Pronab Sen: Demonetisation will hit GDP growth by 0.4%
Demonetisation might be touted by some as a 'masterstroke', but, what is the economic and human cost of it? Catch interviewed the first Chief Statistician of India, Pronab Sen to find out what he had to say about PM Narendra Modi's demonetisation move.
As the former adviser to the Planning Commission and present country director of the International Growth Centre, Sen feels that demonetisation will be devastating for the Indian farmer and the poor.
Shriya Mohan (SM): Demonetisation has led to a money supply-shock of 86% in the economy. What are its impacts in the short-run?
Pronab Sen (PS): Three-fourth of our entire chain of economic transactions - whether it is a manufacturer buying his raw materials, a wholesaler buying from a manufacturer or a customer buying from a retailer - is financed in cash. What demonetisation is doing is taking away 86% of that cash, in effect is crippling about 65% of all transactions in the economy, which is not a joke.
SM: We are in day 10 post demonetisation. Can you put a daily cost to that? For instance, what is the cost to GDP we're incurring currently?
PS: We don't really know. You see much depends on what people are doing with their money. If I immediately spend the money I withdraw from my bank, then the cost is less to the economy. But if I sit on it then the cost is much larger.
SM: And in times of uncertainty like this people are sure to hoard and keep a large reserve of cash at home...
PS: That's right. It is natural that most of us will take a cut in our daily consumption in order to build up our reserves for a time of emergency. If the money doesn't flow then the chain dries up. So it's difficult to put a daily cost because we don't know what people are doing with their money.
But going by macro estimates, assuming people aren't hoarding, my estimate this year says the growth rate will dip by 0.3 to 0.4%. We're expecting a growth rate between 7.1 to 7.2% as opposed to 7.6 to 7.7% which it would've been otherwise. That's a large loss. The bulk of that loss will be borne by the poor and the agriculture sector.
SM: Do you think we will be reeling under the effects of this move well beyond the promised 50 days?
PS: People are now sitting down to calculate how much cash can be printed. And that's coming to about three months. Not 50 days. So the effects of this could be quite protracted.
SM: Some economists have gone on to compare this with the onslaught of the great depression that hit Americans in the 1930s. Is this a valid fear?
PS: That's probably taking an alarmist view of things. In America, this kind of demonetisation drive was carried on for three years. The government is trying to exchange currency as quickly as it can. The problem in India is the physical availability of new cash and the process by which cash is being put back into the system, which is slow.
The real problem we're facing which can have a semi-permanent effect is in agriculture where we're at a critical point - the harvest which is between end-Oct to end-November is either just over or is just coming in. The entire Rabi planting all over the country will take place in December. And there is no cash - neither to buy harvested grains nor to buy seeds and fertilisers for the next season of planting.
If the Rabi sowing is impacted then there will be severe long-term effects. That's a way you can immediately measure the impact of demonetisation. My fear is it will be impacted because there is no credit. Demonetisation has made all local credit systems and local money lenders shut shop.
Beyond a point, even bartering won't happen. That's when supply lines will break down.
SM: And what do you foresee then?
PS: It's like a monsoon failure. It's even worse actually because during a monsoon failure the poor would actually borrow from others to survive until the next crop. Today he can't even do that. The human cost of a bad Rabi sowing can be devastating. We can expect aggravated rural distress and farmer suicides.
SM: The prime minister has managed to use public support for demonetisation as a sort of litmus test for patriotism. Do you think it is absurd that behavioral economics and morality has been clubbed this way?
PS: It is completely absurd. Morality and ethics are good things to have. But to define morality and ethics in a particular way is wrong. Being critical does not make you a bad person. The problem with these people is that anybody who disagrees with them is by definition 'anti-national' and that is objectionable. The people who are saying all of this are people who don't have to earn their daily bread. They are not the wage labourers or the agricultural labourers.
SM: Do you think there is a less costly way and I mean in terms of human cost, of cleaning black money?
PS: Yes. He could do exactly the same thing but only make the old notes invalid from 31 December. That would allow the transactions to take place and give time for the old money to phase itself out and the new money to come into the system.
SM: But wouldn't the hoarders of black money then...
PS: Do what with it? Spend it on assets? But that they can do even now. Let's assume that the old currency is valid until 31 December. If I had a property to sell and you came to me with old notes to buy it in black I would still refuse to sell it to you because the old notes would soon be invalid. When I have old notes of my own to exhaust why would I accept new ones?
The market would freeze up just as much and the small transactions would still continue to keep the system going.
This view that more time would ensure people would spend their money implicitly assumes that the taker of old currency is an idiot. He knows the money is soon going to go out of circulation. Why would he take it? Small amounts yes, large amounts, no. The large black money transactions would freeze anyway.
SM: But is demonetisation the only way to cleanse an economy of black money?
PS: World over, demonetisation is done to tackle counterfeit currency. For counterfeit, this is the only thing you can do. Black money is usually tackled through an investigative method usually used by tax authorities.
SM: But which is the larger problem for India? Is it black money or counterfeit currency?
PS: It depends. Terrorism is a problem that should be stopped. And it thrives on counterfeit money.
An estimate drawn up by the Indian Statistical Institute finds that the sum of black money in the economy is Only Rs 400 crore. So the sum isn't large. But since it's funding terror its impact can be substantial.
There is black money and there are black assets. JNU Professor Arun Kumar estimates that only 3% of the black money is kept in cash. The rest is kept in black assets.
So the other reforms expected to come in about benami property are good things. Using forensic audits to find the sources of black money are exactly the kind of things you need to do. But this, in my view, is using a cannon to kill a mosquito.
SM: The target of this exercise, as you're saying, is not really the people hoarding black money in Swiss and Panama accounts. So what's the point of the exercise?
PS: No they are left untouched. The effect of this exercise is to penalise those who are hoarding black cash. The Income Tax department estimates this to be 6% of black money. Arun Kumar says it is 3%. Not a big difference. That's the impact.
SM: Do you think this is political masterstroke?
PS: There is no doubt that the BJP enjoys a crowd swell of popular support for demonetisation. If elections were held tomorrow this would be a masterstroke. But the elections are three months away. A lot of the hurt is going to come in three months. The support they have right now could just backfire then.