Demonetization has failed, btw I dig this Gin cocktail

Modern Indian is faulted for many things but not for lack of opinions. No social evening since 9/11 has thus remained untouched from the demonetization debate. Opinions have ranged from the objectives of the move, politics around it, plight of the common man standing in long bank queues, how people have done service to the country by paying their sabziwaala with payment wallets, UPI and so on. All this, while glasses of Sauvignon Blanc, Whiskey and the latest Gin cocktail have been refurbished at the usual pace. BJP and PM Modi’s staunch supporters have left no stone unturned in arguing ‘all is well, the boldest move India ever saw since independence, finally someone did something about black money and corruption’ to (after a few drinks and counter arguments from across the table) ‘execution is poor but long term benefits are undebatable’. The anti camp has ranged from ‘all the money is back in the banks so where’s the black money, common man is dying on the street, businesses and GDP growth will take secular hits’. Not that any past arguments of similar national importance (politics, cricket- bollywood nexus, religious gurus..) were backed by rationale or relatively well educated views, but the enthusiasm in pushing respective viewpoints in this case are astounding. Maybe because no one has remained unaffected by this move. Yet I am surprised by the general lack of investigation and academics in these arguments. Let’s put some facts on the table vis-a-vis demonetization:

• $180 Billion (80%) of all illegal tender notes have been deposited back in the banks as of mid December. Only 5% of the deposited money has gone into Jan Dhan accounts.
• Only 3.5% of ~800 million Indian adults file taxes as opposed to 75%+ in developed nations. Further 1.2% only actually pay taxes in India, vs. 1.9% in China, 6% in Brazil, 33% in Russia, and 55% in the USA (this has more to do with socialist vs. right wing tax policies and maturity of a country’s tax economy).
• For a population of 1.34 billion — India has 1 bank branch for 25,000 people and 1 ATM for 8,000 people. 26 million credit card holders and 600 million debit cards (of which less than 10% are really active beyond ATM cash withdrawls) and not to forget 210 million ‘Jan Dhan (JD)’ accounts in existence before 9/11.

Let’s look at all the alleged objectives for demonetization:

a) Curb black money and corruption: Enough has been said about the fact that corruption and uncontrolled (+unreported) political donations are highly correlated in India. Unfortunately no policy change has happened or expected on this front in the near future unless Modi ji has another one of those ‘bhaiyon or behnon bomb shell waiting in the coming weeks’.

Corruption at lower levels is more of an intent and supply side issue (policy ambiguties and government opaqueness in allocation of important national resources fuels it too) which would come back as soon as enough liquidity hits the system. No major tax or policy reforms are being talked about on this issue. The arguments against the fact that less than 10% of black or illicit money is in cash (rest is conveniently parked in tax havens) are academically weak. Hence unless India changes laws around taxation of global income for all Indians (like in the USA) and goes after tax evaders with monies parked overseas (a large % is in the hands of politicians and handful of large business groups so there is a strong intent issue here) in a systematic manner, it is hard to see how sucking out old notes and converting them into new notes (hopefully soon) by the RBI is going to solve the black money and corruption issue.

In-fact the question whether black money is wiped put from the system seems partly defeated with 80%+ of money back in the banks statistic. We know most if not all of this money has not been deposited to pay taxes because reasonable amnesty schemes in the recent past did not invite such amounts of money (not even remotely close); enough has been heard about ‘temporary transfer of wealth from the rich ‘sahib/seth’ to the poor’ (2 years advance salaries to staff, construction workers, or using the help of poorer brethren to park money in JD accounts etc.); finally to ‘cash in hand’ corporates CFO’s coming to rescue of the ‘poor’ crorepatis who were stuck with cash as they poured whiskey over ‘who will the next US President’ while Modiji was hammering away their general happiness on the evening of 8th November.

I would bet (hint for Income Tax officials) that the ‘consulting’ income and ‘new vendor’ payments would increase in 2017–18 as a quid pro quo for this temporary transfer of wealth. More importantly, the results of tax collection increase wouldnt be known until September 2017 when all individual and company tax returns are in. Seriously hope that the government in conjunction with RBI and the IT department will report to the Indian public how successful has tax collections been both in terms of widening the tax net and value of collections compared to prior years. Until then, all arguments on this front are just emotions and nothing more.

Recently when I argued this position in front of a passionate group if IIT’ians in a 20 year re-union (by default the cream of the nation but unfortunately many of whom have no to little contribution to India’s progress and development as they found greener pastures overseas), one over enthusiastic individual didn’t leave the opportunity (when he ran out of any meaningful rationale) to say that this is an anti Indian argument and that Modiji will follow up with a slew of other measures to fill the void in the overall objective. Amen!

(b) Counterfeit and Terrorism funding reduction: An avid BJP minister didn’t leave an opportunity to claim that the no.of protests in Kashmir has gone down since 9/11 as if the drying of old notes had an electric and immediate affect on terrorism funding (not to miss the convenient link of terrorism with Kashmir protests). He conveniently forgot the average temperature drop in the valley and the obvious standstill support from Pakistan due to the change of USA regime or pure fatigue, which could have curbed the public’s enthusiasm to hit the streets in Kashmir. Thanks to ‘WhatsApp’, over 100 million Indians have seen the ‘fake’ news videos of the embedded micro chip and almost impossible to copy technology in the new notes. Unfortunately none of that is true except for the pinkness of the 2000 Rs. note which seems right given the current theme of women empowerment but the technological superiority of the new currency argument starts and ends pretty quickly. Will this put at-least a temporary dent in terrorist funding and counterfeit economy, undoubtedly yes! But we again conveniently forget that 90%+ of the black money is parked outside India some of which can find its way into terrorist funding as easily as before.

Let’s examine now what’s bound to happen:

• Informal economy including informal sector lending has gone to the dogs — take your pick on what % of SME’s and their business models become irrelevant in the coming months. That’s bad for employment and GDP growth
• Cash based businesses (Textiles and other manufacturing sectors with daily labor cash payments, NBFC’s lending cash, logistics and retail sectors and many more) seeing a short to medium term impact in their direct or indirect (vendors, raw materials) business. While some behavior change is imminent towards digital and cashless economy, don’t expect all parts of the value chain swiping their phones with payment wallets in a country where less than 10% of Bank Debit cards are used beyond ATM cash withdrawl and with abysmally low ATM and bank penetration. Digital cash and wallet companies would see valuation increase (did someone notice the Freecharge fund raise from Paypal?), secular change cannot be assumed automatically. That’s not good for the Indian economy.
• Real estate price correction: This is one of my favorite topics. How many times do we hear about unviability of business models in India becasue real estate asset pricing (buy or rent) are out of whack. The usual “How much more can I get with $ 1 million in the USA as opposed to in India” question. While many real estate players and investors aren’t hoping for this, a 20–50% correction in real estate asset pricing could bring Indian RE at par with global standards on metrics like quality of construction, related quality of life, and cash yields.

Let’s hope the ‘settled’ pro Modi/BJP argument is right, i.e. we see a slew of measures that will curb the real menace of corruption, black money with unambiguous and actionable policy, law changes relating to benaami properties, gold hoarding, tax haven asset and income declarations in Indian tax returns, and non witch hunting attitude of IT officials with a purist objective of tax net widening and fair tax collection (but that’s almost an oxymoron but let’s see). Tax rate reductions for corporate and high income individuals would help with motivations to keep wealth within India especially in this uncertain environment.

Concluding with the best party line (and obvious retort) I heard in the last 7 weeks. “To cure an infection, you take a blood sample and then take an anti-biotic if required, but not suck out 86% of the body’s blood”. My response is it depends on whether one sees the ill of black money, corruption as a ‘bacterial infection’ or ‘leukemia’. Leave it for you to decide. Btw did you know that ‘Gin & Tonic’ concoction was invented in India?