Now hat it is close to 50 days since demonetisation, how do you assess the impact—positive and negative?
Demonetisation was a deliberate contraction forced on the economy. We need to understand why it had to happen. Otherwise, we will not be able to arrive at the balance-sheet, in the short-term, medium-term and long-term. The economy from 2004 onwards has been showing a fake growth in terms of asset appreciation — land, gold and stocks — without growth in jobs.
This was largely driven by cash economy outside the system and not by official cash expansion. If the high denomination notes constituted 34% of the total economy in 2004, it went up to 79% in the next six years and touched 86% in 2014. This is what has propelled the spike in asset prices. Once unofficial cash drove this spiral, the official money too started going into these sectors leaving little monies for the production sectors.
The point I am trying to make is that what we have seen thus far is not real growth. One can argue that we could have continued with this — essentially do a holding operation. What has grown from `1.4 lakh crore (HDNs) in 2000 to `14.6 lakh crore now would have increased to `30 lakh crore in the next five years, by which time no government could have intervened unless it is willing to pull down the economy. Even otherwise, the economy would have collapsed on its own eventually. So demonetisation is a hedge against a crisis which might collapse the economy eventually.
My argument is that we have reached a stage where demonetisation was no longer an option, it was an inevitable step. Unfortunately, it has not become a part of the national discourse, in the government or the media. Once you understand this, the obvious next question is how to go about it.
It had to be a big political risk which this government and the Prime Minister, in particular, took. His idea was perhaps not adequately appreciated by the previous Governor of Reserve Bank of India, though the latter did report to the government that two-thirds of `1,000 note and one-third of the `500 note which went out of the bank never came back to the system. This means that over `5 lakh crore was in operation outside the banking system. So, the government felt this was approximately the quantum of black money that existed in the system and it has to be caught. That is what led to this decision.
But was it well-planned?
Obviously, not. But I must say that by the very nature of this decision, it could not have been very well-planned, and there was no precedent for this anywhere in the world. Normally, demonetisation is done when there is high inflation and the local currency loses its value. But, in our case, it is a peculiar situation of explosion of high denomination notes which was shifting the distribution of capital and the direction of growth. It should have been stopped at some point. If in 2004 or 2005, or even in 2006 the government had decided that it would not print any more HDN, maybe this situation would not have arisen.
This is exactly what I was about to ask. It is now two-and-half years since this government came to power. What stopped it from printing more volume of smaller denomination notes and slowly phasing out the HDNs coming into the banking system?
There are two issues here. One, the purpose of this move is to burst the black wealth built up with black money. People are already talking of land and gold prices going down and affordable housing growing at the rate of 20%. Mere phasing out of HDNs would not have helped achieve either of the two. Second, a move of this nature requires the Government and the RBI to be on the same page. I don’t think this was the case until there was a change of guard at the RBI.
Am I to interpret then that there was a complete lack of trust between the Government and the previous RBI governor?
I would not say complete lack of trust. Without full trust, you cannot even open such a sensitive subject. Because once you open a discussion, this would never have been a secret, as it is a once in a lifetime step. Also, the Prime Minister discussed this with only a small group in the government before finally bringing it before the Cabinet. It does not mean that he does not have faith in the Cabinet. It had to be done in such a confidential manner. This is my assessment.
Now that close to 90 per cent of the HDNs have come back to the banking system, can you still claim that the fundamental objective – purging black money – has been achieved?
Yes. As long as it was out of the system, it was unmonitored cash. Except by this measure, this would have never returned to the banking system and thereby get recorded. Once it is back, the system can chase it. May be out of the 5-6 lakh crore, the system may be able to catch 2 lakh crore. Based on how much comes back, we cannot say demonetisation has not worked. It was required to be done to change the pattern of growth. In the process, the economy will surely go through stress but for a short-term.
This is precisely why a large section of the country’s population has been going through the pain. Some 30-35 crore people stood in the queues to withdraw money but did not grudge it, though the opposition was inciting the people, media too was expounding the opposition view more and even SC talked of riots. This kind of popular appreciation of a policy I don’t think has ever been seen in this country, except when bank nationalisation was announced by Indira Gandhi. But bank nationalisation did not cause any pain to the people. Demonetisation caused pain and still crores and crores of people appreciated it.
Do you mean to say there was no inconvenience of any sort?
I am not saying there have been no problems, and there could have been a miscalculation on the nature and extent of problems that could arise. It is more than possible that the RBI may have thought printing 6-7 lakh crore currency would have been enough because it was expected that only `10 lakh crore would come back to the system. This kind of misjudgement may have happened. But, the fact is that this measure definitely will help change the course of economy from speculation to real growth and from asset appreciation to productive growth.
From what we have seen, the Prime Minister’s move has won popular appreciation initially on two counts: one, it is going to flush out black money and two, the implicit trust people have in Narendra Modi. Do you think this is thinning?
I am of the view that when people were excited about this move and supported it wholeheartedly initially, they did understand the pain they would have had to undergo. It was more of an euphoria. Over the next couple of weeks, I expect this pain to go. But, even while going through this pain, people have felt and continue to feel that this is something that is needed for this country. Irrespective of the HDNs which do not come back, it is a success. But, I would say that `13.5 or `14 lakh crore getting back into the system as recorded cash is the real success. The government can later figure out how much of it was black, what kind of tax has to be imposed and so on. Measuring it by the amount of money that has not returned is not the right way of judging this policy.
You have been a strong votary of financial help from the banking system to small and marginal business. Reports, however, suggest that they are the ones taking the maximum hit. How do you respond?
This is precisely the benefit from this move. Imagine 5-6 lakh crore remaining within the system. This will multiply by fractional banking model to seven to eight times that sum, which means more money with banks to lend. Hitherto, banks have been lending only to big corporates, because a large part of the money was operating outside. The MUDRA scheme was brought in to address the issue of financial assistance to small and medium enterprises but the RBI put a brake saying banks have no money to lend. Now that money is there, MUDRA will also work. This will be the extended benefit. Informal sector, as we all know, contributes 50 per cent to the GDP and 90 per cent to the total employment.
I am going back to my question. This move seems to have hit precisely the small and medium businesses?
Demonetisation has hit the sector and that is the only way to improve it. Because they are being funded in black cash at 60 per cent or even higher rate of interest. Now that money is coming back into the banking system, the challenge for the government is precisely how to finance the MUDRA sector. May be the government will come out with a couple of lakh crore guarantee to the banks, which enables the latter to finance the small and marginal businesses.
Now if these businesses which have been running with money borrowed at 60 per cent get the same at 16 per cent or less, there will be lot less burden on them because much of their energy is now spent on repaying the high cost borrowing, leaving them with little margins. This is crucial considering that we have 58 million non-farming units employing 128 million people. The organised sector employs just 12.8 million. Only four per cent of them are funded by banks, and the balance is funded by the unorganised money.
How confident are you of this happening post-demonetisation, given that the policy has evoked equal support from big corporates who may still take the benefit of excess money in banks?
The corporates have supported the measure because cash generation to pay for wrong purposes has become biggest problem for them. Now that will be far less or nil. The banks
need more money on hand than the needs of the corporates. Then only they will lend to the non-corporate sector.
Again unless there is a pressure on the system, it doesn’t work. This is my view. Without pressure, even those who can transact digitally won’t do it. Even I do not do it because cash is available easily. It is not as if the unorganised sector does not want to be a part of the banking system. They have not been because banks have not lent money to them. Once those who are a part of the unorganised open accounts and transact officially, the banks will also lend money. It is a dual process. Even without demonetization, it may have happened incrementally but what this does is to have that quantum jump.
How do you see this playing out on the GDP?
Sound economics suggest that the cash to GDP ratio should be around eight per cent. It is now 12 per cent with 17 lakh crore currency for a GDP valued at 150 lakh crore. Back in 1999, it was only 9.4 per cent. Since then, many have shifted to banking system but still the cash ratio went up because of HDNs. We, at best, require 12 lakh crore in currency and in lower denominations, so that cash remains a flow and does not become stock. Unless some amount of coercive persuasion is put in place, the shift to a formal economy will not happen, either from the supply side or demand side. This is my view.