Krishnamurthy Subramanian: The new CEA's view on Demonetization: Did the poor really suffer?

In the political battle that has emerged out of the demonetization exercise, both proponents and opponents are ostensibly defending the interests of the poor. Some politicians are relying on anecdotal evidence to advocate the difficulties being faced by the common man. We instead use data from the National Sample Survey Organization’s (NSSO) survey to estimate such difficulties faced by the poor. The survey provides estimates of earnings in cash and kind by different income categories. We use the survey data for 2011 which comprised approximately 500,000 individuals across the country. Our estimates suggest that the poor are likely to have visited a bank branch at most once to exchange their earnings in the old currency notes to new currency notes. Thus, we infer that the politicians advocating the difficulties faced by the poor are being disingenuous in pushing their claims for political gains.

To estimate the above, we make the following arguments. First, the poor are unlikely to have substantial savings stored in Rs500 and Rs1,000 notes. Second, the bottom half of the population ends up spending almost their entire earnings on consumption. Third, only two weeks have passed since the demonetisation was launched on 9 November. Therefore, the weekly earnings of the bottom half of India’s income earners provide us the estimate of the cash that the poor would have in their kitty, which they would have to exchange in a nearby bank or post office. Finally, since the survey was conducted in 2011-12, we inflate the earnings by the average rate of inflation per annum during the period from financial years 2011-12 to 2016-17. This is likely to overstate the earnings of the bottom half of the population because, unlike salaried individuals and other richer sections of society, the earnings are unlikely to get adjusted for inflation in a consistent manner. However, the overestimation of earnings would only reinforce the bias against the inference that the poor are likely to have visited a bank branch at most once to exchange their earnings.

As the adjoining table clearly demonstrates, the bottom half—be it rural workers, daily wagers, weekly wage earners, or fortnightly wage earners—earn less than Rs1,350 per week. In fact, even the bottom half among the urban population earns at most Rs1,970 per week. Even if the bottom half of the population has saved up to two weeks of their earnings, the amount they have to exchange will be less than the Rs4,000 limit that was set by the government in the first week. The above inference assumes that the daily, weekly or fortnightly wage earners were fully employed in the past several weeks so that they could not only earn enough for their consumption but also to save. In practice, such wage earners are chronically underemployed. As a result, the total cash in the hands of the bottom half is likely to be less than Rs4,000. Thus, it is quite clear from this data that the bottom half of the country’s population would have by now visited the local bank or the local post office at most once to exchange their old currency.

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This conclusion then suggests that 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.

Beyond doubt, the former category is inconvenienced and the government and the Reserve Bank of India should take all steps to ease their difficulties. But this category comprises people from the top half of the country’s income distribution, certainly not the poor. In contrast, those from the second category who stand in the queue are only making efforts to earn a premium from the dishonest, who are willing to pay them such premium to convert their black money into white. No politician who genuinely wants the country to clean up the black money menace should sympathize with the latter category. After all, they are abetting the dishonest in evading the legitimate tax and penalty.

With respect to the difficulties that the country’s poor are likely to face till 30 December, note that around seven weeks of earnings are left before the deadline for depositing the demonetized notes. So, based on the estimates provided in the adjoining table, the maximum cash earnings of the bottom half would be around Rs8,000. Even if we suppose that they will be paid entirely using old currency till December, at most two more visits to the local bank or the local post office would suffice to deposit their old currency. Of course, it is quite likely that these workers refuse to accept their wage in old currency. In that case, they would not need to make the visit at all. As workers in this income category are likely to have been underemployed sometime in the past, they would have a bank account to receive Mahatma Gandhi National Rural Employment Guarantee Act payments. Therefore, future wage payments can be made via cheque by honest employers. In this case, such workers may have to visit the bank once to encash the cheque.

Note, we are not arguing that poor people are not facing difficulty because of demonetisation. Of course, standing in the queue for a day can mean loss of a day’s earnings for the poor. However, using the large sample data and careful analysis, we would like to highlight the exaggerated claims of disingenuous politicians who profess to be fighting for the poor.

Source : Livemint

Arvind Subramanian,CEA Vs Raghuram Rajan RBI Gov. Different tales.....

                 When Arvind Subramanian was appointed as CEA, the decision was hailed and supported from all the quarters. Former FM P Chidambaram, mentioned that Subramanian had for long been a choice for this post. He was appointed as CEA,despite the fact that he had been highly critical of NDA's budget in 2014. This showed that the government was ready to accept criticism and for a course correction in the eventuality. There have been many hits and misses in last 18 months. One of hits have been we have achieved a greater macro economic stability. Most of this had been aided by lower imports and lower commodity prices. We need to achieve a savings rate of 36% as it was in the high growth era, low inflation(in the range of 4-6%) and million jobs per month. The budget needs to be focussed on agriculture, infrastructure and education. This is where the CEA and RBI governor can play an important role. With two of these finest minds in the world, we need no other economist to prepare a blueprint for the economy and fire it on all cylinders.

Here is a good article on The Hindu comparing the stints of both these personalities in their respective roles so far.

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Chief Economic Advisor (CEA) Arvind Subramanian started 2015 on an over-optimistic note. He is likely to have ended it in disappointment. The economy is slowing down: in the first six months of the financial year, real GDP grew 7.2 per cent, slower than the 7.5 per cent in the corresponding earlier-year period. In 2016-17 too, GDP growth will not be significantly greater unless some specific steps are taken, the CEA has said. Thankfully, there are few takers in the government for the main measure he is suggesting: a further pause on fiscal deficit reduction.

About a year ago, barely months into his job in the Finance Ministry, Dr. Subramanian projected a sharp recovery with growth of up to 8.1-8.5 per cent. He forecast the acceleration even though he did not expect any big-bang reforms (on this count, his forecast was correct). In his scheme of things, the spurt in growth would come from incremental policy pushes, such as to subsidy reforms, direct benefit transfers, and financial inclusion of the poor.

The brave outlook underestimated the weakness in the exports sector. It relied on the Rs. 70,000 crore of public investment that was earmarked in the year’s budget — as suggested by him — for building infrastructure to stimulate private investments. The stimulus he had designed was implemented. It proved insufficient to generate the growth impulses needed to kick-start the over $2 trillion economy and rekindle animal spirits gone numb in the dying years of the United Progressive Alliance’s 10-year stint due to policy paralysis and corruption scandals.

As things stand, it seems unlikely that industrial growth will cross 5 per cent. Growth in lending by banks to industry, a proxy for investment sentiment, hasn’t budged from a 20-year low. Corporate balance sheets are burdened with mountains of debt. The worst exports performance since 1952-53 is inevitable.

A government not shy of its business-friendly credentials should have picked up these stress signals early on and administered the remedies, but its mandarins were too excited: international agencies had declared that 2015 was going to be the year in which India would race past China (the Chinese economy is about five times as large as India’s) to be the fastest growing economy in the world.

It was. But that this had probably more to do with China slowing down rather than India picking up, and the stark difference in size made the comparison between the two economies irrelevant. But the cheerleaders among bureaucrats and ministers couldn’t be bothered with technical minutiae — all that mattered was that India is a bright spot in a gloomy global economy.

Why is growth slowing?

In the boom years during the UPA government’s tenure, four engines had powered the economy. Of those, just two are still running: government investments and private consumption. Exports and private investments, the other two, are out of steam. The UPA years saw an investment boom, which was bound to turn sooner or later, and has.

Lower borrowing costs could restart the investments cycle but the hands of the Reserve Bank of India Governor, Raghuram Rajan, are tied. An agreement that the government and the RBI signed a year ago has made controlling inflation the main objective of monetary policy. The agreement formalised a policy goal that the central bank has always pursued anyway, except that it set the targets in terms of consumer price inflation. Moreover, government-owned public sector banks have been slow to pass on to borrowers the rate reductions that Dr. Rajan has announced. Banks are a cartel and keep interest rates high because higher interest rates mean bigger profits.

Dr. Rajan is well on course to bring inflation within the 6 per cent target that the government set around the same time the CEA made his cheery growth forecast. In fact, the ‘rock star’ Governor, with whom the CEA has worked closely earlier in the International Monetary Fund, has had an excellent year. India was still one of the ‘fragile five economies’ when the year began. Yet, it is the only one to have come out of the phase of heightened currency volatility and current account deficit instability that characterised the group. Besides, the purse-string managers of the government’s budget in North Block, who haven’t yet let its fiscal deficit slip, Dr. Rajan too deserves credit for restoring India’s macroeconomic stability, which the government hasn’t quite leveraged to push growth, just as it has been caught sitting on its hands despite the favourable global trends in oil and commodity prices.

On growth, Dr. Rajan has been spot on. By the end of the summer, he had cut the Reserve Bank’s GDP growth projection for the year not once but twice. In July, even as Dr. Subramanian was sticking to 8.1-8.5 per cent, Dr. Rajan’s call was 7.4 per cent.

The overconfidence in Delhi lasted till the last day of November, when new official data released, revealed a slowdown instead of the promised smart recovery. Within hours, the government cut its growth projection to 7.5 per cent.

In the following weeks, the CEA did a few mea culpas on earlier positions, raised fresh concerns about the state of the economy and declared the official data puzzling and unusually difficult to interpret. And he called for reassessing the government’s commitment to fiscal deficit reduction.

Environment for lower interest rates

Abandoning the committed path for fiscal rectitude now will put macroeconomic stability at risk. It might end up hurting growth rather than supporting it with the government and the RBI working at cross purposes. How? To fund a wider deficit, the government will have to borrow more, which could push up interest rates and crowd out private borrowers.

Inflation might have been tamed but the Reserve Bank’s key interest rate, despite cuts adding up to 125 basis points in 12 months, is still high for a revival in investments and growth. Although higher public investments are desirable, the government needs to do all it can to create the environment for lower interest rates, not higher.

Public investments can be increased without deferring deficit reduction, though. There is a perceptible improvement in the quality of government spending with a shift towards capital expenditure. This can be built upon. Savings from efficiency in spending remain an underrated resource. The government ought to cross the political hurdles for strategic disinvestment. If the government’s fiscal consolidation would distract from the demand in the economy, much of its spending will also add to it. Government employees’ salaries and pensions are set to rise as the Seventh Pay Commission award is accepted and disbursed. The hikes are bound to result in a surge in demand for goods and services. So are other transfers from the government.

The growth and the outlook won’t seem as lacklustre if Dr. Subramanian had corrected his forecast earlier, as Dr. Rajan had. He publicly differed with Dr. Rajan and took a bet on accelerating growth, and it looks as if he is going to lose the bet.

Source: The Hindu