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
    K SHESHU
    Nov 26, 2016 at 2:34 pm
    The loot has already been ' looted' and kept outside India
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      ak dev
      Nov 26, 2016 at 7:26 am
      Same people have rejected them in 2014 and will reject even now and in 2019.
      Reply
      1. O
        Observer
        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.
        Reply
        1. a
          a_D
          Nov 26, 2016 at 9:50 am
          ---gt;what you call open-ness of FM to make changes.....is 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 demand....to may/ may not catch some 2% offenders.....is APPALLING.... signs of a despotic banana republic where the ruler on his whims decides the freedom and fate of his dependent subjects.lt;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
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            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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            1. M
              Mathews
              Nov 26, 2016 at 1:43 am
              It is a known known that DM rooted out black money and counterfeit money, and most importantly sponsored terrorism. And again it is a known known that the affected parties and their agents make now a lot of noise. The Indian economy will reap more benefits in the short and long run.
              Reply
              1. B
                Balachandran Menon
                Nov 26, 2016 at 2:48 pm
                Modi's penchant for optics rather than substance was always annoying; but this time it has acquired truly alarming proportions (by Prof. Jayati Ghosh).
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                1. R
                  Rajiv Dua
                  Nov 26, 2016 at 4:59 am
                  Surjit is a known Modi supporter. Prices are falling as there is mo money to buy fruits and veggies.
                  Reply
                  1. H
                    harun
                    Nov 26, 2016 at 7:47 am
                    Bhalla must also write about inaction on Panama Papers and Swiss bank accounts as well.lt;br/gt;lt;br/gt;Bhalla must also ask about inaction in KG Basin loot of 30000 cr made out by CAG.lt;br/gt;lt;br/gt;Bhalla is plain biased
                    Reply
                    1. H
                      harun
                      Nov 26, 2016 at 2:15 pm
                      Bhalla,lt;br/gt;lt;br/gt;Why dont you ask Questions on 125000 cr loan waiver by PSU Banks.lt;br/gt;lt;br/gt;Why has Govt not used stringent antibankruptcy law against defaulters of PSU Banks.lt;br/gt;lt;br/gt;Why has the Govt not made Political donations transparent.lt;br/gt;lt;br/gt;Why cant the PM of virtue ,set an example by making Political donations collected Public.lt;br/gt;lt;br/gt;Yes it was time demonitisation was done.lt;br/gt;lt;br/gt;But when you ignore Panama,Swiss and HSBC accounts ,the purpose stands defeated.lt;br/gt;lt;br/gt;Your in line for RS Nomination,relax
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                      1. S
                        stranger
                        Nov 26, 2016 at 10:29 am
                        didn't read but wrong in headlines itself. there is nothing ideology for politicians, they are Machiavellist first cl that is why they are politcian. ideals are for followers the one they seek vote from and exploit in return. as far as policies go politicians follow the one that returns them most in terms of political longevity or simply raw $$ returns.
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                        1. S
                          ss
                          Nov 26, 2016 at 1:33 am
                          We know how well Mr. Bhalla uses data. He is the same moron who predicted a run away victory for Hillary Clinton in the US elections.
                          Reply
                          1. J
                            Jagdish Chander
                            Nov 26, 2016 at 11:16 am
                            Unless one knows why black money originates such solutions will fail. Solutions without application of mind will create more way to generate black money. Every one has seen, how black money in banned notes generated further black money after demonetization . These banned currency notes were sold at a discount. This discount is nothing but a black money. Why such situation happened?. The reason is shortage of new currency.lt;br/gt;Black money started in India due to rationing of every thing. Rationing was due to shortage. Corruption started to get quota after paying bribe. Shortage of money created by Govt. itself will be an instrument for generation of black and corrupt money. Which has already started. How can bribe giver to Kandla Port Trust officers got 4 lack new currency notes of R 2000 on second day of release of new notes which were not reached to people standing in lines?
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                            1. J
                              Jay
                              Nov 26, 2016 at 3:28 am
                              Here is the curious element: if the opposition really do have grim forecasts for the economy - that it would lead to the poor rising against the policy of de-monetization and a severe slowdown in GDP growth - then they should be the ones who should be most happy. After all, by the time 2019 rolls around and their apprehensions prove true, they would be the winners and BJP should fall flat on its face.lt;br/gt;lt;br/gt;Then, why this circus?
                              Reply
                              1. K
                                Kumar Neeraj
                                Nov 26, 2016 at 6:32 pm
                                Dear Mr. Bhalla,lt;br/gt;lt;br/gt;I have been following your writing for last 10 years, a lot of people now reading you wouldnt have known you in 2007 when you used to debate regularly with Mr. P. N Vijay, one doesnt get to read or hear him often these days.lt;br/gt;lt;br/gt;By the way unrelated to this I just wanted to check with you if you had time to think about what went wring with your analysis of US Presidential Elections.lt;br/gt;lt;br/gt;It pains me to see your transformation to exactly one of those whom you refer to in your le.lt;br/gt;lt;br/gt;Seriously any data analyst would look for public opinion in the result of by election which were held just a week or so after the demonetization. I am sure you are well versed with concept of information dissemination.lt;br/gt;lt;br/gt;As for yout analysis of inflation let me ask you few question - keeping asid the analysis for a momen a) what proportion of rural household have accounts b) what proprtion of rural potion is literate c) what is rural penetration of internet d) what is the shaf if smart phone in rural india e) what proportion of rural india by potion and by geography is covered by banks etc etc.lt;br/gt;lt;br/gt;Now i just want to remind you two points - which you must already knoe lt;br/gt;A) If you torture the data enough it will confess to anything.lt;br/gt;B) Every thing should be simplified only to the extent it can be simplified.lt;br/gt;lt;br/gt;Will look forwardto hearing from you.
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                                1. S
                                  Shrinivasa Kamath
                                  Nov 26, 2016 at 1:41 pm
                                  Politicians who have been trying to project calamity after demonitisation, must have been sufficiently disappointed by the stable prices. Election results should have been the immediate fall out of deminitisation effects which again gone against their forecasts or wishes. It will not be a surprise if their predictions on reduced growth rate GDP, rural stress etc. will ultimately prove to be mere speculation without any basis.
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                                    karthikeyan
                                    Nov 26, 2016 at 3:07 pm
                                    Have you read about his predictions about US elections ?
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                                    1. K
                                      karthikeyan
                                      Nov 26, 2016 at 3:03 pm
                                      Last time your prediction about the US election went wrong . I prey to god this time your prediction should come right for the country sake .
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                                        Murthy
                                        Nov 26, 2016 at 2:14 am
                                        Surjit Bhai is a good collector and analyser of relevant statistics. You could, with some difficulty, disagree or quibble with his conclusions, but you cannot fault his methods of analysis. To those who are critical of demotenisation, I ask: "How do you smoke out those that have stacks of Rs.1,000 and Rs.500 notes [ some printed in stan ] under their beds, bathrooms and toilets?"
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                                        1. L
                                          L bhadrapati Devi
                                          Nov 26, 2016 at 5:07 am
                                          Rural Indian economy has resilient enough to sustain its economic activities despite many economic socks and natural calamities. The present minor disturbance in the withdrawal limit of cash doesn't affect to the agriculture and informal sector as well.
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                                            angry
                                            Nov 26, 2016 at 6:31 am
                                            What a specious argument to justify the dictatorial action of the government. The author just appears to be one who is sitting in a air conditioned chamber and coming to his conclusions on the basis of doctored information accessed by him. My sincere advise to him is to just take a walk in a village and access details before coming out with such sycophantic conclusions.lt;br/gt; I am now incurring an additional expenditure of over Rs 1500 every week to disburse wages of just 8 workers in a cardamom plantation, in addition to the loss on one labor day on account of me having to send a laborer to the bank to stand in Q to encash the cheque. Does this author take into account all such extra expenses while arriving at his conclusions
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