A dispassionate look on demonetisation

Now that the dust and din have settled on the actual amount of cash returned to the banks on the demonetisation initiative, there are clearly two different camps that have emerged. The government and supporting voices are insistent that the drive has been a success and will have great long term benefits for the economy and country. The dissenters question the move and say that the data now proves beyond any shade of doubt that the move was completely ill advised.

Let us look at this from a fundamental perspective to understand what has really happened, why it has happened and what is the likely fallout. To begin with the objective of demonetisation was to unearth the huge amounts of cash that was being used in an unaccounted manner in our economy. It is important to understand that the proportion of cash in the black or parallel economy is a small percentage, nearly 6 %. The bulk of it is in real estate and other assets. However, this cash keeps working as the lubricant for deals in real estate, film industry and other areas where regulations are weak at best and non existent at worst. Thus, the amount of cash is ever increasing and more importantly untraceable. When the government went for demonetisation, the hope clearly was that some of this unaccounted money will not find it’s way back into the banking system as people will be worried to account for it.

What has happened in reality and why? Well, now we know for certain that the amount of money not returned into the banking system is only 16000 crores. Even though the government had not officially named a figure, it was widely expected to be much higher around 3 lac crores. I think some of the reasons are as follows:-

  • A lot of people managed to use the bank accounts of known people to deposit money. For example, I personally know a few who have done this in the accounts of people who worked for them.
  • While it was a great initiative to open the Jan Dhan accounts, I wish there was some deposit limits set to them based on the economic condition of the account holder. Many of these accounts were unfortunately used for parking black money with a promise of paying a percentage to the account holder.
  • The great Indian ingenuity to circumvent rules was in full display during November and December of 2016. An entire industry sprang up to take your old notes and give back 70-80 % of equivalent new notes. Unfortunately, instead of declaring their money and paying taxes on it, many Indians chose to go by these shady routes.
  • In the initial days there was panic and there were even stories of sackful of 1000 Re notes being abandoned etc. However, it soon dawned on people that even if they could not use others accounts or middlemen, it would simply make sense to claim it as current earning and deposit it in their own accounts.
  • The above was possible as the follow up from IT authorities were not thought to be very efficient in their follow up. Many CA’s also advised people to deposit their money and figure out how to handle tax notices etc at a later date.
  • I know of a Doctor who had 15 lacs of black money and he simply generated current year invoices to show it as current year income. As most people went about this way, the amount of money collected from the amnesty scheme was well below expectation again.

Let us now look at the impact of demonetisation on the economy as a whole. It needs to be understood that the unorganised sector got very badly hit by this move. Cash was the only mode of transaction there and sudden unavailability of it almost shut down entire industries in several parts of the country. Several workers in these industries were suddenly left without jobs and these were the section of people who could not afford to be out of work even for a short while. Yes, over the next two months most of the jobs were back but the short term misery inflicted on these people, cannot and should not be forgotten. The organised sector was more fortunate but here too there was a distinct slow down in business and demand.

Why was this not reflected in the GDP numbers of Jan 2017? Well, for one the timing of the demonetisation was chosen very well. A lot of demand and business got executed in the October period as it was festive season in India. Normally there is a lull in commercial activities post Diwali anyway. The data from the unorganised sector anyway takes a long time to find it’s way into the statistics. So the impression of the 7.9 % growth despite demonetisation was clearly a false one, as latter events were to prove. However, this should really not be seen as a problem as most well informed people did understand that the GDP will suffer by 1-2 % in the short run. I am surprised at the 5.7 % number but had been quite prepared to see something to the tune of 6.5 % for the last quarter.

The other area which has been actively promoted by the Government with the Prime minister himself being the champion is digital transactions. It is true to say that in the initial days there was a spurt in these, mainly due to the fact that cash was simply not available. The aggressive marketing of the payment companies and the Indian inclination for good deals saw a surge in these payments. However, with the cash flows having resumed, the transaction growth in these areas is becoming muted. Also, this was at best a byproduct, for the government to say that this was one of the main aims of the exercise really smacks of opportunism, if not hypocrisy.

With all this said, are there any long lasting gains from this drive then? Yes, there definitely is and only the open minded will be able to see the obvious. We now have all cash in the banking system and in a manner that can now be traced. For example, a Real estate transaction can still have some cash component BUT now the IT authorities know the money trail. This is of significant advantage and will now help IT people to follow up on any suspicious transactions. Yes, this will take time, given the paucity of resources but it is sure process though slow at times. The regulation on cash spending is a good follow up measure and this again helps in tracing the money trail. Also, the fact that cash has come back does not mean it has been accepted as accounted income. If you have a sum of 10 lacs in your bank account deposited last year, you will still need to account for it.

So while the overall impact in the short run may be poor, the long term benefits of a cleaner economy that is far more tax compliant will definitely be there. Other measures such as clamping down on benami properties and getting GST to be effective will also help in this regard. The problem is with the government trying to get mileage out of it politically and hence shifting the stands every now and then.

Demonetisation was a bitter pill to swallow for many of the citizens and for people affected adversely the taste lingers. It will however, usher in a completely new country as long as things are followed to their logical conclusion, without fear or favour.


My take on the budget

The kind of hype and expectation which is normally generated by any budget in India is tough to meet at the best of times. This year was more so due to the demonetization fallout that many of us were affected by. The price of inconvenience was sought and in many cases loss of business and jobs required some level of reparation. Lack of growth and clear decisions regarding black money and political funding also had to be tackled.

Based on all of this, the foremost question will be whether the FM has delivered or not? I would say that he has done it quite well, even though I feel there was room to do more in terms of personal income taxes. The 5 % reduction on the first slab was good but it should have been followed up with similar reductions in the other slabs. The surcharge on the incomes greater than 50 lacs is keeping with the sentiment that the richer people can afford to pay taxes. With the ongoing elections, this is something I can understand, though I do not agree with the approach.

Taxation and black money have been the recurring themes in our economy and polity in 2016 and the FM did a commendable job here. Firstly, he addressed the issue of poor tax compliance and brazen tax evasion in India – it is like an elephant in the room, everyone knew about it but no one mentioned it so far. The FM has put the numbers in context – only 1.7  lacs people saying that they earn more than 50 lacs is abysmally low. With the event of demonetization and the cash being brought into the banking system now, there is real hope that people who had stashed away their ill gotten wealth will now have to face the music. If they declare through IDS 2 then they pay 50 % tax and another 25 % as deposit for 4 years. In case they choose to just take a risk, they will definitely get caught and end up paying 82.5 % tax and in addition get a possible jail term.

As far as the growth part is concerned, the FM has avoided some potentially poor decisions like taxing capital gains on equity etc. On the other hand, reduction of LTCG tenure on property capital gains, shifting the base year to 2001, giving 1 year relief to builders on deemed income will energize the RE sector. With the earlier incentives on housing loans announced by the PM this gives a good fillip to the housing sector, which was much needed.

Agriculture has got a lot of attention in this budget and that is good given a lot of our people depend on it even today. Improvement in agricultural production and rural income will also be able to drive consumption which is vital for corporate growth. We also need to remember that resources are needed here far more, than people like us need it.

The corporate tax relief to companies doing revenues of less than 50 crores in the year 2015-2016, will help the earning of these companies next year. This will be a good push to the elusive earning growth that we have been waiting for. This reform is a harbinger of more things to come and will encourage buying in our stock markets. The fiscal deficit being on track will increase the confidence in the India story as far as the Rating agencies are concerned. FII buying will return and the general mood of our markets in 2017 will be upbeat, though there will definitely be periods of corrections.

Some other good things in the budget was the wait for GST, instead of trying to tinker with Service tax or Excise for 3-4 months. LIC coming up with a 8 % scheme for senior citizens, Companies like IRCTC going public, Safety fund for the Railways, divestment through CPSE ETF next year too are all good measures. Transformation to the Digital economy by stopping cash payments beyond 3 lacs is an excellent idea.

The political funding cap will reduce the impact of goons in our political syatem and this will have the best results in the near future. On the whole, this is definitely a budget in the TEC mode – India is well on the way to Transform, Energize and Clean.

In 2017 politics will decide market movement

Even a casual observer of the stock markets will know that there is a close link between politics and the market performances at most times. Market movements are often decided by news flows and in many parts of the world, particularly in India a lot of these news are from the political arena.

Till about 2 months back the narrative in the markets depended largely on corporate earning growth and the US Fed rate hikes. Both of these were thought to be determining factors in how the FII buying would pan out. As our markets depend a great deal on FII inflows, the overall consensus was for a dip in the start of the year and a pick up as time went by. The budget was likely to be a positive one and a Nifty high of 9000 plus sometime in the first half of the year seemed a definitely possibility.

Demonetization and the subsequent political realignments have changed all of this greatly. At a basic economic level it is clearly visible that several sectors have been affected badly due to liquidity issue and also the overall sentiment regarding consumption has a negative bias now. The FY 17 earning growth is therefore likely to be fairly flat, belying the promise that was evident till the second quarter. The government can point to the tax collections but markets will only consider the growth in corporate earning and that will not be good.

At a purely political level, the exercise and the subsequent coming together of disparate political parties in order to challenge it has created a somewhat unstable situation which is bad for the markets. In general the markets like status quo and is worried whenever some negative disruptions take place. The election dates being announced for the 5 states have made the situation more complicated. It may mean that the budget is delayed and the current political climate also makes the GST roll out difficult by April 1. 

And then of course, there are the elections due in 5 states. They were always going to be important but with the demonetization backdrop, they have virtually become a referendum on the Modi government. Should the BJP lose significantly there will be serious questions on whether the policies Modi wants to practice have any resonance with the citizens of the country. Such type of political uncertainty will inevitably see FII outflows and deep market cuts. How is it looking currently? Well, the BJP will probably retain Goa despite an upsurge from AAP, lose Punjab where their partners have a lot to answer for, win in Uttarakhand where the corrupt Congress government has definitely run their course and may continue their North East success with a win in Manipur.

As often in the past UP will have a huge say in Indian politics – win it and BJP will claim all their policies are a success. Lose it and they will have to be on the retreat for the next 2 years till the general elections are due. In the first scenario both the Economy and the markets will revive quite well in the latter half of 2017. The FII buying will resume with enthusiasm. In the latter scenario a likely sell off from the FII’s will be accompanied by deep red in our markets, maybe even a crash.

In the latter part of the year Presidential elections and the different cases the CBI is pursuing against opposition leaders in different parties will also have a bearing. With good wins in the elections the BJP will be able to deal with these easily, losses will dent it’s moral authority and they will need to be more conciliatory with the opposition in order to get things done. Also there are 62 Rajya Sabha seats to be decided next year, if the BJP can get most of these and strike a deal with AIADMK then their Rajya Sabha woes can be largely over. This will leave them a few months to pass whatever legislation they want and go into the 2019 elections in a confident mood. In Indian politics, the road to Delhi always passes through UP , this year will witness that once more.

How will Nifty be affected in the different scenarios? There are a lot of alternatives to be played out, let me address that in the next post.

Demonetization – slip between cup and lip?

Over the last one month the whole country has been transfixed by this phenomenon of demonetization and it has been a riveting saga. As I had written before about this in the blog here and here. You may also want to read about my own experience as well as the effect on investments.

Now while the intent was great and the strategy definitely a bold one, the implementation has definitely left a lot to be desired. I am not talking about the inconvenience and hardship to the public at large, that will probably be justified if the blow against the black money is a debilitating one. However, from the current data available it does not really seem that the black money hoarders are scurrying for cover. Consider these facts :-

  • Out of 14.8 lac crores banned currency value it is now expected that much of this will find their way into banks through deposits. 
  • Do note that this does not mean that the black money has been laundered into white as once the money is in the system, it will be subject to scrutiny by IT authorities. 
  • However, the windfall that RBI was widely believed to be getting will not happen now and this will be seen to be a serious dampener.
  • The political mileage gained from talking about notes being trashed and possibility of putting some money into Jan Dhan accounts has very nearly come a cropper already.
  • The estimated monetary cost of 1.28 lac crores to the Indian economy will now take some making up, probably not possible in the next 1 year or so.

So what really went wrong as far as the deposit expectations are concerned? While hindsight is always 20-20, I think there were several basic mistakes committed by the planners and this shows their fundamental lack of understanding of how things can work on the ground in India. This is what really happened in the last month, starting 8/11 night:

  • A humongous amount of gold was bought at astronomical prices. The idea was that it was better to buy gold with black money, even at much higher prices instead of paying taxes. It would have been logical to stop all gold transactions for a week or so, surprised that government did not anticipate this.
  • Much of the black money was obviously with people who had access to manpower, whether politically or otherwise. Given the number of people in India who are unemployed or semi-employed it was also possible to hire them cheaply. This was used to both exchange and deposit money in big way. The whole idea of limiting exchanges through inking people was too little and definitely too late.
  • Creative corruption was at the peak during this time. Schools were willing to take money for the next 10 years, businesses were willing to accept old notes and touts had a field day promising to pay in new currency after taking a hefty cut.
  • The much flaunted Jan Dhan accounts actually became a huge negative here and caused a lot of money laundering. The moral fiber of most Indians, especially those surviving in abject poverty is unsurprisingly suspect and this was used relentlessly by a lot of wheeler dealers to channelize money from their clients.
  • The situation was tailor made for compromising some of the bank officials through offering inducements and also threats of exposing past misdemeanors. So while in general the banking community did a great job, there were elements who colluded with the black moneyed brigade to help launder their ill gotten wealth.

Interestingly though, all this has meant that much of the money in circulation is now with the banks. This gives the government an enormous handle, as long as it has the intent and boldness to follow though with things in a logical manner.

How will this get done? Wait for my next post to read about it.

Currency ban objections – too clever by half

So we are now coming down to the nub of the issue. A lot of political parties are trying to get together, no doubt supported by their patrons who have a huge vested interest in this. They have been coming out with a lot of ingenuous arguments as to why the move to ban the currency notes was a bad idea, even demanding for the roll back of the measure, as is their wont. In the last post, I received several comments and responded to a few. I think it will be easier to respond to the comments and other objections all in one place.

  • The fake currency being used for terror and other activities is “only” to the extent of 400 crores so it can be tackled through other means.
    • Are you not able to comprehend the damage that can be wrought to our country with that kind of cash?
    • The figure may or may not be right but, even if it is, what is there to stop people who have counterfeiting machines to simply print more?
    • Most people are unable to see the impact of the existing notes becoming inoperative. Think of all the terror operations being stymied as the system is suddenly dried up of the lubricant it thrives on.
    • It may not be a coincidence then that the news of terrorist operations from the Kashmir valley have really come down in the last week.
  • What is the point of banning 1000 Re note and introducing 2000 Re note?
    • You have not understood the purpose of the scheme at all if you are asking this.
    • The idea is to clean up the unaccounted money supply in the system. People who are having it will either have to use it ( no time to do that ) or deposit it in the bank, where it can now be tracked.
    • The 2000 Re note is a logical step as it is mighty inconvenient to deal with smaller denominations, given the inflation we have had in recent years.
    • Yes there is a possibility of new black money schemes ( people are crooked and clever after all ) but it will have to be from scratch now and in one fell swoop, years of accumulated black money has been dealt a body blow.
    • Similarly the 2000 Re note can also be subjected to counterfeiting but all that will take time and the authorities will be way more prepared now.
  • BJP has done it only because state assembly elections are coming up.
    • I am happy to see that political parties are at least accepting the link between elections and black money.
    • Is the argument that we allow black money to continue playing a role in the Indian elections?
    • Are the opposition parties scared that without the power of black money behind them, they have little or no chances in the upcoming assembly elections?
  • The scheme will not earn much taxes etc as people will not declare black money.
    • Once again this is not the purpose of the scheme. Whether the people declare it or not, the cash will be taken out of the system.
    • People were given a chance to come clean through IDS, those who have made a conscious choice not to do so deserve no more leniency.
    • After the deposits are done the IT authorities will definitely take up the suspicious cases. I foresee a lot of taxes being collected through this.
  • Common people are being harassed.
    • The implementation has had several bottlenecks and money supply through ATM and banks should have been handled better.
    • However, for most poor people an exchange of 4000 Rs is adequate as is the withdrawal limit of 2500 Rs per day now.
    • People getting inconvenienced in weddings and functions for lack of cash, can really start paying through checks and direct transfers.
    • The reason for using cash is not really that people only take cash – it is because people with black money want to keep their transactions out of the system by not having any recorded financial transactions.
  • There is very little black money in the system so this will have little impact.
    • Look at pictures of money in sacks and drains, 44 lacs being anonymously being donated to temples, 10 lacs of air tickets being bought etc.
    • Money laundering is the most searched term in Quora in the last week.
    • In a Bengal village an impoverished old lady has deposited more than a crore in her account which had no money earlier.
    • Make no mistake, the people who are intended to be hit by this are suffering greatly. They will do everything possible to thwart the move but the game has changed for them.
  • Many businesses and the stock markets will be affected adversely.
    • I think this may well be true in the short run but does it matter really? Are you going to support black money just so that your investments do not take a temporary hit?
    • Over time, businesses in India such as Real Estate which have for all skewed due to presence of black money will clean itself up and do well in a legitimate way.
    • Respect for India will increase due to this bold measure and that will ensure that our businesses and markets do well in the medium and long term.
  • India depends on cash, cashless transactions will not work here.
    • Again, in case you have not understood this scheme is not talking about cash less transactions at all. 
    • You may need to rethink – same was said about mobile phones a decade back and look at where we are.
    • Once smartphones are available with the right kind of pricing for data plans we will see a surge in cashless transactions. It will happen faster than we can imagine today.

I am sure there are many others but I suppose the point is made. This is a great step for India, many other mechanisms are needed to eradicate black money completely. Do not fall into the trap of wily politicians who are today really cornered about their ill gotten wealth as well as their situation in being unable to influence elections through cash and liquor as they have done in the past.

If we fall for their shenanigans then the fault is really with us.

My take on the high denomination note ban

There are few things in Indian governance and administration that come as a complete surprise and the banning of the high denomination notes was definitely one of the rare examples. Irrespective of which end of the political spectrum we support and whether we agree with the merits of the move, it will have to be said that the speech by the PM on 8th November took the whole nation by storm. The impact has been such that most people affected by it have been shell shocked and ended up behaving rather irrationally.

How do I see it? Well, I personally think it is a great move. Consider the facts – only 3 % of the Indian population pay any kind of income tax. Even out of this meager number, the majority pay taxes of less than 1 lac every year. Any logical person should be able to see that this is an absurd situation. In reality, only the people who are absolutely unable to evade paying taxes, namely the salaried class end up paying it and almost everyone else avoid it to some extent or the other. The amount of undeclared income in the system is not only creating huge fiscal losses to the exchequer but also resulted in a parallel cash economy where almost 25 % of our GDP is unrecorded.

The first thing to understand clearly is that we are talking about undisclosed income by cash dealing, not about whether one can take cash or spend in it. For example, if a Doctor takes cash from his patients in a rural area and then declares it as his income and pays taxes on it, there is absolutely no problem. However, we all know that most people who receive large amounts of cash either do not report it at all or under-report it to a large extent. If the number of people living in the urban centers were really earning less than the permissible tax exempt income then the living standards we see around us in these places would be significantly lower. Elections and political parties almost exclusively deal in cash and all parties are guilty of this.

The second thing to understand here are the ills of the system :-

  • The obvious one is less money available to the government for carrying out a lot of development work that the country is badly in need of.
  • Such income streams are clearly inflationary as there is too much unaccounted money in the system chasing too few goods that are available.
  • The real estate sector prices have reached astronomical levels and a big contributing factor has been unaccounted and undeclared money availability with buyers.
  • Even people who are honest about paying taxes are also guilty of one or many of the following practices:
    • Paying for services in cash with the hope of a cheaper rate.
    • Not reporting interest income in their annual returns.
    • Not showing rental income partly or fully.
    • Not reporting capital gains in the right fashion.

The third is to understand that our society is already unequal in terms of income and spending ability and this has only accentuated it over the years. The vulgar display of wealth in weddings, the bribes demanded for almost getting anything done and the compromise of the moral fiber resulting in widespread corruption can all be traced back to the dealings in cash. If unaccounted cash was not an acceptable option, all this will not go away completely but there will definitely be a great reduction to the perverse extent we are facing today in such situations.

I went around a bit and checked with a few people I know, in real life and through the blog to see why there is so much panic in the system. Here are some real life examples :-

  • An Uber driver earning 50,000 on an average per month – never paid taxes.
  • A local milk booth earning more than 1 lac per month in profits – never paid taxes.
  • A Doctor who had more than 15 lacs in unaccounted cash. When I asked him why he had not taken advantage of IDS, he told me he was saving it for buying an apartment.
  • A CA friend who has been inundated with offers of sharing black money if he could help in conversion to white.
  • Some friends of my son, whose fathers are in business, were worried as soon as the speech was made. Clearly shows their awareness about how much cash is at home !!

As they say, the road to hell is paved with good intentions and, despite the good intent, the implementation could have been much better managed. The non-availability of the new 500 Rupee note has been the greatest dampener as the ATM money is getting over soon and replenishing it takes too long. Also, the verification could have been just on the basis of Adhaar card, both for deposits and withdrawal. The general public has been put into serious inconvenience and the poor with little experience with banking system have been really the worst affected.

However, with the release of the new 500 Rupee note and the initial rush being over the situation will now become a lot better. I think in another couple of weeks, things will be back to normal. The impact of the aftermath would have been several times worth the inconvenience that many of us have gone through.

So what are the likely impacts of this move? Let me address that in the next post.

Short term politics will affect our markets

In all parts of the world the link between politics and economy is a strong one, more so in a country like Indis where the direction of the economy is often determined by the political ideology the ruling dispensation has. Fortunately, in the last 20 years or so economic policies have not really changed directions too much, even though political alignments and power have changed a few times in the country. However, post the BJP coming into power in 2014 this implicit cooperation that political parties had on economic policies seems to have broken down.

Let me try and explain what I mean by that. In the past you would have expected a serious battle on something like the Land acquisition bill as it involves an ideological issue where both the BJP and opposition have very different viewpoints. GST is a different matter – in this the expectation was for the main parties to collaborate as the benefits were significant for all concerned. This has clearly not happened as the long drawn out blockade of any legislative business in the Rajya Sabha has meant there is no real movement on this front. The impact of this and a few other bills not moving through is serious as the land reforms and labor reforms along with GST were seen as crucial pre-requisites to change the face of the country and propel it to a different league as far as ease of doing business is concerned.

Why has this happened – it is a complex situation but the core explanation is a simple one. The opposition and mainly the Congress party are really worried that BJP and mainly Modi will get into an unassailable strong position once some of the policies start reflecting the results on the ground. This has already happened in the area of foreign relations, where the stature of India today is a hugely improved one. Once the investments happen into the country as committed in the many agreements signed, the economic situation in India will change dramatically and this will start benefiting most people across all classes of our society. This will clearly be a death blow to parties like the Congress, SP, BSP, RJD etc who are more into the politics of caste, creed, religion and poverty. As these parties now have an existential dilemma they will fight tooth and nail to oppose anything that may have even a remote chance of putting the BJP in a good light. The battle lines therefore are well and truly drawn.

With this background let us see what are the events that are likely to unfold in the near future:-

  • The most important event this quarter is the elections in Bihar. In it’s desperation, the opposition has come together forgetting all their ideological differences to somehow stop the BJP. If this succeeds then they will get fresh wind in their sails and keep blocking legislation in the Rajya Sabha.
  • On the other hand if BJP wins, the opposition is likely to turn cooperative out of necessity as they will see their obstructionist attitude is not benefiting them at all in the hustings. Under this situation it is very likely that all legislation that is blocked today, will get passed in the winter session of parliament.
  • The markets are already anticipating good Q3 and Q4 results and some of the other indications on Inflation, IIP numbers etc are already indicating optimism. A win for BJP in Bihar will bolster the investor sentiments greatly and quite possibly even the FII money, which is lately leaving the markets might return.
  • Along with this, if the winter session of parliament goes well from the perspective of passing the blocked bills, the positive optimism will be enhanced.
  • Assuming that the results of Q2 show good earning growth, the Nifty can run up to 8500 on news of a suitable election result and probably much further on the parliament outcome as well as Q3 results.
  • On the other hand if none of this happens, it is very likely that the Nifty will be range bound with 8000 being the base around which it may oscillate over 250 odd points in either direction.

What should you do as an investor? Keep adding to your equity positions both in stocks and MF. Due to the prevalent uncertainty there will be several buying opportunities that the markets will present and you must utilize these. Follow the sound principles of buying in small lots, always keeping some cash in hand and buying through price triggers. Investments made at these times will bear fruit in the next couple of years, so we are not really talking long term here.

We can all hope that some day politics will become irrelevant to the economic growth but India will take some time to get there yet.