With Due Apologies to Pensioners

This appeared in Financial Express on 13th December, 2017 http://www.financialexpress.com/opinion/myths-on-pensioners-busted-check-out-the-real-and-false-arguments/971509/

Inflation Proofing Pensioners – the real and the false arguments

V Kumaraswamy

Our tight inflation targeting in the last 6-7 years are sought to be justified on (i) stable prices being a pre-requite for sustained growth and (ii) that pensioners who largely on interest income should be protected. Such targeting is being achieved by RBI through higher interest rates regime. Similar argument is advanced against correcting our over valued currency.

That the pensioners have suffered in the last few years and will suffer heavily if we loosen controls on interest is a big myth at this point in time when coming out of low growth inertia and near nil new employment creation seems so vital.

Have they suffered in recent times?

The main argument is that the pensioners with fixed income will suffer capital erosion through inflation and will have less and less real capital base to earn their future incomes. If interest income remains constant but expenditure keeps going up year on year due to inflation, progressively they will be left with smaller amounts to consume.

Table 1 clearly shows that this argument is clearly overdone in the last 4-5 years. Ever since the 4% CPI inflation target has been articulated and rather doggedly pursued by maintaining higher interest rates, inflation has fallen steeply whereas the interest rates have not traced the same trajectory.

From 2005-06 till 2011-12, the interest on Bank Term deposits were 1.5% more than the WPI inflation and 0.7% less than Consumer Price inflation. Since then, interest earners have had it good and the interest rates have been more than both – by a whopping 5.6% over WPI and 1.5% over Consumer Inflation.


Table 1: Interest Rates and Inflation – Pre & Post 2012
Period WPI Inflation @ Inflation Consumer Prices # Interest on Term deposits @
Ave 2005-06 to  2011-12 6.6 8.8 8.1
Ave since 2011-12 2.3 6.4 7.9

Source: @ from RBI; # from World Development Indicators.

But why the all-round feeling of being left out by the Pensioners now as the social media would have us believe when in real terms their income is 3 times compared to the period before 2012. In the years since 1991 except for a brief period between 1998 to 2002 asset prices have always been going up, in many years faster than inflation. When there is asset price inflation there is the wealth effect which makes us feel wealthier and prone to spending more, as articulated by economists. But once again in the last 3 years, real estate prices have hardly gone up. Without this illusory wealth effect backing, pensioners may be feeling poorer off.

Class of Interest Earners and Pensioners

People in agriculture tilling the land are unlikely to be living on interest income. They till as long as they can and then reply on family as the social security net on reverse mortgage of sorts – family supports them on the understanding that on death, his property will pass onto them. This is 50-60% of rural population. Landless labour are unlikely to be hit due to interest rate variations; they would need a safety net of a different kind. Non- farm rural labour is unlikely to be living off bank deposits.

People who are largely living on interest income are most likely urban or middle class. Most of them hedge their bets and have houses, gold etc. as safety nets and only a portion of their savings is in interest bearing instruments.

Amongst these are retired Government employees, whose pension is adjusted for inflation from time to time if they have been in service before 2004. They are a substantial proportion among pensioners. Those who joined after 2004 are unlikely to have retired by now.  Those who are most likely sufferers are those who retired from private service. Let’s see what proportion these are.

The total term and savings deposits of the banking system as of Sept 2017 is about Rs 114 lac crores and with the MF, Small savings and Public deposits it would be about Rs 130-135 lac crores, which is about 80% of our GDP. The comparative figures for US is more than 150%.  At an average rate of 6.6% this would give an income of Rs 8.91 lac crores or 5.5% of GDP.

From the above, we have to deduct the interest accruing to people still in service and Government pensioners. The income accruing to those who are surviving on interest alone is likely to be less than 2% of population.

Effect of Currency Devaluation

One of the strident and stubborn arguments against correction of our overvalued currency is that it will lead to inflation and hurt the interest of pensioners. The Urjit Patel Committee has summarised the several studies (see Table 2) on India estimating the inflation over the short term and the long term from a 10% movement in Rupee versus USD. With the singular exception of Ghosh and Rajan, the resultant incremental inflation (from currency alone) is likely to be 0.6% in the short term to about 1.5% over the long term. This is hardly worth the scare given the real income of pensioners have risen 3 times since 2012.


Table 2: Impact from 10% Depreciation of Re vs US $
Author Period Covered Short Term Inflation Long Term inflation
Khundrakpam (2007) 1991 – 2005 0.5% in WPI 0.90%
Kapur and Behera (2012) 1996 – 2011 0.6% in WPI 1.20%
Patra and Kapur (2010) 1996 – 2009 0.5% in one qtr WPI 1.5% in 7 qtrs
Patra et al (2013) 1999 – 2013 1.5% before 2008 crisis 1% after Crisis – WPI
Ghosh and Rajan (2007) 1980 – 2006 4.5%  to 5% in CPI  
Bhattacharya et al (2008) 1997 – 2007 1% – 1.1% in CPI 0.4% to 1.7% in CPI
Source: RBI – Urjit Patel Committee Report


Pensioners Vs Job Seekers 

Should our monetary system be so sensitive to such a small proportion of GDP and the group of people behind that (less than 2%). A 2-3% drop in interest rate in line with inflation would help the investment climate substantially especially in utilising capacities lying idle. The number of new job seekers is about 0.75 – 1% of total population each year.  For years on end the job creation has suffered and they will far outnumber Pensioners and its time their aspirations are also met.

Deposits till death.

If term deposit interest rates spread inflation had been same post 2012 (as between 2005/6 to 2012), Banks would be now saving Rs 164,000 crores on the incremental deposits of Rs 40-odd lac crores. If similar reduction had accrued on Central Government’s net additional borrowings, it would be an additional Rs 74,000 crores. These amounts saved would be sufficient to take care of those who purely depend on interest for survival.

The real sufferers can be taken care of by special deposits which can yield 2 % over CPI inflation s.t minimum of 5%. The deposits can be on joint names of spouses and on death of the latter to die, the deposits can be given over to the designated nominees after deducting tax. If prematurely withdrawn by depositors, the interest can be recalculated as per past prevailing interest rates and the balance of deposit paid to the depositor. Those who are entirely dependent on interest alone could be easily taken care through this mechanism from the potential savings as earlier estimated.

The writer if CFO of JK Paper and Author of Making Growth Happen in India (Sage).   


Is it Time to rework our Monetary Policy Framework?


My article with the title above (different in title between the Print version and e-paper version) appears in Financial Express today.


The government seems to be in a bit of bind over both employment and growth, not for all its as own making. One of the chief contributory to this morass is the inappropriate way the objectives of our monetary policy have been fixed or evolved over the last 6-7 years. The Chart shows clearly the increasing misalignment between the inflation, external value of Rupee (as reflected by REER) and the interest rates caused by the recent shifts in our monetary policy. The Chart uses the WPI instead of the new found CPI which is 57% out of control of RBI’s policies as the report itself admits.

Two main components as it operates in our Monetary Policy Framework are (i) to target a consumer price inflation of 4% with a tolerance of 2%. Both the variable and its levels are recent developments, and (ii) to aim at orderly conduct of the forex markets without seeking to target any particular rates.

Fundamental flaws

Firstly, in both these, the targets are fixed without reference to any end goals in mind. As if these are desirable self-actualising end-goals in themselves. In economics everything is interconnected – inflation, interest rates, growth, employment, productivity, cost competitiveness, etc. To seek a deterministic nominal goal in a web of influences looks naïve at best.

Secondly, the objective that the economy desires to achieve may vary depending upon the stage of growth. It can vary for the same economy from time to time. For EU it is kick-starting growth now, for China is to stabilise it at a high rate, for Japan it is to grow – any growth – even if very low by international standards. For US it was achieving any growth after the meltdown but now slowly crossing over to stabilising inflation. A nominal fixed target does not address these contextual concerns.

Thirdly, economics is mostly about balance and trade-offs between what in general are opposing interests – buyers and sellers, producers and consumers, workers and producers, savers and investors, inflation and growth and so on. One isn’t sure how a nominal deterministic inflation number can work towards an optimal or at least desired equilibrium between savers and investors, between domestic investments and imports at all times even in the medium term.

Lastly, as is explained below, there is excessive and suicidal reliance on the nominal rather than real variables, which is what may be causing the current problem.

No basis

There seems no theoretical basis for the inflation targeting or its levels – not from IMF, not from Basle norms which aims at financial stability or RBI. While nothing can be exact about economics and hence a band is necessary for targets, a 2% tolerance on 4%, is like permitting Usain Bolt to run on his track or the adjacent tracks on either side and the penalties for trespass being imposed 2 Olympics away.

Just orderly movement of forex rates is no policy. When it is clear that it has a significant impact on domestic capacity utilisation, jobs and growth to just aim to only curb the volatility but not be concerned with the values is naïve shirking, much like driving without violating any traffic guidelines or speed limits but towards a wrong destination. By keeping the currency over valued for far too long (over a decade now), we are re-creating conditions of 1991 crisis.

Way forward

Keynes had brought out the true nature of the real and the nominal economy, the rigidities exhibited by the real and how to tweak it by using the nominal to achieve real goals. The current constant 4% inflation (nominal) target can in no way balance the interests between savers and investors, forever. The government should move to a 2% +/- 0.25% real interest rate regime. Whether the inflation is 4% or 9%, such a real interest spread of 2% will be a fair compensation to savers. It will also not curb investment urges if what investors have to pay out is in line what they recover from the market through inflation in prices. This is a sort of inflation proofing both savers and investors.

Such a floating nominal interest (but largely fixed real interest rates) regime will largely ensure that fresh investments and savings do not grind to a halt.

But the existing outstanding stock of savings are in fixed nominal interest regime, which poses problems. It is therefore necessary to move to a floating nominal rate regime and increase its proportion. In the last few years, Bank loans have largely become floating rate with optional repayment and a significant progress has been achieved. It is necessary to increase the proportion of floating rate bank deposits from the savers side as well.

The second thing that is capable of derailing growth and employment in an open economy is the forex rates. An overvalued currency makes imports cheaper, exports far less remunerative which affects domestic employment and growth. A 20-22% overvalued currency as on date is a killer. Government should mandate RBI to walk it along in an orderly manner along the real values. RBI and Government should agree to maintain exchange rates within a band of 97 -103 REER. This REER should be calculated on a base year that is sound when most economic parameters (CAD, fiscal deficit, inflation, growth, etc.) are as close to our desired objective. As it stands now, 2004-05 is one such year. The government should also tailor its inward investment policies accordingly and the degree of capital account convertibility tuned appropriately.

Currently policy rates it appears are decided mostly or solely on inflationary expectations. This can result in fear mongering. In deciding the policy rates, perhaps the actual for the past 2 quarters should be given equal weightage.

By moving to the real from the nominal on both interest and forex accounts, we may have learnt the right lessons from Keynes. Excessive reliance on the nominal on both accounts have made India underperform its potential in the last 4-5 years.



Way to kick start economy – Currency Devaluation or Fiscal Stimulus?

An edited version has appeared in Financial Express on 13 Oct 2017

Currency Correction or Fiscal Stimulus?

V Kumaraswamy

The feeling of sluggishness is palpable everywhere. There are talks of stimulating the economy by fiscal incentives etc. This can be a very innocuous medicine for reasons of (i) dosage, (ii) potency, and (iii) long lead time.

First the dosage. The government may throw Rs 50-60K crores as fiscal stimulus. This is about 0.4% of our GDP. Given the current moribund state of economy with 25-30% underutilised capacities it is too tiny to have any impact. The current closure of capacities or lack of investments have not become so for 1-2% poorer realisations or profitability. While the figures vary for different industries, it is substantial – more in the range of 10-20%. We need a correction of this magnitude. The gaps in our competitiveness with countries exporting to us like China, ASEAN and Korea is 10-15%; not a 1-2% pittance.

Next the potency and wastage. Any incentive will reach both Units operating at full capacity and units with low utilisation and poor profitability. Units which are closed or NPA currently could hardly be revived with a small ‘spread thin’ incentive. The incentives reaching units operating at full capacity will neither create incremental growth nor new employment. There will be a lot of wasted (applying where not needed) efforts.

Finally, the lead time. If stimulus is by way of Income Tax rebates, it will be a year or many quarters before the recipient feels it and reckons it in his decisions. If it is by way of Indirect tax cuts, the recipient knows that it is for a limited period and will not motivate him for taking a long term investment decision. We need some immediate actions and most fiscal measures take a long lead time to get results. It may be well beyond 2019 that one would see perceptible results.

The current problem

The economy is stuck at a low and unresponsive equilibrium.  The current economic impasse is born out of 3 main factors (i) high internal value of currency (low inflation targets resulting in high real interest rates), (ii) may be partially from it, high external value of Rupee and high real interest rates attracting too much forex flows which are beyond the capacity of economy to absorb and (iii) free trade with ASEAN which kicked in from Jan 2014 in full.

ASEAN FTA did increase supplies and kept prices under check. It made import parity as the main basis of price determination for many manufactured goods. But it also eroded domestic industry’s profitability since manufacturing prices have hardly risen to cover inflation of inputs in wages and inputs from agriculture. It delivered customer stable or reduced prices but took away their jobs. India’s growth is creating Jobs but in other countries!

Somehow inflation control has become the focal point of our monetary management in recent years just like fiscal deficit is for our Union Budgets. While the fiscal deficit control is understandable, in an open globalised economy when product of every description could be freely imported, supply shortfall induced inflation is out of question. From Pulses and rice, to apparels, to electronics and Ganesha and Navrathra idols everything can be imported these days. So supply constraint induced inflation is the least that RBI or the Government needs to worry about.

Ways to correct imbalances

The main contributory reason for our lack of competitiveness with other regional players is the high external value of our currency. The sooner it is corrected the better, either by devaluation or dis-incentivising inflows.   But devaluation can cause inflation. As is reasoned out below inflation can be phantom enemy if things are calibrated well.

The first thing is to reduce debt limits available to overseas investors and strictly adhere to such limits. There is nopoint accumulating reserves to earn 1-2% returns by paying 4-5% overseas as interest in $ terms.

Secondly, there could be a temporary tax on overseas investments into India. This can be even for ECBs, investments into government debt and all inflows which are not required for physical imports. Taxing interest on GOI bonds will lower their yields and contain inward flows. There could be a surcharge on inflows till the related imports also take place. These could be used for re-capitalising our banks.

As a corollary, Government can mandate that fresh foreign investments can only be in new government bonds issued, on which the GOI can offer much less interest rate. Such an exercise will help the GOI as well. Such issuances can be allowed for secondary trades may be a separate bond segment with lower interest will develop as a result.

Containing Resultant Inflation 

The Government should bite the bullet like it did with GST and correct the near 22% over valuation in one substantial go. It can reset $=Re at Rs 71-72, which is 11% correction.

Monsoon is good throughout the country and agricultural inflation may not be a risk. If in fact there is excess production, a good forex rate might help evacuate some surplus so that domestic prices don’t crash due to oversupply.

In the long term, a 11% devaluation is about $ 40 billion in added inflation. This on a GDP of approx. $ 2400 is about 1.6% – may not be unbearable. But it’s the short temr effect on imported products and their immediate derivatives and next level products.

Oil is the largest at 25% of import bill.  Government (state and Central) should put a price cap. Their duties (customs, Excise and VAT together) account for a third of final price. There can be a freeze for 12-18 months in Re-terms on these. Oil marketing companies which have expanded their margins in the last few months can be told to absorb a third and the rest can be passed on. An additional 3.7% inflation on oil will amount to about a 1% on final inflation. Gold and Diamonds are next. We should not bother with Gold (the costlier it is, the better) and Diamond is largely for processing and hence related exports will make up for the input inflation.

That will confine inflation largely to manufactured goods. Most prices today in manufacturing sector are determined by import parity prices. A 10-11% correction would most likely translate into a similar uptick in their prices, which could help several factories (most especially textiles) to start chugging again. In any case, buyers of manufactured goods have had it too good for the last 5-6 years without much inflation.

Protecting the pensioners and interest earners needs to be balanced with the interest of freshers in the job market. The total interest paid on all bank deposits and Small savings and MFs is less than 5.5% of GDP. If we remove the government pensioners and those who have not yet retired from this, it would not be more than 1-2%. The number of those entering the job market and finding themselves without jobs will far outnumber those surviving solely on interest.

Currency correction will also solve a lot of NPA issue. A 10-12% increase in industrial realisations will turn many industrial units from potential NPAs to preforming ones.

Superiority over fiscal stimulus

Currency correction will hit the problem where it is. The dosage at 11% on the total value of trade (both imports and exports) is huge. It will alter the domestic profitability substantially and have an immediate impact – from the following day morning.

Sure forex borrowers will suffer. But those who have covered their exposure need not worry. For those who have not covered or partially covered, they have made good gains for the last 12 years on the trot. Why should not they not be made a pay some back now?

An equilibrium cannot be corrected by fiscal stimulus which will be better for rectifying confidence issues.

(The writer is the author of Making Growth Happen in India, Sage Publications).

How high Real Interest Rates can trip Modi in 2019

this artcile of mine has appeared in Financial express today (29/sept, 2017). Link below.


Unedited Version:

RBI’s Interest Rates can trip Modi in 2019

V Kumaraswamy 

Ask any shop keeper, or the lonely looking private security guards, unemployed youth in urban slums or interior towns, or the taxi drivers as to what their main issue today is and pat comes the reply: be rozgari

Not many expected Vajpayee to lose 2004 with the groundswell of national passion over Kargil, Golden Quadrilateral, relative peace and quiet in domestic scenario, great government finances and the political networking he cultivated.  Yet he lost.

The voter at the booth is not going to be thankful for how much wholesale corruption has come down (retail is still alive and throbbing), degree of digitisation India has achieved, how benign inflation is, etc. These are at best hygiene factors which can easily be washed away if joblessness persists. Without a job, a stable one at that, he can’t proposer.

High Manufacturing Real Interest Rates (RIRs).

If more people have to be converted from being losers during the on-going reforms to gainers, we need rapid job creation. Services sector (IT, BPOs, Call Centres, and Telecom) created jobs by the buckets till about 2011-12 but have reached stagnation now and have even started becoming uncompetitive now threatening imminent job losses.  Agri sector is just incapable of creating further jobs; rather it would release lots that need to be absorbed.

Employment should come from only manufacturing and here is where the real interest rates facing Indian industry is proving an insurmountable barrier not just a hurdle. The accompanying chart compares the Real Interest Rates (RIRs) between China and RIRs facing Indian manufacturing.  Manufacturing RIRs are  derived by deducting manufacturing inflation from the nominal interests facing manufacturing sector. For the last over a decade Indian Mfg RIR is about 7.21% versus China’s 2.92% – (i.e 4.29% over China’s) a huge hole for anyone to be interested in investing in Indian manufacturing.

It is a mistake to compare the general RIR which is just 2.04% over China, the country with which we have maximum non-oil trade deficit. The General inflation is contaminated by Fuel oil, Food which have no bearing whatsoever for studying manufacturing investment competitiveness.

Why has it become important now?

Just but for one year, Indian Manufacturing RIRs have been higher than China since 1991. So why has it started affecting investment sentiments now. Starting Jan 2014, duties for imports from ASEAN has become Zero virtually (S Korea is not far behind) making India’s trade borders completely open. China (even with import duties) has cost structures lower than ASEAN for several commodities.

India’s capital account has also been steadily opening up and for practical purposes it is completely open. Even the per annum limits on debt are periodically reviewed and enhanced without even waiting for the year turns.

With open trade and capital flows one has to be more sharply competitive. Added to this is the 25-30% overall surplus capacity in Industry. Who would dare to invest with a huge handicap on interest rates and surplus capacities. It is better to source goods from China or set up facilities there and sell in India, which exports jobs.

Sources of competitiveness

As mentioned earlier, agriculture and services look spent forces as far as employment creation goes.  It rests on manufacturing to create jobs, for which it needs to be competitive, which has to come from any of the 4 factors of production or natural resource endowments (part of Land).

India has tied itself up in knots where land is concerned.  Our socialistic mindset has made a grand backdoor re-entry through LARR and a plethora of court rulings, restriction on land transfer and change in usage, etc. Any acquisition takes 5 years – far beyond the patience time for an entrepreneur to keeping waiting with his ideas.  India has 375 people per sqkm where China has 142 (2015), increasing the pressure on land. So land as a source of competitive strength is ruled out.

Labour can be a source of strength given the wage levels now. But for that to happen we need to repurpose our education. Instead of (or perhaps alongwith)  BE(Mechanical) and B Tech (Chemical) we need 8th Std (textile printing), 10th std (BPO assistant), 12th std (Source coders), etc. i.e. fit for purpose specialisation kicking in at far younger ages. This can perhaps reduce capital invested for turning an unemployed into productive force as well supply the skills that would increase productivity. Such increased productivity can make the labour cheap per output unit.

That leaves Interest rates. Even enterprise is a function of interest rates beyond a point, where it translates entrepreneurism into investments. With excess capacities and high RIRs in Manufacturing, no one will feel tempted to invest in India.

High real interest rates (when the whole of rest of world is underperforming) and an increasingly politically stable India is attracting excess of $s, that cannot be absorbed by a stalling investment economy. Oversupply / unutilised $s in the forex market causes its prices to decrease. With it, it brings down import prices and makes our exports un-remunerative. This causes imports to flare up. Sure we are also gaining in petrol, prices of Chinese goods, goods from ASEAN, etc. But then the jobs in making them is happening overseas. What’s more important now  – employment or lower inflation? People who are gloating at low inflation are looking at just one side of the equation

In the last 6-7 years our Monetary economists have been failing their equilibrium mathematics exams, with their highly out of context imported monetary theories. But the political student to be detained may be Modi’s Government in 2019.

(The writer is the Author of Making Growth Happen in India (Sage Publications))









Singapores Economic Woes


Singapore’s Economic Recession

Singapore has been a powerhouse of economic growth and icon of modernity and innovation in the East.  As recounted by everyone I met, it has been in recession for the last two years. One of the foremost and lead sectors of services is the oil drilling and exploration, oil rigs, and transportation of cargo.  These have been sluggish of late and seem to have affected Singapore also significantly. The sector has seen staff shedding of significant numbers as a result. As a result other service providers to them like legal services, audit services, banking, etc have shrunk a bit – may be quite a bit and have had to down size some staff themselves.

A significant amount of investments by outsiders into Singapore was in real estate. This has caused the real estate prices to climb up steadily. In the recent years native Singaporeans have complained of unaffordable real estate prices and living costs. The minimum house price for a middle class is about SG$ 1 million. They have contended that it is not possible to support such a capital cost/debt on a salary of SG$ 6,000 – 8,000 average salaries and started migrating out of Singapore to Australia and elsewhere.  To tame it down or reverse this, the Govt has put a 15% stamp duty – to discourage runaway property prices due to purchase  by outsiders. This in order to help the ‘locals’. Due to this extreme measure (this must now be the highest stamp duty anywhere in the world), the outsiders have virtually stopped brining in investments.  And construction industry ahs seen a steep slow down and large layoffs.

Added to this, Singapore has signed off on Fatca and other money laundering agreements spearheaded by US. As a result of tight monitoring and policing and KYC requirement, the funds that were managed for private wealth clients out of a liberal and efficient Singapore have seen a steep decline. And this has led to layoffs in this sector of high salaries curbing further their spends.

‘Singa’pore is a highly dynamic and innovative society. You can’t keep it caged for far too long. I understand that the DyPM who was handling economic affairs so far has handed over to someone else (i forget the name) to put back the economy on rails. And his mentor is Dr Y V Reddy who commands a high respect there – RBI for the way it has handled several world- wide crisis 1997 East Asia, 2002 internet bubble and 2008 by their conservative approach is respected the highest by Singapore Monetary authorities I was told by at least 3.

It will be interesting to see how they bounce back. I am sure there will be some lessons for all the rest.

It stands to reason the first thing to be hit in a recession will be the discretionary expenditure. Usually when i walk from my usual Hotel Park Royal to Komala Vilas, MTR, Ananda Bhavan etc – all within 100-300 meters for my dinner, i will hear the blaring music belching out of many Music clubs and Dance bars – Hollywood songs, bollywood songs, Tamil, Hindi, etc. But this time there was just a solitary one. I am sure one day the magazineEconomist will develop a Karaoke index to measure the level of economic activity a la the Big Mac index.   Or use the level of vouyeuristic activities to measure the Economy. 


Demonetisation Lessons from Brazil

An edited version of this article appeared in Financial Express today. Link: http://www.financialexpress.com/opinion/note-ban-lesson-from-brazil-best-way-to-demonetise-is-not-to-have-one/472432/

Public policies are best when a lot of reason goes into their formulation and passion into their implementation.Those looking for an effective recipe for formulation could learn a lot from Brazil. It has demonetised its currency 8 times since 1942 and thrice simply knocked off the last 3 digits of its currency overnight i.e. like a 10,000 Cruzeiro (then Brazilian currency) will be 10 Cruzeiro from next day morning.

Lessons from 1830s to 1942.

Even before from 1830s it has been compelled to experiment with its currency due to evolving politics. The early experiments are to do with metallic convertible bases like silver and gold, metallic copper coins, birth of parallel paper money,  etc.

In early 1830s in order to stabilise the external value of Mil-Reis (then currency), the centre starved supply of currencies reducing the circulation of copper coins in the provinces. The provinces responded by issuing their own notes to neutralise demonetisation. Promissory Notes issued by Commercial banks valid for 15 days by law began to be accepted far beyond their due dates. (Source: Page 39-43,  Monetary Statecraft in Brazil: 1808–2014, Kurt Mettenheim)

Some other time commercial banks were allowed to issue bank notes (like in Hong Kong where currencies were issued by Standard Chartered and HSBC till accession). This led to loss of control of central authority and dilution of monetary policies.

Brazil through its history has clearly proved that no one can ‘starve’ the people of currency for far too long.


This period was mostly about high government expenditure, unbridled fiscal gaps and high inflation. Brazil demonetised 8 times before the last one in 1994.

It has had to change its currency, the ultimate form of demonetization for every conceivable reason – to tackle black money (Indian objective), to tackle hyper inflation, tackle daily cumulating interest rates of 3% (which is nearly 50,000% p.a.), base erosion, commodity price volatilities especially in Copper or just to avoid confusion (if Brazil had retained its currency same as in 1942, it would be 1 US $ =  2750 followed by 18 zeros, a nightmare for the accountants). They have been far deeper than t he Indian type demonetisation – the entire spectrum was replaced and the currency itself renamed.

The last in 1994.

The most recent in 1994 seemed Quixotic. It was aimed more at breaking the psychology of inflation. With 100% inflation consistently for 14 preceding  years (in 4 years over 1000%), shops had to revise prices 3 times everyday. That is when the government decided to use two currencies simultaneously – one virtual for counting the real value of currency and another for payments and settlement – and every shop having to display its prices in both and revise it 3 times a day.

But unexpectedly, people started anchoring their values against the real value (which was set near 1 Real Value unit = 1 US$).  Within a quarter or so, it was clear people were not rushing any longer to shops to avoid their currency buying less than when they started from home. Inflation abated and the real value became the Real the official unit. It was perhaps one of its most successful experiments that has lasted till date.

Lessons from Brazil

People will seek ways to settle transactions in the most cost and effort efficient ways. For many transactions in much of India, using currencies across the counter is still the most efficient option. In 1970s and 80s, when there was a coin shortage of sorts,  Chintamani co-operative superstore in Coimbatore used to issue their own tokens. These slowly gained acceptance with public so much so that even government owned busses and offices used them.

The parallel systems will start issuing notes and IOUs which will be strictly ‘enforced’ amongst its members through extra legal authorities.

One thing Brazil has always got right (between 1942-1994) is to have the 1,2,5,10,20,50,100 note sequence – considered the most friendly from transaction settlement point of view.

Currencies are as much about psychology and convenience as values for accounting and transaction, as the 1994 experiment so decisively proved.

The best way to demonetise is not to have one – avoid inflation, avoid unjustifiable or un-implementable tax systems, and not to issue too much of it anyway. Brazil has about 3% as currency/GDP whereas India’s is11-12%. Government should have incentivised and reduced it by 1% every year rather than force it in one lump.

A parade of demonetisations has not exactly curbed either parallel economy or corruption in Brazil. Corruption and black money is so rampant, their President was recently impeached for corruption, their biggest real estate tycoon is behind bars and may have to spend the rest of life there if not politically rescued.

Why black money or parallel economy, there is a near parallel administration being run by the mafia through drugs, extortion, violent thefts (one murder every 10 minutes i.e 140 a day, down of course from 600 a day not so long ago), etc. none of which will be happening through tax paid cheque money transfers.


In summary Brazil offers 3 ground rules (perhaps not with successful examples as much as negative narratives):

  • the way to tame inflation is not periodic demonetisations but curb state populism,
  • the way to curb black money and illegal economy is not starving people of cash but well thought out tax policies and effective punishments, and
  • the way to protect free trade from causing domestic unemployment problems is to maintain the external value of the currency which in turn is achieved by restricting external capital inflows to just what is required for financing current account deficits. (Donald V Coes, Macro Economic Policies and Growth in Brazil, 1964-90)

One would definitely give credit to both the government and RBI for curbing state populism within FRBMs. But given the levels of corruption in tax collection systems itself, black money curbing through demonetisation seems an ill fitting solution. Unemployment is rampant and growing due perhaps to highly overvalued Rupee and extra terrestrial real interest rates.

The daily dose of RBI circulars does indicate that someone is extremely alert at the wheel but whether he knows the destination and if it will deliver enough gains for the pains people are experiencing, time alone will tell.

The writer is CFO and author of ‘Making Growth Happen in India’ (Sage Publications)

Demystifying GDP numbers – as articulate a statistician as you will ever find

Demystifying the confusion around GDP figures

Attended an address today by Dr Pronab Sen, former Chief Statistician of India and Chairman National Statistical Commission. I must admit despite his slightly absent minded looks, he is the most articulate economist I have heard in a long time. Some excerpts. He threw a lot of light of issues generating lots of heat in the press nowadays. (Errors in figures if any is entirely mine).

Should we believe the new GDP growth rates reported

People confuse output for income. GDP is not the sum of turnover but income. A consumption good may be traded at 4-5 intermediate stages before it reaches the final consumer. Then GDP is not the summation of the turnover of the 4 intermediate trades but just the income (Value added) at each of these stages. Example: if an auto mfgr imports components of Rs 30, assembles and sells the car at Rs 55, the dealer to retail showroom at Rs 70, and the retailer to customer at Rs 80… the GDP will be Rs 50 (25+15+10) not Rs 235 (30+55+70+80) or Rs 205 (55+70+80).

Thus GDP is not summation of  Value of Outputs (VO) but summation of Value added (VA) at each stage.

GDP = ∑VA  or = ∑VO * (VA/VO). i.e output into Value Added ratio at each respective stage.

In India the long term average (1950-1998) VA ratio was 16% for manufacturing industries. Between 1998 & 2003 it increased to 18%. By 2011-15 this has increased to 22.5%. Thus a lot more value addition is taking place in our output than anytime in the past. Even if our output may not have grown at higher rates, the value added component in that output has gone up … giving higher GDP numbers. This is what is being witnessed now.

2             Typically in a downturn, industries invest in efficiency improvements rather than investments in physical assets. In Boom time they invest in physical assets (may be indiscriminately). During 2 crunch times of 1998-2003 credit squeeze and 2011-2015, India has invested and become far more efficient and is achieving higher VA in its output. We are lot more competitive globally today than 10 years back.

3             China also invested heavily in physical assets during boom years. Their VA/VO ratio was also fortunately high in mid-20s which has fallen and stands over the last decade to 19% now, less than India’s in several sectors – a sign of over investment. They are now investing in efficiencies and technologies. The World average (long term) is 18-19%. India is well placed now on cost competitiveness and more industries should identify their strengths and grow; they should not worry too much about our size being 1/5th or 1/10th of China’s in their industry.

Why corporate profitability is low in spite of higher value added

4             The VA  has 2 large components – (i) what is paid out as wages and salaries (WS) and (ii) other operating surplus(OS) (paid out as interest, dividend, retained surplus, etc.). In the last 5 years the average rate of growth in WS for India as a whole is 17% p.a. meaning far more is paid out as salaries and wages and the share of OS is 10% p.a. of which the share of interest has been high. Dividend payout has also increased dramatically affecting Corporate profitability and retained surpluses. Wages and salaries in rural India has risen faster than in urban areas/industries.

Shift in manufacturing profile

5             The share of unlisted firms is growing faster than listed companies. Unlisted firms are growing at 12% CAGR while listed firms output is growing at 7% CAGR. The share of informal sector has quietly reached 40% today.

India is becoming more entrepreneurial. It would not be surprising to see that in the next 5/10 years, the top 20 of the 40 construction companies will be totally new and unheard of now.

6             Black money distorts asset allocation.  Most of it is kept in black assets – gold and real estate. Now that there is drive against black money, real estate is suffering.

On Why IIP numbers (index of Industrial production)  don’t reflect our higher growth    

7             IIP numbers are constructed from select industries. Those mfg industries/product which contribute at least 2% of total is selected first. Some of these may have 8% some 5% and so on. 14 such products contribute 80%.

For these products/ industries, just the top 6 firms (turnover wise) are selected. Their rate of growth is taken and averaged and reported as IIP numbers. The index we are using has a base 2004.

During the last 10 years between 2004/5 and now, the small and medium scale sector in these industries have grown far faster (at 14% p.a) than the corporate sector (7% p.a) and the sample 6 have grown even slower. The share of small firms have grown from 30% to 50% in the last 10 years – a fact not captured by the index.

Construction of any index is a time consuming and costly exercise based on extensive surveys. Thats why they are not done frequently. A new series with base 2011 is in the offing, which might set right the anomaly between GDP and IIP numbers.

Why Indian industry is not investing even if it is growing

7             Informal sector which is growing the maximum does not have much savings – it is squeezed out by the money lenders – their main source of finance.

More is paid out as wages and salaries, who may not have the same investment urges as retained earnings.

and of course the High interest rates (see below)

Interest rates

8             Indian interest rates are very high. It attracts a lot of portfolio flows which come in and keeps Rupee artificially high and un-competitive. The way to correct it is to let the interest rates fall which will enable the industries to invest and absorb these flows. If the flows are properly absorbed the currency will find proper level ($ may be Rs 72/75 instead of being Rs 67-68) and portfolio flows will be moderated. This has not been allowed to happen and our real interest rates have been kept artificially high.  We are just accumulating reserves instead of putting it to productive use.

9             Indian industry is crying hoarse on high real interest rates. What they should be screaming at is the differential interest rates. Between 2008 and now these have moved significantly against India.

Our corporate interest rates were 9% average towards end of last decade when the global interest rates were 4.5 % – a gap of 4.5%. Today our interest rates are 10.5% when the global interest rates are kept at 1.5% a gap of 9%. Not an ideal situation for investments. It is better to invest overseas, even if to supply to India.

Thus Indian industry is caught between artificially high interest rates and artificially high forex rates which does not enable them to raise prices in line with costs.

Difference between Planning Commission and the current NITI AAYOG.

10           The previous planning commission had a 15 year, 5 year and 1 year plans/horizons.

15 years – There was a broad perspective plan which was not generally well known or publicized.

5 years – Better known as 5 year Plans. This was an approach paper.

1 year – laid out the expenditure for various programmes.

The NITI AAYOG has a 15, 7, 3 year cycles.

15 year. Vision document – the Government has asked the Niti Aayog to come up with this.

7 year – plans and programmes.

3 year – implementation plans for the above.


11           The current NPA is entirely that of Corporate sector. The priority sector NPAs have remained at their usual 1.5%.

12           From financing just working capital needs from retail savings our Banks are now financing long term loans from the retail savings. More than 50% of lending today is for long term loans.  This is inherent mismatch. Our commercial Banks are not just designed to deal with NPAs.

13           It is not that we were without NPAs earlier. The long term loans were earlier met by DFIs (IDBI, ICICIs, IFCIs) which financed themselves with long term Bonds (15 year types) and were far better able to deal with temporary fluctuations in business and time taken to rectify/reconstruct even bad decisions. It is simply not feasible to deal with them on a quarterly basis, which is what the banks are expected to do now.