Demonetisation’s short-term cost

Ideologies are determining politicians’ assessment of the costs of the policy. Amid the commotion, food prices have been stable

Written by Surjit S Bhalla | Updated: November 26, 2016 6:13 am
demonetisation, demonetisation news, demonetization, demonetization effects, manmohan singh, manmohan singh speech, manmohan singh rajya sabha, manmohan singh parliament speech (Illustration by C R Sasikumar)

It is now more than two weeks since 8/11 and the government has stopped exchanging notes for cash. Politicians and analysts alike are worried about the short-term costs to the economy, especially the effects on the poor and on the agricultural economy. Former PM Manmohan Singh believes that the cost to the economy may be as much as a two per cent drop in GDP growth rate this year; he also described demonetisation as “organised loot, legalised plunder of the common people”.

Let me first put down the agreements shared by both supporters and critics of de-monetisation (hereafter DM). The known knowns are three. First, that DM was a bold, radical and unprecedented move — there is no template with which to analyse the short-run effects of DM. Second, that implementation could have been possibly much better. A known unknown is the fact that secrecy was of the essence for DM to have any chance of success. And it deserves emphasis that the ministry of finance has never had such an open mind to criticism from the public, and has actually implemented some improvements (like the indelible ink requirement for exchange of cash). Third, and possibly most importantly, no one believes (including myself) that DM will do much to stop the creation of future black money. There will be a mild deterrent effect, but one whose amplitude will fade in a few years — unless accompanied by additional economic reforms.

Many believe that besides the inconvenience, the short-run costs to the economy are considerable and will even feed into significant negative effects over the next few years. Politicians (especially of the Mamata and Kejriwal kind, though the Congress is not too far behind) have shouted themselves hoarse as to the costs the poor are paying because of DM. Some brokerage firms (especially the small ones) see this as their Andy Warhol moment; a few days of fame (later ignominy?) can be garnered by making forecasts that are out of the ballpark, if not out of the universe — one brokerage/investment firm has forecast that over the next five months, GDP will register a rate of -2 per cent. The economy grew at 7.5 per cent for seven months (April-October) and will need to “grow” at -2 per cent to register the Ambit Capital “forecast” of 3.5 per cent for this fiscal year. (As comparison, the Lehman crisis quarters, 2008 Q4 and 2009 Q1, registered a growth rate of 1.9 per cent and 0.8 per cent respectively).

Some other forecasts are equally dire; we see newspaper headlines that the important rabi crop is in trouble, deep trouble, because of DM. The rural economy is primarily cash-dependent and a Times of India (November 24) front page story stated that job losses (among poor daily wage labourers) were mounting and prices of essential vegetables had dropped significantly between November 16-22. For example, potato prices were down 25 per cent, onion prices were halved, and tomato prices were down “only” 11 per cent (see table for all-India actual estimates).

When poor people lose their jobs, and when land is idle, and/or produce is unmarketed, there could be riots in the streets. There are two short-run indicators of how the public is “feeling” — by-elections held on November 19, after the “earthquake”, and the pattern of food prices since November 8.

Surprisingly, the voting public is not that angry with the BJP. In by-elections in five constituencies (Lok Sabha and Assembly) across four states in which the BJP was a contender (Madhya Pradesh, Assam, Arunachal Pradesh and Tripura), the BJP did about as well as the previous election. In three assembly constituencies (Nepanagar, MP, Baithalangso, Assam and Barjala, Tripura), the BJP did much better than previously. This is not supportive of the great DM negativity observed among the media and politicians.

The DM-induced cash crunch was expected to considerably slow down the sowing for the rabi crop. Fortunately, and surprisingly, this has not happened. As of November 18, 241.7 million hectares (Mha) had been planted in 2016/17 — compared to 243.4 Mha in the previous year. But shouldn’t the acreage be more, given that this year was a much better rainfall year than the previous two years? No, because acreage varies little for individual crops, and responds to changes in relative prices. Acreage under pulses and oilseeds has increased significantly, under wheat, it has stayed the same. Furthermore, yield (output) is most affected by rainfall, so a decline is unlikely to be much affected by DM.

One important source of information about the effects of DM is the pattern of food prices subsequent to November 8. The DM-induced cash crunch is expected to have two short-run effects on food output and consumption. The first is demand destruction in urban and rural India as consumers just don’t have the cash to buy food — this would suggest that food prices should decline. If supply is really affected (supply destruction), then we should expect prices to shoot up. It is impossible to identify which effect is dominant.

But attempt to infer we must. Hence, the presentation of detailed price pattern data for food items. For the last six years, the average November price change is reported for identical days across the years. The per cent change reported is between the average price observed across about 15-25 cities in India for each item, that is, brinjal, potatoes, apples, grapes, milk, etc. The data is collected daily. We have taken the median price for each day and each item. The average price for November 1-8 is the reference price; the per cent change reported is between the average median price between November 9-24 and this “reference price”. (If means are used rather than the median, there is little difference in the results).

The reader can make her own inference; all the relevant data is provided. The conclusion we reach is that the net effect of the supply and demand destruction is very little on the price of food observed in urban markets.

Let us look at the average change in vegetable and fruit prices. Vegetable prices have fallen by 4.3 per cent, but November is generally a time when vegetable prices decline. In 2011, despite healthy double digit inflation, vegetable prices fell 7.9 per cent; last year, vegetable prices were up 2.8 per cent. Fruit prices (a discretionary “luxury” food item) show a marginal increase of one per cent; overall food (with consumption weights as in the CPI) prices are down just 0.6 per cent in November.

The strong result is that there is no “juice” for inference about destruction in the rural food economy. This result is not surprising for most agricultural experts — but the noise politicians don’t want to hear that which is not convenient to their political ideology.

The writer is contributing editor, ‘The Indian Express’, and senior India analyst at Observatory Group, a New York-based macro policy advisory group. Views are personal

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  1. K
    Nov 26, 2016 at 2:34 pm
    The loot has already been ' looted' and kept outside India
    1. A
      ak dev
      Nov 26, 2016 at 7:26 am
      Same people have rejected them in 2014 and will reject even now and in 2019.
      1. O
        Nov 26, 2016 at 6:46 am
        Surjit will twist data till it confesses to acche din. Indeed the economy is strong enough, that this earthquake has been managed. However, it has dealt a severe blow to the supply/demand equilibrium. The Momentum is down, and the effects are already being seen. Prices are not going up, because people are just not buying. Discretionary spending is sharply down, durables are not selling( ask Bajaj Auto, maruti), and kirana stores are seeing a drop of 30% of daily s. This was a unnecessary step, and a foolish one. No one has shown, how it will help in future.
        1. a
          Nov 26, 2016 at 9:50 am
          ---gt;what you call open-ness of FM to make in reality confirmation of being disorganized to the extent of being clueless....and then acting in desperationlt;br/gt;lt;br/gt;--gt; Only some inconveniences....that the govt and it's supporters and economists deem it's oK to deprive a 98% citizen basic right to access his fair money on may/ may not catch some 2% APPALLING.... signs of a despotic banana republic where the ruler on his whims decides the freedom and fate of his dependent;br/gt;lt;br/gt;--gt; prices are falling....lets use an analogy of *an overweight guy can lose weight not because of dieting and fitness efforts only....but because has cancer or severe stage of diabetes*.lt;br/gt;the commodity price drop is because nation is struck by cancer
          1. A
            Anurag Gupta
            Nov 26, 2016 at 5:36 pm
            Supply distruction will be for longer period for two reasons : lt;br/gt;lt;br/gt;1. It takes time to producelt;br/gt;2. Scarcity motivates boardinglt;br/gt;lt;br/gt;Where as, imoact of demand distruction will start vanishing the moment people start getting cash ( hopefully by December end ).lt;br/gt;lt;br/gt;In this perspective, I can foresee a increase in inflation at least for next few months may be till March -April ' 17.
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