1980, and especially 1991, India steadily reforming Indian GDP has grown at 4.5% per capita for 35+ years, only 3 uninterrupted democracies have done better in the post war period (Japan, Israel and Botswana) 59

60 1.Ambivalence about: Embracing Private Sector and Protecting Property Rights Retrospective actions Twin Balance Sheet Problem Civil aviation Public sector fertilizer plants Strategic disinvestments Public sector banks Agriculture: Essential Commodities Act, export restrictions 60

61 Attitude to Private Sector: India and Other Countries 61

62 .State Capacity/Delivering Essential Services Flailing State with exceptions: PDS (Chattisgarh), power (Gujarat) etc. Health and education outcomes poor Weak regulatory effectiveness Competitive federalism visible in attracting investment and easing cost of doing business but.. Little evidence of competitive federalism in delivering essential services (health and education) 62

63 3.Inefficient Redistribution Aggregating over major subsidies and 6 major programs, about 15-25% of central government subsidies goes to bottom 40% of population JAM and DBT: Eliminating leakage and duplication but changes in prices facing consumers limited to petroleum products Fertilizer subsidy (0.7% of GDP) GST experience: Few political voices for low and simple rates 63

64 Possible Explanations Precocious, cleavaged democracy, shaking off colonial chains will distrust private capital Ambivalence about private sector instituted historically and then reinforced by license, quota, permit raj Precocious, cleavaged democracy forces early and ineffective redistribution: Lot of poor means need to redistribute but ability to do so effectively will be limited 64

65 Precocious India : Premature Pressures to Spend Income level at which country governments spent 27% of GDP (what India spent in 2010) 65

66 Voting age population (million) and ratio of tax-returns to voting population (Per cent) Number of taxpayers to voting age population (Per cent) 66

67 Few taxpayers, low tax compliance Taxpayers to voting age population and log per-capita GDP controlling for democracy Taxpayers to voting age population Ind Taj Ban Cam Phi Col SA Mta Gce Bra Tha Tur Cyp Por Ita Jap Isr Atr Nzl Spa Lit Indo Bul Fin Lat UK Den Swe Pol Nor Can Est Vie Hun Net Aus Slo Bel Fra Arg Mex Chi Mal Ire US Rom Rus Log per-capita GDP controlling for democracy Ger Cze Kor Lux Chn 67

68 Ideas Ideas Ideas!!! Ambivalence/Ineffective redistribution/ineffective state-capacity. Fundamental meta-challenges created by and/or shared across the social, political, ideological spectrum. Addressing them will require fundamental shifts in shared ideas. [T]he ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly 68

69 Recommended Readings Chapter 1, Economic Survey, Chapter 3, Economic Survey, Chapter 2, Economic Survey,