Earlier post contended that a logical conclusion of the demonetization move is expected to take the M1 money in circulation to about half - 8 trillion rupees. It is also likely to take some B2B and B2C transactions online, while the other transactions may become more efficient (more transactions with less working capital).
Considering the resilience of Indian economy, the GDP will be maintained overcoming the short term pain that is felt as I write - 1) productivity lost in queues, 2) lost transactions due to shortage of currency notes, 3) perverse transactions arising out of differential aversion to illegitimate currency. Following examples of perverse transactions came to my notice 3a) gold purchases at above market rates, 3b) payment of school fees in advance - up to 10 years in advance, 3c) exchanging a 1000 rupees note for 7-8 notes of 100 rupees, 3d) depositing cash in a dormant account for a fee.
None of this is likely to impact the true GDP, unless the currency situation goes totally out of control. I have confidence in Modi administration and RBI to step in at the right moment and make mid-course corrections. What is beyond their control is how much of economy will move to electronic payments (green circle) and how much of the demonetization will be absorbed by transaction efficiency (purple circle). One of the factors determining the size of these circles is the size of brown circle - amount of currency to be brought in (M1). This brown circle is the trade-off for Modi's fight against black money and smoothly running the economy. Success of the demonetization initiative could be measured as the relative sizes of green and purple.
Irrespective of whether the purple circle grows more or the green circle grows more, I'm assuming that the true GDP will be maintained, just to keep matters simple. By true GDP, I mean the perfectly calculated GDP by measuring actual product at every economic unit. This is different from the official estimates of GDP. One major difference arises from the presence of informal sector (a lot of it is black money). When a restaurant serves a customer, but does not pay taxes then it contributes to true GDP; but it does not get measured in official GDP. Similarly, a roadside (under the tree) barber serves a customer, it is in true GDP, but not in official GDP. The restaurant example is black money, but barber is not; because barber probably earns less than subsistence level.
With the demonetization move, there is going to be some trigger in consumption expenditure as spending is better than hoarding/depositing cash, and risking getting caught. Secondly, previous sources of black income will now be spent in formal economy - say buying an iPhone rather than a benaami property. Thirdly, a positive change in green circle will result in an increase in reported transactions - both black money and informal sector. Lastly, more people with white income will now switch to electronic payments, as acceptance for cards would improve and as experience of last week would have forced merchant establishments to accept cards rather than lose business. Thus, I see a significantly higher official GDP in coming days. In Q1 next fiscal (I sincerely think its going start in April and not Jan as speculated by WhatsApp forwards), we'll definitely see a double digit growth rate in official figures - riding on the back of a) GST, b) demonetization, c) 2016 monsoon and hopefully d) tax collection efficiency. This could even be seen as early as next quarter !
Thus, there are four possible events after the demonetization, depicted in figure below -
Considering the resilience of Indian economy, the GDP will be maintained overcoming the short term pain that is felt as I write - 1) productivity lost in queues, 2) lost transactions due to shortage of currency notes, 3) perverse transactions arising out of differential aversion to illegitimate currency. Following examples of perverse transactions came to my notice 3a) gold purchases at above market rates, 3b) payment of school fees in advance - up to 10 years in advance, 3c) exchanging a 1000 rupees note for 7-8 notes of 100 rupees, 3d) depositing cash in a dormant account for a fee.
None of this is likely to impact the true GDP, unless the currency situation goes totally out of control. I have confidence in Modi administration and RBI to step in at the right moment and make mid-course corrections. What is beyond their control is how much of economy will move to electronic payments (green circle) and how much of the demonetization will be absorbed by transaction efficiency (purple circle). One of the factors determining the size of these circles is the size of brown circle - amount of currency to be brought in (M1). This brown circle is the trade-off for Modi's fight against black money and smoothly running the economy. Success of the demonetization initiative could be measured as the relative sizes of green and purple.
Irrespective of whether the purple circle grows more or the green circle grows more, I'm assuming that the true GDP will be maintained, just to keep matters simple. By true GDP, I mean the perfectly calculated GDP by measuring actual product at every economic unit. This is different from the official estimates of GDP. One major difference arises from the presence of informal sector (a lot of it is black money). When a restaurant serves a customer, but does not pay taxes then it contributes to true GDP; but it does not get measured in official GDP. Similarly, a roadside (under the tree) barber serves a customer, it is in true GDP, but not in official GDP. The restaurant example is black money, but barber is not; because barber probably earns less than subsistence level.
With the demonetization move, there is going to be some trigger in consumption expenditure as spending is better than hoarding/depositing cash, and risking getting caught. Secondly, previous sources of black income will now be spent in formal economy - say buying an iPhone rather than a benaami property. Thirdly, a positive change in green circle will result in an increase in reported transactions - both black money and informal sector. Lastly, more people with white income will now switch to electronic payments, as acceptance for cards would improve and as experience of last week would have forced merchant establishments to accept cards rather than lose business. Thus, I see a significantly higher official GDP in coming days. In Q1 next fiscal (I sincerely think its going start in April and not Jan as speculated by WhatsApp forwards), we'll definitely see a double digit growth rate in official figures - riding on the back of a) GST, b) demonetization, c) 2016 monsoon and hopefully d) tax collection efficiency. This could even be seen as early as next quarter !
Thus, there are four possible events after the demonetization, depicted in figure below -
Why are the markets not rallying ? 1) The domestic investors are shit scared to think rationally. 2) FIIs are clueless about what is black money, and where does it link to. 3) Nearly every investor is exposed to real estate, which is likely to take a hit. In such times, risk aversion spills over to other sectors. 4) Spill over effect from small caps / real estate that have exposure to black economy.
A balanced view from Mint. Barring operational inconvenience, the salaried class (40 Crore people) will rebound soon. The traders may see lower activity. This is where I disagree, as the article ignores credit sales and purchases. Considering those, the economic activity may not be lower. A part of black economy activity may be lower, but that was never reported in the GDP - so we're not bothered about it.
ReplyDeleteThe professionals - lawyers / doctors / accountants - may be forced to bring out the cash component of their wealth, but again a short term impact not so much on the GDP. Real estate, of course, will be badly hit causing "downstream effects in cement, steel".
http://www.livemint.com/Opinion/OBjsLy2iZn1Huoyzz1v6WP/Consequences-of-the-demonetization-shock.html