INDIA Is Not Demand-Deficient, Spending Would Recover Fast...

As the demonetization story is slowly unfolding in terms of the effects on the demand, supply, and prices and growth, expectations… about the future that how long we have been in the trail of facts would signal the agents to do the best in their budgets, investors included, during this short-period of crisis of cash, matter. If people would feel that demonetization has benefitted them apart from the hardships they have faced they would support it since it is a big social-reform that is worth a short-run-pain since black-money is a form of social injustice and add up to illegitimate demand in the economy. The common-man is the agent to bring this big social-transformation, from corruption to a clean system, since his welfare is dependent on good public-services and state support in the form of direct benefit transfer and social-security net. Higher taxes are spent on the important things in life which are difficult to provide by a small vendor and the money from demonetization would be spent on the welfare of the poor, the Pradhan-Mantri-Garib-Kalyan-Yojna (PMGKY) has been started to show the government’s commitment to improve the condition of the poor of INDIA. Good infrastructure and employment-skills are sine-qua-non to a good standard of living and would help reduce poverty. Employment is best insurance against poverty and exploitation and the curb on black-money would improve the distribution of income and reduce inequality. Black-money in cash is saved after evading taxes that has a direct bearing on the spending on public-purposes to increase the quality of life and social-progress. Tax-evasion is a crime against the society, it holds-back development and growth, and higher spending by government may increase demand and supply. Apart from this a sweeping change could be expected when the banks are flushed with deposits and would be able to finance the loan demand at lower-rates when we say that INDIA is not demand deficient and the RBI has kept levers tight due to inflation and inflation expectations which would lower growth-expectation. However it is expected to cut rates when it has maintained an accommodative stance in case of lower inflation. Demonetization has improved on expectations about loose fiscal-policy and monetary policy in the next few quarters. The economy would definitely gain beyond demonetization because of better expectations for the key economic-variables like low-inflation, lower interest-rate and higher-spending, consumption and investment, and lower unemployment, too… The economy meanwhile is getting its math right… Higher savings due to limit on cash withdrawal would also be spent… Demonetization has increased expectations about the growth-rate in the following quarters. The economic-growth rate could touch 9% in the next few quarters on the back of rebound in demand till the cash-cripple is over because spending would recover at a faster rate …        

Demonetization Would Increase Value of Money, Demand and Growth...

The commentators on the demonetization are often heard advocating the positive long-run effects of it and that it might also cause disruption in the everyday exchanges with cash for some-time since a large part it has been replaced by new currency and digital transactions, which seems to be right. The long-run effects would play-out through the effect of money-supply on inflation and interest-rate and the value of money, however disinflation and lower interest-rate observed after the demonetization due to lower cash, although unemployment has increased temporarily with the shortage of cash to finance economic-activity, are likely to increase demand and growth-rate in the future. Inflation in INDIA has come down in the data following demonetization, moreover the expectations about jobs and incomes is not so grim because investors have only delayed investment and the improvement in the supply of cash day by day would soon help to revive investment and employment. When income is more or less fixed and inflation and inflation expectations are biased lower, would increase spending as soon as the economy adjusts to the money-supply and demand. We generally assume higher inflation while increasing money-supply, but when it is reduced we may also expect inflation to go down too because some of the demand and spending would go down. The black-economy which could be as big as a third of the white economy might be an important source of demand in the economy, especially for a home. Prior, real-estate was a cash and black-money oriented market which is now going to see a price-correction because of demonetization which is likely to increase demand of the common people, it would make homes affordable for the poor section of the country, however lower demand and prices would also lower the EMI and increase demand. When demand for construction would go up employment would go up too. The real-estate sector is an employment intensive sector which mostly uses unskilled labor; more employment would increase demand and the economic-growth. Demonetization would help the government in its mission of house for all by 2022. Lower prices signal more spending if employment and income do not go down, it is more expansionary because real-wages, real interest rate or real return on capital and real exchange rate increase domestic and external demand, lower prices could make the economy competitive. In INDIA’s case spending is only being delayed which is likely to come-back except the black-money demand and that people would find the market cheap after the pain-period is over. Demonetization could lower money-supply and increase the value of money, because it would make money scarce relative to goods and services by the way of lowering inflation and inflation expectation by reducing black-money dependent illegal demand. 

Liquidity and Cash...

In November the Consumer-Price-Index (CPI), the preferred gauge of inflation to set policy-rates, has dropped from 4.2% in October to 3.6% which is far from that the RBI expected in its review in the recent meeting and lower than the banks inflation-target for 2017 at 5% that might now force it to increase liquidity to increase transmission of the rate-cuts by the commercial-banks to increase falling investment and economic-growth due to demonetization and the cash-crisis. Now, when we have inflation lower than the inflation target for January 2017 we may expect the RBI to cut policy-rates in the next policy review to revive the economy that is trying to gather recovery from the previous down-cycle when there is still more scope to push for exports and pursue double-digit growth. There is, now, a gap of 2.6% in the key-rate and the CPI which gives more space for rate-cuts when the central-bank has already committed an accommodative stance. The bank had been in a rate-cut round even before the advent of demonetization which has further strengthened the case of rate-cuts in the event of falling growth-rate due to finance and cash gap. A rate cut at this juncture would help increase spending when it has been delayed by the public.

All the major economic-variables and expectations have been on a downtrend because of interruption in the supply of cash from the bank-accounts, inflation, unemployment and economic-growth, which might signal expansion in the RBI and the government’s balance-sheets, it is expected from them to try to improve consumption and investment by adopting the right-policies, this time to improve transactions, even by credit and debt outside the banks and bank-accounts. The government might try to induce small and big, wholesalers and retailers to use buy now and pay later service to build the trust economy to avert the cash-problem by using the Adhar-card and maintain account of credit/debit by receipts. Demonetisation and cash-crunch has struck business and trade, but we might create trust-economy based on identification and the ability the pay later. Everybody knows that there is cash emergency. However, the cashless-transactions through cards and mobile are also helping to reduce cash-hardship.  

The government has re-oriented the black-money-movement to the cash-less-movement... The government is pressing for wages and income-transfer direct to the bank accounts... It would help parity in the minimum wages and would reduce exploitation... Higher tax collection would increase allocation towards poor and lower interest-rate due to higher bank-deposits would increase investment and employment... Lower black-money-demand would make things affordable for common man... Nobody can deny that black-money would increase inequality... Black-money-is bad for an equal society...

However, it takes only few hours to learn cashless... People would have to learn because of income and consumption or living... Mobile and Jan-Dhan accounts would act as a base... Their penetration is higher...

The Fed Review This Month...

The discussion over the US’ Fed policy in December among economists and analysts is gearing-up as we approach the date and the consensus view is that it would increase tightening depending on the inflation target and the unemployment-rate. The actual inflation has remained on the upside but lower than the target, when the unemployment-rate has fallen close to 4.6 % and the economy has grown more than expected in the previous term which further bolsters the chance of a rate-hike this month. However, the recent jobless claims do also strengthen the rate-hike case. Therefore, the Fed is almost on its mark to increase the Fed’s Fund-rate to stop overheating and to increase traction in the future slowdown by increasing its ability to cut-rates in the future by increasing them at the moment, but as we know the natural-rates are on a downward trend, therefore we could not expect the Fed to increase sharply because that would affect the economic activity in a negative stride and would bring the slowdown in the economy. The natural rate theory says that interest-rate should not produce inflation or deflation so as to make the economy stable because inflation fosters inflationary expectation that is neither good for consumption because aggregate demand would go down, nor for investment because the value of capital-stock would go down. However, deflation would increase deflationary expectations, but since lower prices would also discourage supply people would rush to buy the inventories. The expectation that people would delay spending is not acceptable. In addition lower-prices would again lower interest-rate and interest-rate expectations which would increase supply in the future which further means price correction or lower prices. Lower borrowing cost is a larger part of the overall cost which is likely to increase supply and lower prices. The Fed is targeting inflation and has increased inflation expectations which have made the economy costly when there is already a long-term marginal-productivity and real-wages gap. Nonetheless, Janet Yellen has conveyed to the government to increase productivity by investing in education, skills and innovation. But, what would be the use of increasing productivity when there is already a big gap in real-wages and productivity since 1970s. Paul Krugman supports the stagnant-wages theory. Nonetheless, the Fed too might help increase real-wages by increasing deflation and deflation expectations by keeping the money-supply little tight… Or by increasing nominal wages by continuing with lose money-supply and increase inflation and inflation expectation which actually reduce demand. Milton Friedman in his optimal-monetary-policy envisaged deflation as the right strategy and maintained that nominal interest-rate should be sufficiently down. Therefore, the Fed might increase rates again after a complete year to keep the prices lower and lower inflation expectations in the future, but there might be a trade-off between inflation and unemployment, a little higher unemployment at which prices and wages support a higher or increasing real wages which also means lower prices is the right thing to desire for. Wages or real wages should increase to keep demand intact in the face of lower population and labour-force-participation rate. Revival in the lagging demand due to low real wages compared to the productivity might also help to increase domestic-demand and spending and economic-growth…. Nevertheless, in the next five years we could expect natural interest-rate not above 2% which is currently negative… By increasing nominal rates the Fed would also increase real-interest rate because inflation and inflation expectations would also go down… But, sharp tightening is not expected because that would also lower growth and growth expectations… 

The Missing Data...

The government’s Chief-Economic-Advisor Arvind Subramaniam praised the RBI for the status-quo it maintained in the repo-rate which was unusual because normally the government has demanded rate-cuts to boost growth. But, the RBI disappointed everybody else who hoped for a 25-50 basis-points reduction in the key rates in the expectation of the demonetization-unfolding that is yet to become clear, say inflation and the economic-growth. The RBI expected only a 15-20 basis points reduction in inflation when it downgraded the economic-growth forecast to 7.1 from &.7.6 % because it is probably expecting data for November. The apex bank even though admitted a lower economic-growth and inflation in the aftermath of the note-ban, but unable to justify its course of action in the absence of the latest data. Probably the monetary-policy date might had been set post inflation numbers for Nov. However, if inflation falls below 3.5 % in the month the RBI would regret a missed opportunity to push the falling growth-rate. Nonetheless, the RBI has made it clear that it continues to expect inflation to have an upwards bias, but lower demand and growth expectations mean inflation could go down, but the question is how much to accommodate the real interest rate of 1.25 % which also depends on inflation which it thinks has still biased higher. The bank sees inflation target for 2017 to have upward-risks. De-monetisation experiences before had mixed effects on the economies in which they had been implemented. The RBI is clouded by uncertainty which might be a novel situation to deal with. It is true that the current phase of the transition from demonetization to re-monetisation in not much a liquidity- problem, it is mainly a problem of cash; people have money in their accounts, but not in the physical-form of currency notes which is the dominant form of trade for which consumption is being delayed. This is why the PM is pressing for cashless transactions to evade the problem of absence of notes which would also make transactions through bank-accounts a standard practice which would help to curb black-money transactions and fake-currency to finance terror. Nevertheless the RBI has proposed to end the incremental Cash-Reserve-Ratio of 100% to normal which might help to adjust the interest-rate spread between deposits and loans rates lower or help interest-rate transmission by the central-bank. The banks are full of liquidity and the bond yields are on a downward trend, deposit-rates have come down, but the RBI is probably wary of the nature of the excess liquidity, temporary or not. The RBI in today’s review did not expect too much lower inflation and the economic-growth after demonetization, however if inflation and growth falls too much in the recent data and the expected data we might not rule-out an out-of-date rate-cut by the Monetary-Policy-Committee which would be convenient when growth risks are on the downside…    

Early for CRR and MSS...

We have the next monetary-policy review on Dec 7, 2016 and the economists and analysts are hoping that the RBI could cut repo-rate by another 25 basis-points and some are hopeful to the extent that it would deliver a 50 basis-points reduction in the view of reduction in demand/supply and prices or economic-activity or economic-growth-rate in the face of demonetization and cash-crunch. However, it is quite clear that demonetization would lower demand and growth and prices in the short-run because money-supply and demand would be hit due to liquidity-crisis posed by the drive which is likely to recover with catch-up in the money-supply and demand for consumption and investment with time. Nonetheless, a good kharif-crop and lower vegetable-prices or inflation and inflation expectation, and low demand due to demonetization, are the factors that may push further lower interest-rate expectations which would increase investment-demand and growth-expectations. The interest-rate-cut expectation due to more deposits in banks is another factor that may increase interest-rate cut expectations. Lower borrowing cost when demand/supply has been cut by lower money-supply is likely to keep prices lower and increase demand and growth in the future. The increase in incremental Cash-Reserve-Ratio (CRR) requirement by 100% and the Market-Stabilitsation-Scheme (MSS) to mop-up extra liquidity in the hindsight of negative-effects, probably because it would retard the interest-rate reduction process by the RBI because the commercial-banks are already flooded with deposits and are cutting the savings-rate that might create uncontrolled swings in the mood of the economy. Too, much lower interest rate might increase inflation and inflation-expectations and hurt real-interest-rates and savings which might require tightening in the money-supply and lower growth-rate-expectations soon. It is quite rational to curb overheating expectations because the objective of the economic-policies is to achieve full-employment and price-stability with full-growth. But, inflation and inflation and inflation-expectations in the Indian-economy are biased lower also because of low food-inflation and inflation expectations and probably it is too early to think of tightening – higher incremental CRR and MSS. The policy-makers should let the public taste the sweetness of lower-interest-rate and more consumption and investment when prices and price-expectations are possibly on a downward-trend and the general income is fixed except the lower black-money demand. It is right and true that the size of the formal economy would increase after demonetization and lower-prices, the economy’s real-Gross-Domestic-Product (GDP) would increase… Lower prices and interest-rate would increase demand and supply and growth in the economy…   

The Black-Money Hang-over...

A large part of Rs 500 and Rs 1000 black-money has been converted in to gold even after demonetisation in the shadow market... There was no ban on gold accumulation and sale of it... Black-money can easily be converted into gold and make high value denomination notes black money into white... There was no restriction on selling gold and depositing the money as sales turnover... Gold traders could easily sell gold by accepting banned notes and then submit the money at banks as profits... There was no restriction on depositing money with PAN as business-profits... Unusual gold-sales must be brought to scrutiny...

Delaying the time limit to cut-out high-value denomination black-currency would increase the hangover... Black-money hoarders are smart people... More time to them would increase conversion to other asset classes to create black-wealth... Cash is still not abolished absolutely and banks are still accepting the banned-notes which could be a business turnover after selling something... Cash in Rs 500 or Rs 1000 notes still do not require a bank-account-number or PAN to verify the source of income to buy investment assets such as gold or foreign-exchange or land... A lot of black-money has already been converted in black-wealth... Unusual income during the demonetization-period should be brought under the lens... No significant price-crash has been observed even after replacing 86% of the currency from circulation which might be attributed to the grace-period to exchange old currency or deposits in bank-accounts... Gifts and inheritance in a back-date are still out of the purview of scrutiny... Only income has been targeted... There is alot of room for improvization to reduce ill-gotten wealth in the last five or ten-years... Notwithstanding, cash-less transactions would decide the fate of black-money-less-transactions, black-money and black-wealth...

A help of few thousands to the poor after increase in government coffers after demonetization would not last too long... PM should invest in innovation and skill-development to increase productivity and wages and incomes ... something durable... it is likely to increase demand in the economy further on a solid base...

Demonetisation is likely to lower inflation which could make things affordable for the poor... even food... poor people could buy nutritious-food... It is a strike on inequality... PM has repeatedly said that this would benefit the poor...