New currency notes for old

A one-off reduction of unaccounted money must be followed by long-pending structural economic reforms.

Some of the most insightful arguments on the demonetising of high-value currency notes have come from Takshashila associates.

Ajit Ranade has long been a proponent of getting rid of the high-denomination bank notes, pointing out that this will make a big dent in holdings of unaccounted money.

Karthik Shashidhar, on the other hand, has calculated that the exercise will be very costly. In other conversations with some colleagues last night, we noted that the real costs will be even higher, given the higher transaction costs, friction and so on.

[Update] Anupam Manur has a thorough analysis of the demonetisation.

Deepak Shenoy, one of India’s shrewdest analysts of capital markets, has more recent analysis that argues that the Modi government’s move will have short-term negatives but long-term positives. You should read the articles I’ve linked to above.

The Modi government’s move (even if it rightfully ought to be the RBI governor’s move) to demonetize Rs 500 and Rs 1000 notes and replace them after some time with new Rs 500 and Rs 2000 notes will act as a move to massively reduce the existing stock of unaccounted money and counterfeit currency. [Update: There will be new Rs 1000 notes too!] This will generally hurt the people who are sitting on large amounts of cash holdings (mostly for evading tax) and also, temporarily, those who are holding on to some cash, but have no bank accounts. This is significant.

A senior colleague argued that this was an extremely courageous move by Prime Minister Modi, not least because it hurts business communities that have long supported him and the BJP. However, given that this is one of the few moves that makes honest citizens feel good, it is likely to strengthen Mr Modi’s personal popularity. Effects on electoral outcomes have probably been calculated by those whose business it is to do so, and are probably as good as the best (or the worst) guess. There are just too many factors at play when it comes to how people will vote.

Now, if the government (or the RBI) had merely demonetized the big notes, the effect would have been to put permanent brakes on tax evasion and a faster move towards ubiquitous electronic banking. However, since the big notes will be back, the effect will be one-time. In fact, as another colleague pointed out last night, the same mattress will hold twice as much cash if filled with Rs 2000 notes. Also, many cash holders will convert their current holdings into gold, foreign currency or some other assets until they can change it back to cash again. There are limits to how much money they can hide this way, but many middlemen will make healthy commissions by providing such “services”.

Bank accounts will see a lot more transactions as latent account holders begin to transact through banks. This effect too will not be complete, as some might just decide to wait until the new notes arrive, and then lapse back to old habits. Behaviour is very hard to change easily. Until mindsets towards banks, taxes and scruples change, people will continue in the old pattern. It’s a good time to refresh the case for structural reforms: deregulation, getting rid of the license raj (no, it didn’t go away in 1992), tax reform and liberalisation. This will require even more courage on the part of this government (or any government, for that matter).

Will the move hurt confidence in the Indian Rupee? A sober Anupam Manur, Takshashila’s macroeconomics analyst, noted that denominations don’t impact the value of the currency. He doesn’t think the rupee will be hurt. On the other hand, another colleague likened this to Mr Modi’s Tughlaq moment — more politically, perhaps than economically.

The war against corruption and unaccounted money can only be won when economic incentives change, and in turn, change behaviour patterns (and ‘culture’). Disclosure schemes and demonetization of high-denomination currency notes have a salutary, but temporary effect. There is, however, no alternative to Reforms 2.0.

Where are our defence economists?

Defence budgeting would do well with more economic reasoning

One of the topics discussed at the Takshashila Executive Programme on Strategic Affairs in New Delhi earlier this month was the issue of defence budgeting. Mukul Asher and Sushant K Singh have an op-ed in DNA today that covers one aspect of it—the need to have competent defence economists in New Delhi’s policy & budget planning establishment.

Here’s an extended excerpt:

The current focus in defence sector budget formulation, in parliamentary approval process, and in post-budget assessment is almost solely on accounting procedures and practices. Even these are outdated as neither outcome nor accrual budgeting, which permits both income-expenditure flows and balance sheet assets and liabilities to be formulated, are utilised. The capital component of the defence budget involves multi-year expenditures and planning, which annual budget cycles are unable to accommodate effectively.

The current defence budget formulation largely involves incremental budgeting (e.g. 10% increase in nominal terms over the previous period), with usually no separation between inflation-induced and real increase in expenditure. No groups at the planning or strategic levels, whether at the Planning Commission or at the Prime Minister’s Economic Advisory Committee appears to be analysing the defence budget from forward strategic planning perspective incorporating current and prospective threat perceptions. The budget proposals are also not subjected to analysis from the perspective of defence economics as a distinct sub-discipline and profession.

This is a serious gap, which needs to be urgently addressed in an era when geo-politics and geo-economics are increasingly inter-related. While this is recognised by other major powers, particularly China, India has been relatively slow in integrating the two to enhance its economic and security space and leverage.

An important step towards integration of the two would be to give greater prominence to the role of defence economists at every level of the defence sector, and encourage their coordination with economists in other sectors.

There are three critical aspects of defence economics: projecting national resources available now and in the future; working out the proportion of these resources which should be allocated for internal and external security and division of resources within each of the two areas; and tracking the efficiency with which the resources so allocated are used.

The above requires developing a competent group of analysts specialising in defence economics. Currently, no university in India, to our knowledge, offers such specialisation at any level. The need is particularly acute at the post-graduate levels. The absence of such expertise in defence related think tanks is also striking. The media and professional military and economic journals have also not promoted this branch of economics.

In the short run, such specialists would need to be trained (or recruited from) abroad; particularly in the US where defence economics is a thriving discipline. But there is no substitute for developing indigenous capacity to train its own defence economists and analysts.

As India revamps its higher education sector, and Knowledge Commission advances the scope for applying knowledge and technology to a wide variety of sectors to bring about greater economic efficiency, the need to subject the defence sector to greater economic reasoning and analysis should receive deserved consideration.[Asher & Singh/DNA]

In defence of Bibek Debroy’s purported defence of the UPA’s budget

Out of context

To draw attention to Bibek Debroy’s commentary on the second UPA government’s first budget, I wrote, on Twitter:

Bibek Debroy in IE: “If con is antithesis of pro, Congress is the antithesis of Progress.” [@acorn]

In response, Zahan Malkani writes (via email):

This is regarding your Tweet about the IE opinion piece ‘Read Between the Lines’ posted on @acorn approximately three hour ago. I’m replying via email as my account is a protected one and I’ve realised that my replies never reach you.

The Tweet in question is, in my opinion, a blatant misrepresentation of the spirit and overall tone of the article by Mr. Debroy.

Sure, you did quote him verbatim, but thoroughly out of context. Not unlike the legions who quote Marx as having once said ‘religion is the opiate of the masses’, which completely misses the point.

Not to sound pretentious, but in an era defined by 140-character-or-less, it becomes all the more important for you to represent other’s work in an unbiased manner that captures the spirit of the piece.

As I see it, Mr. Debroy was rather upbeat on the new budget and its ramifications. The thesis, if you can call it that, seemed to be that this budget was rather a good sign, given the circumstances.

Indeed to draw from Mr. Debroy’s last paragraph,

“I am glad the Budget isn’t flashy and spectacular. It seems pedestrian. But given the constraints, it isn’t quite that… Despite public expenditure and the doubtful efficacy of Central universities in every state, there is nothing to kill green shoots.”

I would appreciate it if you posted an update reflecting the context of the article that you extracted the quote from. This government has a hard enough time ahead impressing critics like yourself (whom I readily admire for your work) without misrepresentations.

Yours sincerely,
Zahan Malkani

Now, whether or not the Indian government cares about twittering critics, whether or not its twittering critics matter, and whether or not the ball was inside or outside the line, Mr Malkani’s email is worth bringing to the attention of this blog’s readers.

Swaraj – a new blog on The Indian National Interest

It will be about individual rights, economic development, and smart welfare

Harsh Gupta joins us on INI with Swaraj, new blog that will discuss “issues that are not really big ticket glamorous ones, but rather more like Raghuram Rajan’s A Hundred Small Steps.” His first post addresses the problem of malnourished children and how to tackle it India must “slowly but surely…replace the public distribution system (PDS) with food stamps.”

Go visit Swaraj and subscribe to his RSS feed.

Goodbye cotton, hello soyabean

The rational farmers of Maharashtra

Just how does P Sainath position facts that show how Maharashtra’s farmers are capitalising on the opportunity created by rising global foodgrain prices? Oh, by saying that they are replacing one type of volatility (planting cotton) by another (soyabeans).

After pointing out how farmers are reaping the benefits of growing soyabeans, he goes on to point out the risks of growing soyabeans, and the dangers of planting the same crop season after season. As if there are crops that somehow defy these risks.

Mr Sainath, unsurprisingly, fails to underline three really important points: first, that given a chance, farmers can help themselves by taking advantage of available opportunities. Second, information about prices, weather and market conditions enabled this. And third, following from the above, just letting them do what they like (and not placing value judgements on what they should grow) is the best solution.

Related post: Rising foodgrain prices present an opportunity for Indian farmers

Slapping cess

How you should react if the government increases taxes to subsidise petrol

Over at Barbad Katte, Ramesh makes a startling call:

Here is a possible response to the Petroleum Minister’s proposal to levy a cess on income tax payers in lieu of a hike in the price of fuel. Get hold of your neighbourhood Congress man and give him one tight slap. [Barbad Katte]

No, no, it’s not a partisan thing. Go read his post to understand why.

Now, this blog deplores the use violence to make political points (and this has to be said, because there are always some irony-deficient, metaphor-deaf people). Instead, it recommends that taxpayers to line up in large numbers and vote against the simians making economic policy.