Chief Economic Advisor Arvind Subramanian sat down with Delhi-based journalist Puja Mehra and gave his thoughts on how the success and impact of Prime Minister Narendra Modi’s strike on black money should be measured.
Q: How will the success of demonetisation be measured?
A: The penultimate section of the chapter on demonetisation has markers of success. You will not measure it today or tomorrow, but a few years later. There are two or three clear indicators. The cash-to-GDP and the cash-deposits ratio, which is about 12-12.5 percent. When it comes down sustainedly, that will be an indicator.
Q: That will be a measure for what impact?
A: For saying that we have now converted an illiquid form of savings to financial savings.
Second, clearly, would be the number of income tax payers. We have a baseline, which is today – a steady increase in that over time.
A third marker of success would be: In the new equilibrium, the real estate prices would lower. That would have a beneficial effect if you want to flush out black money.
The fourth marker will be the impact on the indirect taxes. If you see an increase in registrations of taxpayers then that will be a little more complicated measure because at the moment you have registrations for central excise, VAT and there will be GST.
So disentangling that will be complicated, but in principle you should see many more people registering to pay indirect taxes. I would say you should monitor these four clear identifiable markers of success in the next few years.
Q: How will we measure how much the black economy will shrink due to demonetisation?
A: One of the lessons we have learnt from this is that there is no such thing, as black money in cash or in real estate.
It's all fluid.
If you thought there was 3 million or whatever lying in cash, it can get laundered and come back as white money.
That is a lesson we have learnt, to not compartmentalise our thinking about black money.
But (to look at it) as a more general problem of how do you staunch the flow both of illicit transactions and the accounting of transactions?
You can have legal illegal transactions. You can also have legal transactions that are not accounted for. Or illegal transactions that are accounted for. So we have to work on all margins.
The way you do it is that you have sticks. Which is what demonetisation has been. The flow is affected by the carrots as well. Which is why we say it is very important to go through with the follow-up action.
Q: Would you say that the success of the strike on black money is in fact not simply dependent, but actually conditional, on the follow up?
A: These are all degrees. The more you do things, the more successful it will be. Bringing land and real estate, reducing stamp duties, making tax administration much more non-discretionary are things we have to do in any case for a lot of reasons, but also to ensure the flow generation of black money.
This is an action against black money because you want to go against cash. It has also been the stick side on the flow because you are saying that in the future you have signalled a regime shift. Then you need carrots as well.
Q: Black money hoarders know that there is unlikely to be another demonetisation any time soon, so in that sense there isn't a stick. It's an exhausted option.
A: No. There are two ways of interpreting this. One is to say we went after black cash. The other is to interpret it as a regime shift. We have shown you we can do this on demonetisation; we can do this anywhere.
Q: Your estimate of the impact of demonetisation on the GDP falls short of Dr Manmohan Singh's.
A: I am not privy to the calculations that went into his estimate. On our estimate, I am not going to pretend it is hard science, but what we did do is show that there will be an impact of the cash (shock).
Our methodology is out there for you to see. One is that liquidity came down, which greases the economy. There could be a reduction in activity. But it is a very unusual monetary shock because while liquidity went down, other forms of money went up.
So are other forms of money substitutable? If they are highly substitutable then the impact will be muted.
For example, if you could use credit because of digitisation. Or because interest rates went down, you could borrow to tide over things. Impact will be reasonably quick.
Q: The savings and investments growth data that comes with two years’ lag from the Central Statistics Office shows that the household sector’s savings and investments – and this includes the informal home based business enterprises – growth has been sharply declining. With demonetisation, they will face a double squeeze. What will this then do to the feel-good sentiment in the economy?
A: Savings declining in the household sector also has a lot to do with the growth (itself) coming down.
Now, as interest rates come down you will have the ability to borrow more easily. To that extent, the impact on households could be cushioned as well. Those that don't have access to credit or digitisation are going to be more affected because their incomes will come down.
That is why the recorded headline GDP number will understate the impact of demonetisation on the informal sector.
Q: In fact, don't GDP estimates use as a proxy for the financial sector, the data for bank deposits, which will, post-demonetisation, probably show an artificial spike?
A: Finance sector uses bank deposits, that will be an artificial bump up. On the other hand, we measure on the manufacturing side, the informal sector estimates, based on the IIP (Index of Industrial Production). So that is how it will be understated.
Q: So will the feel-good factor weaken?
A: There isn't something necessarily permanent about this. Cash went out. You couldn't transact. Maybe you borrowed a lot more. Cash comes back. It should recover back again.
Q: What is most crucial to bringing GDP growth back on track?
A: In the short term, it will be the balance sheet problem. If you want to get private investment credit up, that is the next frontier.
Q: Demand generation?
A: Once you take care of the credit, get the investment climate going, demand is going to be taken care of.
Q: Despite the international climate ?
A: The irony is that in the short run, the economy could be up because of the fiscal boost from the US. That is why the IMF (International Monetary Fund) has upgraded its forecast.
Puja Mehra is a Delhi-based journalist.
Video Editor: Mohd Irshad Alam