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.
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