Tuesday, December 20, 2016

Tax reform - Introduction to the new series

After demonetisation, it is widely expected that next step will be tax reform. So I wanted to examine and recommend the possible taxation reforms we can expect.

But this time, I want to open the research process to you all. So this post will be the beginning of a series of posts on this topic. Each post will be ideas under exploration and may end with some questions too. At the end of the series, I will convert it into a proper research paper and an explanatory article. 

So to start off, let us begin by asking basic questions.

What is Tax?
Tax is essentially a levy charged, on the people, by the government, to fund its activities.

You can find equivalent definitions in Wikipedia and Investopedia. Let us examine the crucial aspects of this definition and the question it raises. 

Tax is a levy. It is a charge on something such as a transaction or an asset. It implies that there exist transactions or assets that are visible to the government.

Government or its equivalent implies some authority that can bear the force of law on the person. The person may be a citizen or foreigners (including friendly aliens or enemy aliens).

Activities of the government include all the activities taken by the government upon itself. Initially, it included mere protection from enemies (army). Then expanded to provide safe internal law and order (police). It was further expanded to include dispute resolution (Judiciary). It further expanded to infrastructure for citizens (markets and city infrastructure). And now includes education, social security, health, etc. 


Distinction of tax
In purely communist countries there is ideally nothing like taxes. Everything belongs to the government and the citizens only get what they need for living.

In capitalist societies, a tax is something government takes from the people in return for the services it provides. It envisages a government to charge fairly for the services it provides even though the government can impose itself by authority of law.

Capitalist societies want to restrict the scope of government so that only a minimum amount needs to be taken from the person. The individual himself is best placed to spend the rest of the amount. So better to tax him less and leave him enough resources to achieve her own potential. This is the republican position on government.

The left-wing position on government is somewhat contrary. Their view is that government should provide the common services that could enable the individuals to achieve their full potential. They are for expanding government role in activities that involve common good. So they are happy to pay higher taxes.

In either case, taxes are a reality only the extent differs. We discuss this distinction because it has a bearing on HOW the individual is taxed not just WHAT he is taxed.

Power to tax
The constitution of the country grants power to the government to tax the citizens. The constitution decides what level of government can tax what activity. These powers are then refined by relevant laws and hence collection or even benefit from the taxes collected can be allocated to other government (usually lower).

Notice that power to tax is embedded in the constitution and hence amending it is a considerably expensive legislative exercise.

Types of Taxes
If you search for types of taxes, you will end up with taxes at the level of various governments. Local taxes, state taxes, central or federal taxes etc. But when designing tax policy the relevant classification is a bit different.

  1. So one way to differentiate taxes is - income taxes v/s expenditure taxes. Expenditure taxes means sales tax, VAT or GST type taxes. Income taxes are fairly well understood. But people forget that income for individuals is salary and for corporates is the profit.   So in accounting terminology, individuals get taxed on revenues and corporates get taxed on profits. 
  2. Another way is to look at is flow taxes v/s stock taxes. Flow taxes include income or expenditure taxes while stock taxes include property taxes or estate taxes, inheritance taxes etc.
  3. Some taxes are mixed taxes - capital gains. It is partly income and partly stock tax. Experts have intuitively suggested that short-term capital gains are like income and therefore it is closer to income tax. Long-term Capital gains is an investment gain, therefore has second and third order effects hence taxed at lower rates.
  4. Transaction Taxes are another type. They are incurred only when a transaction occurs. Banking Transaction tax being discussed currently is part of this.
  5. Policy taxes like import taxes, sin taxes and environmental taxes, carbon taxes etc. These are not essentially taxes but instruments designed to influence the markets. So if extremely low costs imports are threatening the domestic industry some import taxes may be charged. The objective of these taxes is not to create fund for government activities but to influence the markets or policy. The fund created from them may be used selectively but the aim is different.

Tax Collection
Taxes are collected from taxpayers (different from citizens) either by direct deductions (Tax deducted at source) or by seeking payment of taxes.

Tax payment is accompanied by a statement by the taxpayers that details her assessment of taxes and proof of payment. It is generally called Tax Returns.

Tax inquiry and approval
If you note, taxes are self-assessed. Hence, by definition, the government will create an oversight mechanism to ensure your assessment is correct or not. This is done by tax scrutiny, wherein an officer or a computer checks for correctness of your statement. Your statement or return is examined against the data generated by your banks and other agencies and tallied with your return. If it is correct, your return in approved and tax liability is extinguished.

In every country, there is a limit as to how long the tax liability stays active. In India it is presently 5 years. In other countries the years varies depending upon how efficient the tax department is. Once this period is passed you are no longer required to pay for liabilities that may be discovered for prior period.

In sum
These are the very basic things about taxes. Next we will dive into the main topic.


Buy my books "Subverting Capitalism & Democracy" and "Understanding Firms".

Thursday, December 15, 2016

Demonetisation - The leap-frogging mobile banking tech

I am experimenting with videos these days. Mostly because the commentary is same - biased and boring. No new interesting ideas are being highlighted by the media. So I thought may be we should be talking about the different aspects of the demonetisation initiative. I am fascinated by mobile banking technology the government is promoting.

Before the launch of Demonetisation initiative, the government and RBI have made two platforms operational. The Unified Payments Interface (UPI) is platform for smartphones and Unstructured Supplementary Structured Data (USSD) is platform for feature phones.


  1. Both these systems interface directly with your bank accounts. That is unlike mobile wallets, they do not store the money in a special account created for you. The business of keeping mobile wallets recharged is not applicable here.
  2. For using the same data charges and transaction charges are applicable. But there are no other charges. For example, if you use mobile wallet, you pay data charges and also charges to transfer funds back into your accounts. These charges are borne by the person getting the funds. UPI and USSD work between banks and are authorized by the RBI and National Payments Corporation of India.
  3. UPI interface is simple but we must remember it is embedded within the mobile apps of banks. So be sure to select UPI and bypass all other layers.
  4. The USSD system is a bit iterative - not difficult to understand but requires you to memorize account number, pin, enter the counter party phone number or id etc. Here are some articles describing use of USSD - from BGR, from ET and one by WPXbox.

Now imagine if the country does make a move to mobile payments system. It will be leapfrogging about 2-4 generations of technologies -conventional banking, ATM-based self-service banking, credit and debit cards, internet banking all in one go. We will directly reach mobile banking.

This mobile banking is different
The mobile banking promoted by the government is not the same as carrier-promoted mobile banking. Carrier promoted mobile banking involves another layer on top of your accounts. Such layer can be physical (banking agents) or through telecom-operators themselves. Each layer adds costs and thus inefficiency. The UPI and USSD based system government of India is promoting is layered on bank accounts themselves. 

What supporting infrastructure is needed?
We need to get POS machines that can initiate USSD / UPI based transactions. Thus, the vendor can initiate payment amount and his own id. Based on which the user can accept and authenticate this transaction leading to debit in his account. Such a system






Monday, December 12, 2016

Demonetisation - What was the targeted black money held in cash?

Total black money (cash) in the system was estimated to be 3 Lac Crores or 3 Trillion. This number is now being questioned. One reason this number is important is that some believe that this is the number government was targeting using the demonetisation initiative. So what is this number? Is it 3T? Is it more? Is it less? Does it matter?

As an aside, that logic is flawed. The government has not given any target for black money it wants to unearth. It has maintained that it wants to unearth all black money. The government's definition as supplied by the White paper on black money 2012 includes cash, assets and everything. In short it refers to black economy not just cash.

Simple calculation
Nevertheless, the number 3T came from media and they calculated it thus. The total currency in circulation 15T (only 500 and 1000 notes). about 20% of this is in black hence 3T is in black. 

Pseudo-data backed
Another way is to estimate how much percentage of black wealth held in cash. If you look at the data from white paper on black money, it is about 5% for those were caught. So one journalist calculated 5% of 15T (currency in circulation) to arrive at 0.77T as his estimate. To put it in context, this is  comparable to the amount government got through tax amnesty scheme. Naturally, he pooh-poohed the government. But this calculation is wrong on many levels. First, 5% of wealth (stock) is not same as 5% of 15T (which is flow - money in circulation). So 15T is not comparable to wealth of Indian economy. When IIM teachers make such miscalculation, I am surprised.

My calculation
(In INR)

India nominal GDP = 125 T
Total currency in circulation = 16 T
Ratio = 7.8

Estimate of black economy = 62T
Estimated cash in circulation (using about ratio of 7.8) = 7.9 T
(By Arun Kumar Estimation of the Size of the Black Economy in India, 1996–2012 EPW = he says its 60% based on some regression. check out his paper)

Now to temper the estimates: The size of black economy may be lower i.e. Arun Kumar may be over-estimating. Say the size of economy is 25% (this comes from world bank estimates).

So 25% of 125 T = 31 T
currency supporting 31 T at ratio of 7.8 will be about 3.9 T

The ratio logic: The ratio for the black economy will be different. One can argue both ways. The transactions are black so ratio will be lower or that people want to rid of the black cash so ratio will be higher. But for bulk money (high amounts) it is difficult to move black money. So ratio could be lower. Which means the black cash will be higher than 4T.

So 3 Lac crore / 3 T is ok estimate.


But does it matter?
No. First, this money is fungible. It can move from black to white. You cannot trap it completely. So what can be done?

First get this flow into stock. Let the currency come out white - but wealth will still remain black. Let it go into assets, gold and other stock items. It is easier to shoot at stock than flow. Second if you are vigilant, their conversion will give their location away. To do that we need to push the cash holders into converting, Coax them into action. Demonetisation does that trick. Now that thieves are moving they become visible.

Now the black money is both visible and cash component is revealed. The success will depend on whether the government takes out the black money or not. Let us wait and watch.


Saturday, December 10, 2016

Demonetisation - Can anaesthesia cure the cancer?

It has been one month since demonetization was announced. So naturally it is time to assess how it is doing. But I am not going to do that. I am going to assess the criticism of the initiative.

Just to reiterate, since the announcement, I have maintained two things. First, that the true effect can only be determined when you consider the whole picture - the entire gamut of initiatives, execution and operations on black money, cash-less economy, and such other co-terminus objectives. Till such a time it is premature to pass any judgment. Second, it is a step in right direction. So let me assess the criticisms.

Draconian move by sidelining RBI
This is factually not true. The Gazette notification states that powers were exercised on the recommendation of Central Board of Directors. However, many commentators rely on fact that there are vacancies on that board. But, as per law, vacancies do not invalidate the Orders of the board. The board was authorized to act and it did recommend. Then people question of all the information was disclosed to the board. Well, it is the prerogative of the board to establish that. Unless the board members complain, citizens raising such questions are undermining the authority of the board.

Certainly, the move was quick and secretive. But that does not make it illegal or unlawful. The legal merits of the move seem to be on sound footing.

The Poor are suffering
This argument is usually the first. In their article in Mint, Krishnamurthy Subramanian & Prasanna Tantri argue that data would show otherwise. The poor will have to visit the bank about 3 times between Nov. 8 and Dec 30 if they continued to accept the old notes. And just once if they refused to accept the old notes. Therefore they wonder:
the long queues seen stem from two sections of the population: (i) people from the top half of the country’s income distribution, i.e. the richer folks, who want to exchange their honestly earned savings for new currency; and (ii) people who are acting as agents for the dishonest. The significant decrease in the queues after the government decided to use indelible ink to identify people that have exchanged their currency suggests large presence of the second category of people.
Note, I am not saying that poor are not suffering, neither are the authors above. What is being said is they are not suffering as much as alleged by these commentators. 

So next, you go and ask the people themselves. Just remember, if you are watching videos online to gauge public opinion - ignore the videos uploaded by the media (pro and against) and political parties (right and left). Search for videos of people speaking directly with common people waiting in line or otherwise. These videos are positive. Better yet, speak to the people directly yourself, they are positive. They are suffering, but they understand and they are positive. Some are hurt but they still understand.

Currency in circulation will be destroyed - will lead to deflation
This was textbook economics commentary - money supply has reduced therefore prices must fall. Unfortunately, it is not true. The principle is sound but the money supply is not reduced. People still have the same amount of money. The form is changed. If people are genuinely transacting, paying taxes on it, then they will merely do it through banking channels.

If they are not genuine then it does not matter if there is a loss of such activity. Please note, demand will be affected, but it will be short term. You may even see a surge in a quarter or two. Just like this lull was temporary the surge will also be temporary - adjustments taking place.

The argument was advanced in light of the fact that for undisclosed amounts tax was 200% penalty and some additional cess. Thus for every Rs. 100 deposited you ended up retaining about Rs. 10. (in top tax bracket). Thus, it was better for such holders of black money to destroy it rather than return it. This, as per media estimate, was "the money that would never return". These IOUs that never returned would be gains for the central bank. This was quickly rectified with a modified amnesty scheme that said that effective tax rate will be 50% and some terms were imposed.

Government will not get windfall gains it was expecting
This is the most fervently promoted falsehood I have ever seen. I have never read any government press release or any official statement saying the government will gain because RBI will give windfall dividend on the notes that are not returned. 

This benefit was claimed by the media and it was false. It showed a lack of basic knowledge of central bank balance-sheet. [Refer to the primer by Bank of England I linked to in my first post.] The nature of adjustment remains on the same side of the balance sheet. There was never claimed to be revenue impact from this activity.

If the government was expecting a windfall from RBI then would the government announce modified amnesty at 50% tax and thus impair its own chances of getting gains.

That said, the fault lies with the government officers and bureaucrats as well. When they speak to the media, anonymously, they fan the rumors about this approach. Some such officials are claiming that RBI Act can be amended by the Government to take the dividend. This undermines the basic structure and legitimacy of the government's initiatives.

[Some idiot will say - maybe they did. Initially, government thought it will get windfall gains, but when former RBI governors challenged that on our channel/ newspaper/magazine, government quickly announced amnesty to save its own face!]

All the currency in circulation will return - so demonetisation has failed
This is another popular argument. If all the currency in circulation comes back, government will not get any windfall and thus costs of demonetisation will outweigh the benefits. Hence demonetisation has failed. 

First, if all money returns to the system, it is good. It means there won't be contraction of currency on hand. And therefore those who got scared about deflation would not get scared.

Second, what if money returned is higher than money in circulation? Does it not mean that there were high quality fake Indian currency notes (FICN)? If they come to the banks is it not a benefit of demonetisation? Based on the present run-rate it is possible.

[I want to ask something to the people who were going to give windfall profits to government. The day deposits/exchanges will exceed RBI's currency in circulation figure, will you ask government to pay RBI for those liabilities?]

No benefits for anti-black money initiative
Then there are people saying once all money comes back to the bank there is no gain for black money initiative. Those who created black money will create black money again. Those who converted are sleeping peacefully. So why trouble everyone.

The benefits to black money initiative will be seen only later. But some are evident right away. People moving to cash-less economy is good for black money initiative. Remember, when black money is deposited into banks it is good. It exposes the total money in the system and its ownership. Coupled with laws on benami holdings, it will reveal the extent of black money problem. Note that by alone it won't do anything. But without it black money initiative would not make proper impact. Thus, viewed from black money prism demonetisation is necessary but not sufficient.

[I am happy these people are not in charge of surgeries or some such life-threatening issue. Just after anaesthesia, these people will criticise the doctor that the cancer is not cured. "I can still see the cancer cells growing". They will come out of the operation theater and tell the patients relative - operation has failed. Cancer refuses to die so better let the patient die.]

Black money is not held in cash so exercise is useless
Tackling black money is like cleaning a tank. Unless you stop/slow the water pouring into the tank will not empty itself. This is a classic flow-and-stock problem. So best way to tackle black money is to attack the flow problem first. Then stock problem. Demonetisation tackles the flow problem.

Because of demonetisation, the black money will be forced into stockpiles i.e. in bank accounts, in gold, benami assets etc. This is good. The flow needs to stop. Hitting the flow is like shooting at a moving target. Hitting the stock of black money is much easier.

Note that if further actions do not continue, flow will resume and the stock problem cannot be rectified. This tells us what kind of initiatives will come after December 30. They will attack stock problems at critical places. 

Government keeps changing the rules, focus on cash-less economy so demonetisation has failed
There is a classic problem involved with government. If they talk too much, their talk is criticised. If they talk too less, their silence is criticised. Government officers have been talking too much. RBI is talking too little. Hence there is a problem for both. Unfortunately, there is no escape for the government or RBI from this. It is a lose-lose scenario.

First, the government has been quite responsive. Asking the government to maintain its stance is foolish. Imagine in Apollo 13, Tom Hanks and crew are calling Houston to help them, but Houston continues to be head-strong. Any exercise of this sort requires nimble-footed decision-making. 

Demonetisation is good opportunity to push people into a cash-less economy. And no-one is arguing that it is bad. The argument is that if sole focus of demonetisation was to push for cash-less economy then it could have been done better. But cash-less was not the focus of the demonetisation exercise - no one said so. Read the initial release. It was an ancillary benefit. But it is a benefit nevertheless. Better push it when you can.

Poorly planned initative - hence bad
This is a genuine issue. But people attacking poorly planned issue slant it differently.

First, there was no way under any conceived planning model to pre-inform any one of the demonetisation move. The move had to be sudden and out of the blue. There was no getting around that part of criticism. 

Second, criticism is at logistics of notes reaching ATMs.  Some say the new notes should have been same size so no recaliberation of ATMs would be needed. Now, even if new notes are same size and weight as old notes, ATMs will have to be configured to understand that these are new notes and not old notes. So there was no getting around recalibration too. Could it have been done in advance? No! Otherwise, the information would be leaked. In fact, 2000 note pictures had started appearing before demonetisation was announced.

Shouldn't RBI printed the notes and kept them ready? Well yes. In fact, if you see the timelines, I think the government was aiming for a January announcement. It appears that some news related to terrorists or FICN coming in the country in a big way pushed the government to announce on Nov 8th. This is a legitimate question to ask the government. It is possible that they will share some information once the anti-terror part of the operation has concluded. We will have to wait for that.

A 2000 rupees will help stock black money - hence demonetisation failed
When the government introduced the 2000 rupee note, people were aghast. This note will definitely facilitate holding black money. 

Arthakranti had proposed a 2000 rupee note. Their logic was that if you are repairing an arterial road with lots of traffic you have to give some by-pass. So this 2000 rupee note is a by-pass. They further said that in terms of printing quantity v/s printed value it reduces time to replenish full currency back into the system in half the time of 1000 rupee notes.

I agree with that basic premise. To add to it, think who will use 2000 rupee note. It cannot be used for transacting as it is too big a denomination. People found 1000 rupee note also too big. The reason we feel that is because of metric design system of currency. (from V. Anantha Nageswaran) But I think it is by design rather than by mistake. In a year or two these notes will find their way back to the black money hoarders. Then these notes will be demonetised gradually. That is the reason why there were rumours about microchips installed in the notes. There are no microchips the notes are traceable to black money holders. That is all. 

Black money holders are depositing money in Jan-Dhan Accounts - hence failed
This logic is applicable to many such devices black money holders are using to launder money into white. In this process, people with Jan-Dhan accounts are also involved. But more importantly, cooperative banks, small businesses and others are involved in a big way.

We must remember that these acts constitute money laundering. They are also under the purview of benami property acts. The fines and penalties are severe. So once investigations are done we will find the culprits.

People have died
That, unfortunately, is true. Some people have indeed died. Should they have died? Absolutely not. That is why implementation is receiving poor marks. The government should have set up a task force and convened the meeting via video conference - all bank CEOs, Finance Ministry and others. The government should have pushed them to monitor this like an emergency situation. There should have been End of day recap meeting and things should have smoothened out.

But I personally thought there could have been more deaths. Seriously! And that was why I was against the policy. We are 700 million not counting old and too young. That's more than the entire population of USA. 700million went to the bank in distress and yet no riots broke out. People are not cribbing they are supportive. That number once verified can be debated. But at present, we are talking about 2 people in one crore. Yet, even one casualty is one too many.

Tax terrorism
At the end of the 50-day period, the authorities will unleash a new compliance program. Income Tax (IT) authorities are  known to be very unfriendly to the lawful and buddies of the corrupt. IT department is the reason that people have joined the black economy in droves.

Tax reform is absolutely essential. Without tax reforms and reforms of tax departments, we will not tame the corruption and black money monster ever. The initiative has indeed armed this monster. So without reform it will unleash a fresh round of terror.  Once victimised the population will be reminded of the pains that pushed them to black economy in the first place. Without this critical reform the political costs of this exercise will be too high to bear.

Chanakya, the person prime minister admires, used to say that governance must BE fair and must BE SEEN to be fair. So also goes a prominent legal doctrine - justice must not only be done but also seen to be done.

I have 100 employees but I cannot pay my employees. 
This is boat-load of bullshit. A person who has 100 employees should be doing business through banking in any case. If this fellow goes to the bank and asks the bank to open the account for his 100 employees, he will be able to do it quickly. In fact, the benefit of demonetisation is that such fellows will come into the formal sector. 

Corporate sector is hurt in a big way
Post demonetisation there has been an impact on demand. People are focussing their spending on essentials. This has hit industry to a certain extent. Yet, there is no reason for high-value goods industry to be affected. Thus, if people are buying cars, there is no reason that should stop. Most of the car purchase was using bank money anyways. Bicycles and Two-wheelers have been hurt.

If businesses are hurt because their distribution chain is cash based then this is no argument. There was no business for this distribution chain to be cash-only if they are paying relevant duties. In fact, these dealers and shopkeepers are a major source of black money creation.  Please note that they are not without bank accounts, they are cash-based by choice. That such businesses will come into the mainstream banked economy, is a boon and benefit of the demonetisation.

So what do we conclude
At the end, demonetisation is not a single initiative that will rid India of corruption. The anaesthesia cannot cure this cancer. The surgery is ahead of us. Possibly, demonetisation will insulate the law-abiding people from the pains of this anti-corruption surgery. But corruption has seeped into the character of this country. Every fellow is corrupt as much as his ability, opportunity and self-conscience allowed. In this game everyone is dirty. The system did push people into the black economy. But that has to change.

The example of Georgia is documented in this World Bank Report hold many learnings as to how a corrupt country can get clean. The president of Georgia started out by firing all the traffic police known to be most corrupt. The result is that Georgia went from a poor country to a middle-income country in a short time.

The process of change has begun. How far the prime minister takes us, how successful he is, depends on the next steps. There are workable models, but India will have to fashion its own solutions. India has to take the leadership, forge new paths against corruption.

Thursday, December 08, 2016

Demonetisation - What if deposits in banks are greater than 15 Lac Crores?

On November 28th the Reserve Bank of India stated that
Banks have since reported that such exchange/deposits effected from November 10, 2016 upto November 27, 2016 amounted to ₹ 8,44,982 crore (exchange amounted to ₹ 33,948 crore and deposits amounted to ₹ 8,11,033 crore). They have also reported that the public have withdrawn, during this period, ₹ 2,16,617 crore from their accounts either over the counter or through ATMs.

The expectation was that thereafter the RBI will release similar data every Monday. On Dec. 5th, when RBI did not release the data for the week past, speculation was rife that most of the money may have actually returned to the RBI. And further that it amounts to a failure of the policy and that there is no black money at all. 

The amount forecasted / estimated by sources of journalists is Rs. 12.6 Trillion. has been deposited in banks till Dec 6. Total bank notes in circulation as of Nov. 8 was about Rs. 15 Trn. We still have about 3 weeks to go. 

The correct way to establish how much money has returned is to look at this 8.44 Tr figure. That is the focus. 

So weekly average is about Rs. 2.8 Trn as per RBI and as per Moneycontrol it is about  Rs. 3.15 Trn per week. Going by the same run-rate estimates we can get at least Rs. 19.64 Trn to Rs. 22.46 Tr. If you understand the "last-minute" psyche of Indians, I think last week will get at least twice the weekly deposits. Then you will get between Rs. 22.4 Tr to Rs. 25.2 Tr. 

Please note that these numbers are more than Rs. 5Tr  to Rs. 10 Tr more than what RBI has printed. 


So here are my thoughts on this:

  1. It is OK if all the money comes back to the RBI and either gets changed or deposited in the banks. It means there won't be any disinflation because of loss of currency. 
  2. If money is deposited in the bank that does not make it white money. It merely becomes visible black money as opposed to invisible black money. Knowledge of the quanta so revealed that itself is a benefit. Further, it is open for authorities to review and tax these proceeds accordingly. So it is ok if the deposits reach Rs. 15 Tr. 
  3. The problem is what happens when the total deposits/exchanged amount exceeds Rs. 15 Trn. Once it reaches 15 Trn can RBI tell banks now don't accept any more notes? Or it accepts and asks Government to pay (reverse of dividend)? [Please refer to my previous blog-post on Black money and demonetisation before demonizing me.]
  4. I would say, the fact that entire Rs. 15 Trn comes back itself means that the problem of Fake Indian Currency Notes (FICN) was more potent than was admitted previously. If our run-rate calculations turn out correctly, FICN could be between 33% and 66% of legitimate Indian Notes. That is not a joke. It is also a success of the Demonetisation drive.
  5. I would say about 20-25% of the notes would have been definitely destroyed. But given the tax amnesty announced let us assume about 10-15% were destroyed. The black economy was estimated at 20-25%. Assuming some can be dissipated as white (through jan-dhan and other tricks) we can say at least 10% would be black. Still about 20% of the currency in circulation could be FICN. Compare this with estimates of about 2-5%. 
To top it all Modi did not ask for 50 days to clean up the black money he asked for 17 months. So there will be more action coming. This will be interesting, to say the least.

Saturday, December 03, 2016

My Response to comments on Idiotic debate on Demonetisation

As expected, once I published this I got some flak. I do not wish to detail the flak here. But case in point is an argument by some let us call her "M". Her point is that there are so many "experts" who have trashed this move. Here is my response to her. This is a response to all the "M" out there. Please don't think I single her out.

I completely understand M. I have written a book on economics myself - two to be precise. And just for your information I gave an "average rating" on Modi's app. 
But I want to form my own opinion. Not simply accept Hanke who is speculating. I admire him too FYI. If you want to negative opinion. There is Jim Rickards who is a gold bug who also has negative view. There are many in this camp in fact.  
I am trying to understand why many poor are giving positive views on this measure. I don't accept that people are so sick-minded that just because few corrupt persons holding cash will lose their money, 700 million will become happy. I think we Indians are better than this.  
So I filtered out the media - all media. You will see I haven't quoted Swaraj mag nor have I quoted the wire. 
I wanted the concept explained properly somewhere. I need to understand what govt wants to put out. That I came across in three interviews - Kant debroy and bokil to whom I have linked to. I also linked to the proposal which was presented to Modi. That is the only media I have linked to. 
The public opinion that I have linked to is from people who at least have no stated affiliation to media. They may be pro Modi but it did not seem so. I have linked to one lady who was ranting against modi too. 
My friend, had visited Guwahati and he saw the situation on ground and he says that there are difficulties but things are calming down. You can check his views on my stream. I personally visited ATMs in South and Central Mumbai - I found long queues. But then I returned at 1030pm and I found quite a few ATMs free. There were lines at some but not others. I withdrew 100 Rupees notes. (These are anecdotal but when MSM is biased we have to rely on that) Roahini Ali whose video I linked to seems to have done better structured feedback. So I linked to her video. 
Then I thought it was important to lay out the goalpost that will tell us if the policy is successful or not. If I see those goals being met then I will change my mind and say the policy is a success.  
By now you know that I am not yet sure if this is good policy or not. I wrote a prior post explaining black economy and demonetisation.  
Please consider what will make YOU change your mind on the policy either for or against. Establish your own goalpost. Do it in your own mind - but do it. You will love to see the events against it. 
Sometimes people tell me - look 100 people died in the last almost one month. I personally thought there could have been more deaths. Seriously! And that was why I was against the policy. We are 700 million not counting old and too young. That's more than the entire population of USA. 700million went to the bank in distress and yet no riots broke out. People are not cribbing they are supportive. That number once verified can be debated. But at present, we are talking about 2 people in one crore. 
To end I must suggest one exercise. "M", try to connect with people and get their feedback. Positive, negative it doesn't matter. Let the real feedback come through. Unedited. Post it on YouTube. I will be happy to see it. Don't let these biased guys from right and left influence you. Between unbiased you and unbiased me there won't be conflict. But we know the biased even go to war with each other.

The thing is we are passively choosing the sides. Both sides are wrong - the reality is the third side. If we try to find that side, we will enter into a healthy debate. Please try, country and society will be thankful to you.

Friday, December 02, 2016

Idiotic debate on Demonetization

Since the announcement of demonetization we have quite a lot of noise but no analysis. I am on the look out for genuine criticism of the policy.

Semantics of false criticism
There is a lot of criticism of the government's policy. The international criticism is uninformed and disconnected from Indian ground realities. Quite a bit is a shallow analysis of Nigeria, USSR and some other countries which had demonetized previously. Generally, the criticism falls into the following buckets:
  1. Demonetization alone will not stop black money: That is not proper criticism. 
    1. The government never maintained that it will. 
    2. In fact, Finance ministry circular highlights various measures undertaken by the government till date. 
    3. Further, the prime minister indicated that this was just the beginning and more announcement will come.
  2. Removing 85% of the currency will cause a lot of pain to the people
    1. Well when you ask the people, most are happy with it. Some are very angry. In a country of 1.2 billion you will have voices. 
    2. The prime minister took a smart-phone based app poll which revealed 90% approve of the move. Media quickly jumped up stating the questions are biased. I myself took the poll. The questions were not as biased as media made them out to be. It is a fair poll - you CAN express dissent if you don't like the move.
    3. But the fact remains none of the media channels or anyone tried to do a sms-based poll. We can have a poll for Indian Idol or some crazy show, can media people not fashion a proper poll and report if people are indeed pro- or against.
    4. I tried to go through You-Tube videos about demonetisation uploaded after November 28. I suspected people will give proper reaction once they have been in ATM lines for a few days. I left out videos uploaded by news channels and focussed on videos uploaded by general people. Not many have uploaded but I found one by Roshini Ali & her friend exploring the poor of Kolkata informative. One other fellow explored Mumbai and Aurangabad but he wasn't as comprehensive as Roshini Ali.
  3. Economy will be hurt as currency is withdrawn from circulation
    1. This is the closest people have come to making rational arguments. I don't mind general public making this argument. But from experts, I expect more.
    2. Many experts confuse the measured part of the economy (GDP etc) with unmeasured part (black economy). In an extreme view, since the black economy is not measured its destruction won't affect measured economy. That is flawed as black and white economies intermingle often. Yet they are not quite as intermingled as people make it out to be.
    3. A substantial part of the black economy comes from tax evasion. For example, sales without bill are quite rampant in India. Over billing (for cold drinks) is also rampant. These are black transactions. With proper triggers, these transactions will come to the white economy. (Though demonetization is not that trigger).
  4. Only time will tell if it works:
    1. I understand general public expressing this sentiment. It is a healthy attitude to take.
    2. But when experts take this position, I don't like this. I expect the experts to define their goals for the policy - when will they say it worked. 
    3. And I want them to state it now not once results are out. Because once data is available the narrative will be tailored to the outcome.
    4. Further, be realistic as to what can be achieved by demonetization. I don't want people setting targets "I want black money to become zero".
    5. I want to see the goal post that is set out by all these experts.
  5. Bull-shit interviews/feedback:
    1. Many interviews of government officials and supporters of policy are quite brash. The interviewer does not want to know the policy but instead he wants to hammer the expert. Karan Thaper did that to Bibek Debroy (who I don't really admire - but he is most lucid in the lengthy Ashok Malik interview).
    2. Most media reporting is negative and most general people reporting is positive. One TV channel interviewed a Hindi Speaking shopkeeper in Chennai.
    3. If I watch TV channels interviews then I get different pictures. Pro-government channels say good things and anti-government channels always highlight bad things.
    4. Some channels have shown non-working ATMs quite a few times. And others have shown longer queues giving impression that the queues are that long all the time. People who are on the ground dont find that many long queues all the time.
    5. I have concluded that most of the people do not yet understand what exactly the possible strategy is. None have read the Arthakranti proposal even those who have interviewed the founder Anil Bokil.

Basic framework
Just wanted to clarify one thing here.

Tackling Black money requires a repository of measures. Yes many measures together will help reduce black money. Black money cannot be eliminated completely, it can be reduced drastically.

Demonetisation results in many things out of which one is hurting black money transactions. It freezes the black money transactions and not the assets created out of black money. It also results in other effects - anti-counterfeiting, promoting cash-less transactions etc.

The two are only slightly overlapping. Government hasn't claimed that demonetisation is only aimed at black money. It has correctly stated the what demonetisation can achieve. To confuse the two only shows your ignorance.


Policy Details - possible and others
For interested readers who want to know what is the possible logic behind Government's measures, you can parse some of the links here:
  1. Amithabh Kant on CNN (focusses on going cash-less)
  2. Anil Bokil on ABPMaza (in Marathi) in Anil Bokil in Hindi
  3. Arthakranti Proposal (click here for benefits, benefits to individuals, objections)
  4. Bibek Debroy on Demonetisation and other issues
  5. Ken Rogoff author of The curse of Cash advises gradual demonetisation of high-value notes.
  6. James Henry's article calling for surprise currency recall (from Ken Rogoff)


Setting Goalposts
It is important to set out clear goals when we announce the success of a measure. My goalpost is thus:
  1. I want to evaluate current demonetisation on following parameters:
    1. Total amount deposited with banks / total currency in circulation: I suspect we will get close to entire currency in circulation back into the bank accounts/exchanged. This is because I suspect counterfeit currency in the system is to the tune of 40% i.e. ~ Rs. 6 Trillion making total currency in circulation at ~Rs. 20Trillion.
    2. GDP in Q3 and Q4 of FY 2017 should not reduce more than 1.5%. Thus I expect Q3 and Q4 to be at least 5.8%
    3. Net bank deposits gain: After stabilization, i.e. say by Sep 2017, bank deposits should appreciate by at least 40% of currency in circulation i.e. Rs. 6 Trillion. This is figure after deposits and withdrawals have stabilized.
    4. Share of E-transactions: As per Mastercard data 2% of transactions (number) are cash-less. I would like this number to be around 33% ~ 1 of every 3 transactions should be cashless. 
  2. With respect to Black Money targeting, there should be a continuous targeting of black money holders and black economy.
  3. Tax simplification and rationalization proposal in Union Budget 2017 (which will be in January). I think we should try Banking Transaction Tax once 2 out of 3 transactions are cashless.