Saturday, November 19, 2016

India’s Lesson in Demonetization

This article was first published by the Global Association for Risk Professionals on November 18, 2016.!/risk-intelligence/operational/political/a1Z40000003McKvEAK/indias-lesson-in-demonetization

The victory of Donald J. Trump in the U.S. presidential election was not the only surprise in the global news on November 8, 2016. That evening, Indian Prime Minister Narendra Modi addressed the nation and announced that Rs500 and Rs1000 currency notes would “cease to be legal tender,” effective at midnight. “This step will strengthen the hands of the common man in the fight against corruption, black money and fake currency,” he said.

The announcement shocked the nation. Technically speaking, the move was not unprecedented. But the demonetization was in 1978, and given that 65% of India’s population is under 35, memories of it are limited. According to news reports, preparations were under way for six months and shrouded in secrecy. Only about 10 senior people in the prime minister’s office, Finance Ministry and Reserve Bank of India were aware.

The scheme in 1978 was not deemed to be very effective, as “the element of intended surprise and secrecy was also not well maintained and thousand rupees notes were already out of circulation one week before the demonetization. Reportedly large amounts of high denomination notes were sent to Gulf countries, especially to Dubai and Kuwait, a few days before the ordinance was announced.” (Kishore C. Samal, Chasing Black Money in India)

So secrecy became an absolutely necessary condition. Any leaks would have rendered the entire exercise futile by tipping off the black-money hoarders.

In a 1976 paper, On Black Money, K. Sundaram and V. Pandit wrote, “Since it is infeasible to demonetize currencies of all denominations, the success of this policy [demonetization] turns on the extent to which black liquidity is in the shape of currency of the denominations to be demonetized.”

Data from the Reserve Bank of India show that 86% of all currency in circulation is in the Rs500 and Rs1000 denominations, amounting to Rs14.2 trillion, or $212 billion.

Sundaram and Pandit added: “. . . insofar as the measure is anticipated in advance by some and conversion of currency in the relevant denominations takes place, success of this measure is further eroded.”

The policy did not take care of black money in the form of real estate or gold or other non-currency  assets. There are expectations and rumors of crackdowns in the near future on those who have bought real estate and gold through black money.

Impetus to Go Cashless
While the Rs500 and Rs1000 notes were to be removed, Rs2000 notes have been introduced. People were given a window of 50 days to deposit and/or convert the 500 and 1,000 denominations at banks and post offices – a deposit bonanza for the banks that lowered bond yields.  There were limits on the amount of money that could be converted on a daily basis.

Those who got Rs500 and Rs1000 notes converted were handed Rs2000 notes by the banks; Rs100 notes were available at automated teller machines (ATMs). The long queues at ATMs, and out-of-order ATMs, indicated that many people were either without cash or, with Rs2000 notes, were unable to complete small-value transactions because retailers, unequipped with smaller-denomination notes, were not willing to accept the Rs2000 notes.

As a result, many people who had never used debit cards began to do so. Many small retailers and suppliers of daily provisions started asking people to pay by card, cheque or digital wallets – cashless modes of transactions that will bring greater transparency and help curb the creation of black money in the future.

Inflation and Taxation
Dr. Arvind Panagariya, vice chairman of NITI Aayog, told the Economic Editors’ Conference—2016 that “as the black money goes out of the system, the money supply will shrink to some degree. This will reduce inflation rate in the absence of any open market interventions by the Reserve Bank of India.”

A drop in inflation, coupled with banks deposit flows, will give the RBI room to lower interest rates in the future.

The scheme is designed in such a way that people hoarding large amounts of undeclared income in cash will find it difficult to dispose of that cash. There are no limits to deposits of Rs500 and Rs1000 denominations, but it has been made clear that deposits above Rs250,000 would be scrutinized and matched with the account holders’ income tax returns. Mismatches could lead to penalties of 200% of the tax payable, along with the payment of the tax payable.

Modi Initiatives
One of the reasons for the Narendra Modi government’s coming to power was public reaction to scams and corruption. Modi promised to fight corruption and bring good governance and in his November 8 address listed previous measures taken:
·         A law passed in 2015 requiring disclosure of foreign black money.
·         Agreements with many countries, including the U.S., for sharing banking information.
·         A strict law in force from August 2016 to curb benami (nameless or fake-name) transactions.
·         A voluntary income-disclosure scheme for declaring black money after paying a stiff penalty.

The prime minister told the citizens that almost Rs1.25 trillion was uncovered due to these efforts in the last two and a half years. He vowed that many more measures will come in the future.
Acknowledging the inconveniences, Modi implored the citizens to be patient and support the fight against corruption – to accept temporary hardships in the interest of a better India.

Political Reaction
Although the national mood seems generally positive, there was strong opposition from other political parties. Indeed, many political activities in the country are funded with black money.
Then there are cynics. To them, I would suggest an analogy: Corruption and black money is like cancer. A patient might prefer to withhold information from doctors in order to avoid painful treatments, or might want to avoid treatments without 100% assurance of a cure, which is unrealistic.

Tackling black money is important and should not be avoided. No amount of preparation will be enough in a country of 1.2 billion people, and there is always room for improvement.

Singapore’s The Independent hailed the demonetization, saying, “Modi does a Lee Kuan Yew to stamp out corruption in India,” a reference to that country’s transformational leader.

Time will tell if the policy will contribute towards making India a fairer, transparent and corruption-free economy. Black money and corruption are so deep-rooted that they cannot be completely eliminated. More efforts and persistence will be required. To paraphrase Robert Frost, there are miles to go before we sleep.

Wednesday, November 16, 2016

In Global Competitiveness, India Is Trending Higher

This article was first published by the Global Association for Risk Professionals on November 11, 2016;

China is 29th, India 39th in the World Economic Forum’s annual index, which is led by Switzerland, Singapore and the U.S.

India ranked 39th in the 2016-’17 Global Competitiveness Report, recently published by the World Economic Forum. The South Asian nation is 16 places higher than it was the previous year, and 32 above its 2014-’15 rank, and now most of those ahead of India are developed countries in terms of income or other parameters. (See illustration below for factors that go into the WEF analysis.)
In the competitiveness ranking topped by Switzerland, Singapore and the United States (unchanged in that order from a year earlier), followed by the Netherlands and Germany (switching places 4 and 5), China was 28th, unchanged since 2014-’15. Brazil has slipped to 81st (from 75 in 2015’-16 and 57 in 2014’-15). Russia improved to 43 from 45, and South Africa to 47 from 49.
In its region, India was best-performing in areas such as infrastructure, goods market efficiency, financial market development, market size, business sophistication and innovation. India still has a long way to go in health, primary education and labor markets — despite significant improvements health and education over the last decade.
What is behind the rise of India in the world competitiveness ranking?
Market size — India’s huge domestic market worked in its favor. Johan C. Aurik, chairman and global managing partner of strategy consulting firm A.T. Kearney, in an interview with Livemint, said that India, with an economy trailing only those of the U.S. and China, “is lucky that it is so big that it does not need the world.”
Financial market development — After being marred by scams in the 1990s and early 2000s, India’s stock markets have advanced in terms of modernization and technology, with the regulator (Securities and Exchange Board of India) backing efforts to bring them up to international standards.
Figure 1

Source: World Economic Forum
Similarly, the Reserve Bank of India (RBI) has taken steps to improve the bond markets, bring transparency to non-performing assets and bring inflation under control. The image of the central bank went up many notches under its 23rd governor, Raghuram Govind Rajan, who was succeeded in September by Urjit Patel.
Institutions — Policy paralysis, misuse of public money and infrastructure were among the reasons that people lost trust in public institutions and administration in the last few years of the United Progressive Alliance (UPA) government. In 2014, when the National Democratic Alliance (NDA) came to power, the Narendra Modi-led government has lifted public confidence.
Goods market efficiency — Although India is the best-performing country in South Asia in goods market efficiency, it has actually declined in this measure over the last decade. With passage of the goods and services tax (GST) by the parliament earlier this year, and efforts ongoing for an April 1 implementation, there may be significant improvement in overall market efficiency. “GST was a miracle, I thought it would never happen,” Aurik said.
Infrastructure — The key infrastructure ministries are seen as having done their job well over the past couple of years. The government has designated infrastructure as a top priority, and there has been significant, perceptible progress in power, roads and shipping, and railways. Besides planning to spend billions of dollars on infrastructure, the government has relaxed regulations to attract foreign direct investments (FDI) in the sector.
Labor market efficiency — India ranks lowest in this pillar (112th out of 138 countries). The current labor laws are outmoded and rigid. Although labor law reform is on the government’s agenda, it is a politically sensitive issue, and small steps meets with resistance. The proposed reforms would make hiring and firing easier for the large public sector undertakings.
Macroeconomic environment — The Indian economy is poised for further growth. Per capita income has almost doubled in the last six to seven years. The foreign exchange reserves of more than $360 billion help in maintaining confidence in monetary and exchange rate policies and enhance the capacity of the central bank to intervene in forex markets. The economy is well placed for meeting external obligations, and maintaining investor confidence helps to attract much-needed FDI.
Although fund managers are parking money in India due to the advantage they get from the positive interest rate differential, a lot of these funds, just as in other Asian economies, are seeking a more permanent destination. India is now the top FDI destination for the world. Prime Minister Modi sends out the right signals about the commitment of the government to providing the right environment for development.
Technology readiness — India has not done well in technology readiness despite its success in IT outsourcing. Regulators must keep up with the sophistication in market technology and new market structure. Enforcement cases will become more complicated as market manipulation and other misconduct are now also conducted on the Internet, where they are difficult to detect.
Cybercrime surveillance should be updated periodically. Also, whether a demutualized exchange should be regulated as any other listed company, or as a utility, will be a challenge for the regulators.
Health and primary education — Jim O'Neill, the British economist and former chairman of Goldman Sachs Asset Management credited with coining the term BRICs (Brazil, Russia, India and China), wrote on Bloomberg View about 10 things that India must do to achieve its potential. Two of those 10 were related to education — primary and secondary as well as colleges and universities. (Liberalizing financial markets and building more infrastructure were among the others.) Education is essential if the population of India is to be a true asset for development.
On the health front, the average growth in total health care spending is lower than the average GDP growth rate and lower, as a percentage of GDP, than that of even low-income countries, as classified by the World Bank. (India is classified as low-middle income.) It is estimated that nearly one million Indians die every year due to inadequate health care facilities, and close to 700 million have no access to specialist care.
Higher education and training — The country is home to the Indian Institute of Technology and the Indian Institute of Management, yet many graduates in India are unemployable. The quality of faculty and infrastructure and the number of institutions of higher education need beefing up.
Business sophistication and Innovation — There has been significant improvement in both business sophistication and innovation owing to increased research and development activities and the ecosystem for promoting start-ups.
Although many indicators are favorable, Prime Minister Lee Hsien Loong of Singapore, on a recent visit to India, said the country remains a difficult place to do business. Gaps in the regulatory framework and other crucial areas need to be addressed. India’s competitiveness ranking is an endorsement of the steps that have been taken and a reminder that there are still “miles to go.”