Demonetization – NDA’s Smart Move Towards Dismantling The Parallel Economy

On the 9th of Nov, 2016, the NDA Govt came out with an announcement of the discontinuation of the Rs 500 and 1000 currency notes. The news created great discomfort and unrest amongst the people. The move was in the wake of increasing black money and counterfeit notes in circulation. The topic is of immense interest since this move is going to impact the several sectors of the economy and the way policy decisions are approached. I would like to bring out the overall meaning of the parallel economy, the causes, the key commodities which lead to the creation of the parallel economy, the cost that RBI will have to bear because of the decision and further a set of comments on the cost-benefit analysis of the decision from a central bank perspective in this blog. In addition to the above, I would also like to bring out the effects of the Govt’s decision on the near future RBI Monetary policies in the context of the rate and the liquidity, the likely near-term effects on the stock markets, liquidity management of the banks, the effects on real estate, MFIs etc. Let us look at the overall situation and a quick impact analysis on the same.

The parallel economy has been a critical pain point for the NDA Govt to function smoothly. A Parallel economy, based on the black money or unaccounted money, is a big menace to the Indian economy. It is also a cause of big loss in the tax revenues for the government. The Indian economy has grown by 30% in the last 5 years whereas the high value denominated notes have gone up by around 90%. This essentially indicates that the transactions which take place are largely in cash and are unaccounted for and that eventually leads to a creation of a parallel economy and all such transactions do not contribute to the net GDP thus creating hindrances to the growth rate. In order to take a stance against this, the NDA Govt decided to discontinue the old currency notes and replace them with new so that the parallel economy transactions reduce significantly or might come to a stand still in a bit.

Key cause of Parallel economy creation:

  1. Tax Evasion
  2. Cash transaction in trade and services
  3. Corruption
  4. Equity market manipulations
  5. Real Estate etc

Key Investment Avenues for such lump sum cash:

  1. Gold
  2. Informal lending/deposit market
  3. Real Estate

 

Effects on the Monetary Policy:

The Reserve Bank of India may have to change the policy course amidst removal of high value notes as the huge accretion in deposits will increase the overall liquidity in the system. In this situation, the RBI might have to sell out bonds to suck the additional liquidity in the system. The high liquidity in the system shall lead to cheaper loans thus boosting inorganic growth. RBI may want to minimize such impact if any. The additional CASA deposits shall lead to low rate deposits thus leading to cheaper lending with a lagging effect of about 2 quarters.

Sectoral Effects on the Economy:

  1. Real Estate – With lower interest rates in the near future and a liquidity crunch in the real estate sector, home prices might come down by about 20-25% in the medium term.
  2. E Commerce – Reduction in cash transactions has already forced amazon and flipkart to discontinue their cash on delivery services thus impacting their reach and business in terms of the overall sales.
  3. Infrastructure – The sector might face immediate heat since most of the payments to the labourers are made in cash
  4. Agriculture – Agri might face immense negative impacts since the trade largely is carried out on cash basis including the purchase of seeds and fertilizers. However, the impact will be short-lived.
  5. Housing Finance Companies – Sector finance companies shall have opportunities for higher demand amidst lower home prices. However, it might face the heat in terms of the overall credit quality where the lending has been largely for low-income groups.
  6. Banking – Banks/NBFCs shall be benefitted since a large sum of low-cost deposits in the form of CASA accounts shall be accumulated. However, liquidity management and efficient operations shall continue to pose challenges to the banking institution at least till December.

Market Outlook:

The markets shall continue to be volatile in the short-term and significantly jittery in the medium term. The markets are yet to price in the effects of the sudden decision but we can the markets to neutralize by the end of the month. However, the long-term outlook shall be bullish as far the demonetization impacts are concerns. Ultimately, the markets will take their own course based on the likeliness of the future events. Nifty should rise back to the 8500 levels by November end is the majority consensus so far.

Cost Benefit of De-monetization (RBI Perspective):

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Total Cost of Printing Vs Demonetization Benefit Comparison

What the above numbers mean is that the cost for RBI to print new notes shall be close to Rs 62 Billion. The Govt, on the other hand, has targeted to demonetize around 170 Billion. Assuming 100% success, the Govt shall be demonetizing close to 170 billion which is as good as three times the cost the Reserve Bank shall bear to make a smooth transition. It largely is a benefittin trade-off for the Govt as well as the RBI.

The decision of the NDA Govt is one of the most prominent moves of the decade towards making India a better country in terms of growth and transparency . However, the approach of the Govt in handling this chaotic situation smartly will drive the near future results. The Reserve Bank on the other hand, will have to make sure they keep mopping up the additional liquidity in the system and intervene when required to ensure the financial stability of the system. India has clearly welcomed this decision as far as the reactions all over are to be considered. It will be challenging to see the handling of the outcomes that evolve from the decision taken. Hopefully, this should be the fresh start towards making India a more transparent, efficient and the fastest growing emerging economy. If not complete eradication, this will definitely reduce the overall impact of the parallel economy and transfer the reduction as a contribution to the real economy growth rate. I hope as citizen, we will make an effort to ensure the new notes being printed are not soiled by writing on them or keeping them in unhygenic conditions as it adds huge cost to the Govt and the Reserve Bank.

I would love to know the diverse views of the readers as well. Thank you. :).

 

 

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When The Acche Din Were Around The Corner…

When the acche din were just around the corner, here are two big events that have occurred in the past two weeks (Brexit and Rexit). I would like to talk about brexit in one of my other blogs, and would be focusing on Rexit ( Dr. Rajan opting out of the second term as the RBI Governor) in this one. Raghuram Rajan will step down as the 23rd governor of the Reserve Bank of India when his term expires on 4 September,2016. In this blog, I would be giving in sense of his achievements post his appointment as the RBI Guv, the likely impacts on the markets due to REXIT and the next likely predecessors for the position of the RBI Guv. I will also share statistics in terms of the key indicators before and after Dr. Rajan took over on the Sept 4, 2013.

From converting the Reserve Bank of India into an inflation targeting central bank to forcing a long overdue clean up of the banking sector, Rajan’s three year term has created significant progress. Dr. Rajan, has always been a inflation targeting Guv since the belief was strong that neither higher inflation nor lower interest rates are going to boost growth solely, the growth is always a mix and balance of the two parameters. With his highly focused regime of concentrating on the monetary aspects of the economy by considering various external and internal events has been effective in all the possible ways.

Here’s a list of the key improvements/actions/achievement by the veteran:

  1. MPC (Monetary Policy Committee) – Dr. Rajan announced a committee to review the monetary policy. Although, the attempt was then tweaked by the Govt in such a way that currently there is a hint of RBI Guv losing his rights to take the final decision on the policy actions.
  2. Inflation Targeting – Right after taking over as the governor, Raghuram Rajan appointed a committee to review the monetary policy framework. The committee recommended that the RBI formally shifts its focus on to the consumer price inflation index as the nominal anchor for monetary policy in the country rather than WPI. As part of this framework, the RBI was to bring down inflation to 6% by March 2016 and 5% by March 2015. Over the medium term, the RBI now has a target of bringing inflation down to 4% (+/- 2%). Looking at the current situations, the RBI has fairly achieved its targets.
  3. Revitalization Stress Assets – RBI took various measures against the stressed assets of the banking sector especially in terms of the corporate and strategic debt restructuring norms.
  4. Bank Licensing – While the process of licensing another round of universal banks was kicked off during D. Subbarao’s tenure, Rajan’s tenure saw two new banks (IDFC Bank and Bandhan Bank) being licensed. The more significant step in this context, however, was the licensing of differentiated banking licenses.  11 payment banks were given an in-principle approval and at least eight of them will launch operations by early next year to increase penetration in the rural economy. In addition, ten small finance banks were also given in-principle licences to serve small borrowers and businesses. Rajan also floated the idea of wholesale banks and custodian banks, although, with no guidelines as of now. The RBI put out a draft framework for on-tap universal bank licensing as well.
  5. 5/25 Scheme – RBI allowed corporate to extend tenors of credit in case of infrastructure projects thus providing them with a higher gestation period.
  6. Market Development – Market development has been top of the agenda for Rajan as well. The RBI, under Rajan, has also for the first time put in place a framework for foreign investor participation in the bond markets. The RBI may start accepting corporate bonds as collateral for its liquidity operations.
  7. Repo Rates Decline – Repo rates were brought down to 6.5% ( Lowest in the past 6 years) with inflation targeting as the key focus.

Apart from the above mentioned monetary measures taken, Dr. Rajan’s timely actions on the monetary policy decision has enabled a huge change in the key macro economic indicators of India before and after Dr. Rajan taking over. There has been a huge difference in the numbers including the credibility in the world economy and the reduction in the instability of the economy. Here’s a quick stat on that:

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Although, it was an extremely surprising decision by Dr. Rajan, it was very well anticipated looking at the tension between the RBI and the Govt in the recent past. The markets have reacted negatively because of the sudden decision to not continue. The short-term blip will continue for the next 3 months and might settle down once the monetary front is stabilized post appointment of a new RBI governor. However, markets will keep dipping in the short term amidst the uncertainty on the global front, whereas the medium and long-term trend look significantly bullish.

Who Will Fill Rajan’s Shoes:

Lets look at behind-the-scenes scenario of how the RBI Governors have been appointed till date. Even though the Appointments Committee is the official vehicle to do the job, typically, the Prime Minister’s Office chooses the governor with inputs from the finance ministry and the outgoing governor and, on most occasions, there is no written recommendation. The politicians of the ruling party play an important role in the selection but the corporate houses that normally try to influence the appointment of CEOs of commercial banks do not have a voice here, although they have their own preferences.

Here are some of the options that the government may consider as it searches for the 24th governor of the RBI. The four likely candidates are: the current RBI Deputy Governor Urjit Patel, former deputy governors Rakesh Mohan and Subir Gokarn, and State Bank of India Chair, Arundhati Bhattacharya.

Here’s our quick analysis on who would be the probably choice of the Govt:

  1. Rakesh Mohan – A former Dy Guv and a veteran economist. Logically, he will be apt for a fiscal role rather than a monetary chair role due to experience in the former. However, politically he might stand a chance in case the Govt is looking for an economics reforms expert to head the RBI.
  2. Subir Gokarn – A former Dy Guv and a veteran economist especially in the areas of food inflation and inflation related research. However, he might not be the right candidate to head the RBI since that would require the expertise and experience on handling the monetary front of an economy.
  3. Arundhati Bhattacharya –  A career banker, Bhattacharya may make a good candidate against the bad loan crisis in the banking sector. The trouble with appointing Bhattacharya as the head of the central bank is that there is no precedent in recent times of a banker being appointed as the RBI governor. While one of the four RBI deputy governor’s is always a senior banker, the central bank chief has typically been someone who has had an understanding of the wider economy.
  4. Urjit Patel – Current Dy Guv of the RBI. Urjit Patel, who chaired the committee on a new monetary policy framework, has overseen the RBI’s transition to an inflation targeting central bank. Patel has also been driving the central bank’s liquidity policy as well. According to me, Urjit Patel has the highest probability to be appointed as the next Guv of the RBI. However, the political front of the appointment may be different from the predictions that are logically sound.

To sum up, India was in deep trouble in terms of macro economic indicators and the stability of the economy. Dr. Raghuram Rajan, took over on 4th Sept, 2013 and changed the overall image and credibility of the economy. However, it is a sad event that he choose to return back to academia from being the dashing RBI Guv. Although, he has made his choice to join academia, he will always be remembered as the youngest and the most respected Guv of RBI in the coming years. It will be difficult for any other veteran to fill in his shoes, but however, Urjit Patel and Arundhati Bhattacharya look to be the probable candidates to head the RBI so far. When the acche din were around the corner, its hard to believe that Dr. Rajan has quit. 

Thank you. 🙂

 

 

 

 

 

 

GST – So near, yet so far…

Goods and services tax is finally running its last lap. But it has not reached this stage without hurdles. It has been facing various problems to get implemented right from the time it was mentioned in the 2006 budget for the first time.

In India, the powers to levy taxes is divided between the states and the centre. There are lists which define who is to levy taxes. In some cases the entity comes under a common list thus creating multiplicity of taxes and substantially adding to the compliance and administrative costs for businesses. All of this calls for the need of a comprehensive way of taxation which is being brought in the form of GST.

Goods and services tax is a single tax rate on any supply of goods or services or both. The GST will wipe the indirect tax slate clean, replacing around a dozen indirect taxes and excise levied by the state and the centre. It is a courageous step to reduce the current tax complexities, encourage tax compliance, and streamline the system of tax credits. Although courageous, we are pretty late in implementing this reform compared to the rest of the world. More than 100 countries have already implemented these.

GST, as far as the implementation is concerned, will be decided on the basis of a tax rate to be levied. This tax rate to be levied is termed as the Revenue Neutral Rate (RNR). RNR is the rate at which there will be no revenue loss to the states after GST implementation. RNR is decided, bill is passed, everyone is happy right?? That does not seem to be the case so far. Calculating the RNR and finalizing a value which is acceptable to all the stakeholders seems to be a challenge. The Ministry of Finance had given the task to a few committees to come up with a rate for the same, bifurcated as state rate and central rate. The picture looked something like the given below table.

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The suggestions of empowered committee were void since the RNR of 27% is too high, while the 13th finance commission rates were way too low. If the rates are too low or too high, they would have to face opposition from states as well as consumers and industries. Mr. Finance Minister has so far indicated, based on a consensus, that the GST rate will be somewhere in the range of 21-27% which will be subject to agreement by all the states. Many experts believe that RNR less than 25% might lead to revenue loss. Despite what the RNR is decided, GST will definitely reduce the cascading of taxes to a great extent and would help in increasing the GDP by 0.9-1.7% from the current growth rate.

Although GST, India’s most ambitious tax reform, is being implemented with slow pace and is likely to be rolled out next year, a lot of roadblocks still remain as a challenge. Following are a few :

  1. Passage of the bill in the Rajya Sabha (as it is already is cleared in the other house) and ratification by at least half of the states.
  2. Arriving at a RNR and a minimum threshold level
  3. Deciding on the goods and services and exclusions if any.
  4. Formulating “place of supply”, so as to determine the point at which tax is to be charged
  5. Most important and crucial, is the designing of an effective information technology infrastructure and enable the credit flows

India is a country that thinks too much and is hesitant to implement it. There are around 132 countries who have implemented the GST with different names and in different forms. But are all those GST reforms perfect?? As a matter of fact, they are not. They have implemented them with certain predefined form and are improving based on the experiences witnessed. Sometimes the best way to achieve something is to just implement it first, and then go on improving the same. Anyway, despite all the roadblocks, it’s always important to be optimistic enough to believe that the GST will be rolled out next year and India will become the fastest growing emerging economies, probably. Lets hope the bill is passed in the monsoon session of the rajya sabha where the NDA Govt will have to face some more opposition stunts.

Thank you. 🙂

NDA Govt..Has it Fared Well so far ??

NDA Govt will complete a year in power on May 26th. It came in power with promises to implement some reforms that will make India one of the fastest growing economies.. The productivity and number of hours spent in the sessions seem to be promising from its rosy figures. But how far have they been able to keep up with their promises is still not clear from its actions so far. Hope you will get a clear look on whats been done and whats not!!

Modi

Here is a list some of the key Bills that are under consideration:

  1. The Constitution (One Hundred and Twenty-Second Amendment) Bill, 2014 (Goods and Services Tax)
  2. The Insurance Laws (Amendment) Bill, 2015
  3. The Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement (Amendment) Bill, 2015
  4. The Andhra Pradesh Reorganisation (Amendment) Bill, 2015
  5. The Motor Vehicles (Amendment) Bill, 2015
  6. The Coal Mines (Special Provisions) Bill, 2015
  7. The Mines and Minerals (Development and Regulation) Amendment Bill, 2015
  8. Citizenship (Amendment) Bill, 2015
  9. The Public Premises (Eviction of Unauthorised Occupants) Amendment Bill
  10. The Black Money Bill (Money Bill)

Each bill has to be passed in both the houses of the parliament, the Lok Sabha and Rajya Sabha. NDA with majority in Lok Sabha will have minimal troubles of getting them through. Although, in Rajya Sabha it looks a little difficult to get the bills through for approval ( having a strength of 47 out of the total 245 seats). It’s important to note that rajya sabha approval is required for bills which are not introduced as money bill(ex Black Money bill). Thats why NDA should be credited to roll out the black money bill. Black money bill although has been passed by Lok Sabha and is bound to be cleared by Rajya Sabha. Black money bill although has been passed by Lok Sabha and is bound to be cleared by Rajya Sabha. NDA has so far passed most of the bills. But GST might have to wait for a while more to be passed in the Rajya Sabha after recently being passed from the Lok Sabha. GST has recently been referred to a select committee for legislative scrutiny. The road ahead for GST and land reforms seems tough with a strength of 47 seats in the Rajya Sabha.

Overall speaking, the NDA Govt has fared well in the past year with some hurdles because of the strong opposition. But they seem to bring in the required reforms of GST which are proposed to be rolled out next year. NDA has sure shown signs of reforms from making GST a success story in Lok Sabha.The way forward is tough for the Govt but if they convert this hurdle into an opportunity, NDA will be credited for introducing the biggest reform(GST) after 1947 for the development of India as the fastest growing economy.

Next up is all you need to know about GST and the way forward for it to be rolled out next year. Do read. It will be very informative in nature.

***Heres something about what do you do when you have to vote the next time. Most of us are not aware of this *** 
Next time when you vote, visit this :http://www.prsindia.org/ …check out your constituency’s MP track record and how has he performed during the session, has he asked the right questions, has he put up some issues of his constituency..and more to read about them..Do visit.. It might make us more aware about how things are and whom should we vote the next time 🙂

Thank you.