NEW DELHI—Three years after Prime Minister Narendra Modi forcibly implemented demonetisation, the Indian economy has entered a full-blown recession, said economics professor Arun Kumar, widely considered to be an authority on black money in India. The controversial decision, announced in a surprise speech by Modi in November 2016, affected the unorganised sector so adversely that the overall Indian economy is not growing any more, he said in an interview.
Kumar, who has been researching on black money in India for the past four decades, also said that far from addressing the problem of black money, demonetisation created new avenues for earning “black incomes”.
“Some people were taking their own notes and converting into new notes and generating fresh black income,” he said.
An economy is said to be under recession if it registers negative growth for two consecutive quarters. In Kumar’s view, India has been under a recession for three years. But it was not visible thus far because the organised sector was growing at 7% or thereabouts so the government could claim India was the fastest growing big economy, he said.
But now that the unorganised sector’s woes, which began with demonetisation, have hit the organised sector as well, the overall Indian economy is in a negative rate of growth.
“You have a negative rate of growth at the moment rather than a positive rate of growth. So it’s not 4.5% or 5% or 5.8%, it’s -1%,” he said.
The former JNU professor said that the effect of demonetisation on the unorganised sector is continuing to play out even today.
Kumar, who currently teaches at the Institute of Social Sciences in New Delhi, said the current state of the economy is being called a “slowdown” because people look only at the official government figures about the growth of the Gross Domestic Product, which capture data only for the relatively better-off organised sector.
“If you take the unorganised sector into account, our rate of growth became negative during that period of demonetisation and for months after that. And it has remained zero or negative right through. If you take only the organised sector into account, then there is a slowdown. But if you take the unorganised plus organised sector into account and look at alternate data, then we have been in a recession for the last three years, not a slowdown,” he said.
The Malcolm S. Adiseshiah Chair Professor also said finance minister Nirmala Sitharaman’s announcement last week of a multi-crore package for the real estate sector will neither help the sector nor the economy emerge from its core problems. Announcing one package after another, as the finance ministry has been doing, shows “panic”, he added.
Edited excerpts from an interview:
It is now three years since Prime Minister Narendra Modi announced demonetisation. In your book Demonetisation and Black Economy, you write that “Demonetisation is one of the most important economic events in the country, not only of 2016-17, but possibly of the last two decades, even though other momentous events have taken place...its implications are playing themselves out even now and will continue to impact the economy for some time”. You wrote this in 2017. How do you look back at the event in November 2019? Does it have any impact at present on the economy?
So, you know, what is demonetisation? It means that your currency, the high-denomination currency notes, it stopped being legal tender from November 8, 2016 midnight.
Now, what is the role of cash? Role of cash is to circulate incomes. I buy something from you so I give you cash, and I get goods or services in return. You pay that as salary or you purchase something; so cash is only circulating incomes. Now, when cash becomes short, then circulation of incomes stops or slows down. So as I have been characterising, it’s like blood in the body. The blood in the body supplies oxygen and nutrients to all parts of the body. If blood becomes short, then the body dies. So similarly when cash becomes short, then the income generation process goes down and therefore the economy runs itself down.
And in India, we have two sectors, the organised sector and the unorganised sector. Organised sector is the big sector, it’s more formalised, it can work with banking and cheques, credit cards, debit cards, electronic transfers but the unorganised sector is very small, it does not work like that, it depends on cash. So the moment the cash shortage came, it’s the unorganised sector that got hit very badly. And unorganised sector produces 45% of the output, 94% of the workforce is there. Now when such a large workforce loses its jobs, it starts running itself down, then the demand in the economy comes down. When the demand comes down then it slows down the investment in the economy and therefore growth rate slows down. And that is exactly what happened with demonetisation.
“When cash becomes short, then the income generation process goes down and therefore the economy runs itself down.”
Unorganised sector really slowed down. All the data that was coming from private organisations like the Punjab Haryana Delhi Chamber of Commerce and Industry, the State Bank of India, all that showed that the unorganised sector declined dramatically. And therefore, the rate of growth of the economy also declined. The rate of investment, as per CMIE data, became half of the average of the preceding eight quarters. From Rs 2.5 lakh crore average it became Rs 1.36 lakh crore.
The demand for MGNREGA shot up. The reason is that people went back from urban areas to rural areas because they didn’t have work in urban areas and therefore, they went back and demanded work under the MGNREGA scheme. So the budgetary allocation shot up and that has not yet come down. That has continued to grow. From Rs 38,000 crore it went to Rs 47,000 crore to Rs 55,000 crore; now it’s more than Rs 60,000 crore. The RBI data shows that the work under MGNREGA is only 45 days, not 100 days. So if full 100 days was given, then instead of Rs 60-65,000 crore, you would have been spending Rs 1.5 lakh crore, which shows that people haven’t really come back to the urban areas from the work that was lost in the small, micro sectors and so on.
So my argument was then and remains that it was the unorganised sector that unambiguously got affected, and that affected the organised sector also at that point of time. But our GDP data does not include the data for the unorganised sector separately. It assumes that the unorganised sector is growing at the same rate as the organised sector. So if the organised sector is growing at 6%, it is assumed that the unorganised sector is also growing at 6%. That was true on November 7, 2016 but not true on November 9, 2016.
So since that time, our GDP data does not represent the unorganised sector.
“...the effect of demonetisation on the unorganised sector is continuing to play itself out even today. And therefore the rate of the economy is negative, it’s not a slowdown of the economy to 5% or 4.5%.”
Now, if you take the data from the alternative sources like the MGNREGS data, like the decline in employment which the CMIE and the NSSO both have shown, the fall in the credit offtake, decline in the investment rate. You know, all that points to the fact that the rate of growth became negative at the time of demonetisation. Soon thereafter, the GST hit the unorganised sector. So even though the GST exempts the unorganised sector, it is so complicated and structurally flawed that the unorganised sector took a hit again. And then the third shock was the NBFC crisis (because) the loans from there do matter for consumption as well as for production in the unorganised sector.
So these three big shocks one after the other affected the unorganised sector adversely. And that is now affecting the organised sector also. The organised sector rate of growth has also been coming down from 8.1% six quarters back to now 5% and my guess is that this quarter, it will be less than 4.5% because the growth has continued to decline. You know, the automobile sector and other sectors are continuing to decline. So therefore the rate of growth is likely to fall even further.
So at this point again, the rate of growth is negative. Because this is only the organised sector rate of growth, it’s not the unorganised sector rate of growth. And you have evidence pointing to the fact that the unorganised sector is continuing to suffer because, like for instance last year, the pressure cooker industry chairperson Mr Jagannathan, he said, we find that units in the organised sector are growing because units in the unorganised sector are not able to cope with the demand problem. They are not able to cope with the various other problems that they face. So he says that demand has shifted from the unorganised sector to us. And similar things you will find in the textile industry, in the show industry, in other industries.
The point I am making is that the effect of demonetisation on the unorganised sector is continuing to play itself out even today. And therefore the rate of the economy is negative, it’s not a slowdown of the economy to 5% or 4.5%.
If you take the unorganised sector into account, our rate of growth became negative during that period of demonetisation and for months after that. And it has remained zero or negative right through. If you take only the organised sector into account, then there is a slowdown. But if you take the unorganised plus organised sector into account and look at alternate data, then we have been in a recession for the last three years, not a slowdown.
If I were to parse the different strands of what you said, you mentioned three different things that have adversely affected the Indian economy since 2016—demonetisation, GST and the NBFC crisis. But how much of causality can we really link back to demonetisation alone? Because these are three different processes, policy decisions or events.
So there were three shocks to the economy one after the other. But the demonetisation was the first shock and its impact has continued, even though it ended, because of the cash shortage. You know, the recovery of the economy becomes difficult unless investment rises. And investment rate has been stagnating at 30% since that time. So the investment has not risen. In that sense, what happened during demonetisation, impact on investment, output, employment, credit off-take, all that initiated the shock and we have not recovered from it.
But the absence of recovery, as you put it, can it be fully blamed on demonetisation?
So, as I said, that was the start, right? And then the shocks continued, and further aggravated the situation.
So if we were to parse separately demonetisation alone, its impact till date in 2019 November is being felt in the investment rate...
Investment rate, in the MGNREGS demand for work that means people haven’t come back, the low credit off-take that has been there in the last three years—all of these started then and have continued.
Of course, as I said, the other two shocks also contributed. But the initial shock was from there and there has been no recovery from that.
So it was the beginning of a series of shocks.
Recently I interviewed Prof. Pranab Sen. In that interview he said that demonetisation was the “initial trigger” for the current economic slowdown. Former PM Manmohan Singh also seems to agree with Mr Sen. What is your view about their assessments? Are you essentially saying the same thing in a different way?
No. I said slowdown was triggered because the rate of growth became negative. So what Manmohan is not saying, or others are not saying, is: how do you measure the unorganised sector? Manmohan Singh only talked about decline of 2% but I am saying the decline was 7% or 9% during demonetisation. Because unorganised sector is 45% of GDP.
According to Punjab Haryana Delhi Chamber of Commerce and Industry, the impact on unorganised sector was 50%. Now if 45% declines by 50% that’s -22.5%. And if you add to that the organised sector growing at, say, even 6% or 7%, that still means a -15% rate of growth. I am saying, suppose the fall was not 15%, only 10%, then also the rate of growth became negative.
So my argument is that the data for the GDP is incorrect after 9 November 2016. Because it does not take the unorganised sector into account. Now, Pronab Sen says that but doesn’t follow it up with the implications of that. Because if you are using the unorganised sector data as being the organised sector data then your data is incorrect. Because all evidence says the unorganised sector got hit disproportionately more. So while the organised sector may be rising, the unorganised sector is falling.
“Black means cash was one of the misperceptions because of which the government went for this step. And the public also thought something positive is being done on this score. This was a complete misperception on the part of the government and people and that is why all cash came back in the banking system within 60 days...”
As I said, if 45% falls by 10% that’s -4.5%. And if organised sector is rising at 5%, then 55% rising at 5% is 2.7%. So therefore you have a negative rate of growth at the moment rather than a positive rate of growth. So it’s not 4.5% or 5% or 5.8%, it’s -1%.
All of it tracing back to the demonetisation decision?
It started there but it has continued because of these additional shocks. So in that sense, what Manmohan Singh or Pronab Sen are saying is not really the complete picture.
Unorganised sector data has to be taken into account because you can’t say that we will continue to use the GDP data because the government is not correcting it, because it is incorrect. It is based on the incorrect assumption that the unorganised sector is rising at the same rate as the organised sector. So we have to look for alternate data and then calculate the rate of growth. There is where the problem of rate of growth exists.
In a recent interview, former chairman of the Prime Minister’s Economic Advisory Council, Surjit Bhalla, said that he still believes demonetisation was a “big bang” and important economic reform. He also said that demonetisation has nothing to do with the current economic slowdown. What do you make of these assertions?
So Mr Bhalla, when demonetisation was done, had himself argued that if he had been asked whether demonetisation should be done, he would have said it should not be done. That is what his statement was. Now whatever he says, is a different matter.
So indeed it was a very major step. It damaged the economy no end. But to say it was a positive step is a problem. Because it impacted the unorganised sector and therefore the GDP. So if we lost, say, 7% or 8% growth at that point of time, then on a Rs150 lakh crore economy, we were losing about Rs 10 lakh crore of GDP. Nothing can make up for that.
Coming to the current economic realities, data for core sector output for September shows that it has fallen to -5.2%, the lowest in 14 years according to reports. So what does this say about the ongoing economic slowdown in India’s economy?
This is an indication. Because what is the core sector? It is an input into the economy. Whether it be energy, transportation and so on.
All the data, the core sector data, the decline in Index on Industrial production—they are all pointing to the fact that we are in a recession, we are no more a growing economy for the last three years. So we have lost at least Rs 28 lakh crores worth of output in the last three years cumulatively.
That’s a mind-boggling figure.
In the budget, the government said it expected 12% rate of growth of the GDP but the economy is growing, according to official figures, at barely 7%. Therefore, instead of being Rs 211 lakh crore, which was assumed in the budget, the GDP will be something like Rs 196 lakh crore. Therefore, tax will be short. And therefore fiscal deficit will rise, and therefore they will cut back on expenditure to maintain 3.3% fiscal deficit then that would mean further decline in the economy. So it’s a bad situation whether it be taxation, expenditure by government, output or investment and employment.
“This is my problem with what the Ministry of Finance has been doing over the last three months: announcing one package after the other. First, what this shows is panic. Because they have been in denial for the last three years that the economy is in recession. They have been claiming that the economy is the fastest growing large economy in the world.”
In response to the ongoing criticism of the government from several quarters regarding the slowdown, the Finance Minister Nirmala Sitharaman announced that the cabinet approved the establishment of a ‘Special Window’ fund to provide priority debt financing for the completion of stalled housing projects that are in the Affordable and Middle-Income Housing sector. An official release said “real estate industry is intrinsically linked with several other industries, growth in this sector will have a positive effect in releasing stress in other major sectors of the Indian economy as well.” What do you make of this?
We have to see why the real estate/construction sector went into a crisis. And this crisis is not just from the time of demonetisation, it is a six-seven year old crisis because of oversupply. And why the oversupply there? Because real estate prices shot up.
This crisis that has been there in the real estate sector is because of the high land prices and high cost of housing, which the unorganised sector is not able to afford. People dependent upon the unorganised sector largely live in slums in urban areas. So this will not touch them. This is a package for the middle class and the upper middle class. And we have to admit that that’s where the problem is. But what is the problem? Problem is that there is a lot of black money in that. Therefore there is a diversion of funds by the builders and developers. And the second problem is that this business was running on what are called financiers. The financiers are ones who initially put up their money for half or three quarters of the project. Now they have withdrawn money because they see no rise. The financiers were investing for speculation. Because they have withdrawing money, that’s why the crisis is there. Second reason is the developers would transfer whatever money they collected to other projects. So the project would suffer. Now, under RERA, that can be stopped.
But the point is at these high prices, how many people would really be able to buy property? So therefore, problem really is not what they have done. Those are some of the problems, but the other problems of black, high cost of land, of transfer of money etc. Those problems need to be addressed. Then the upper middle class and middle class may be able to get their projects, construction would revive. But I think this is a long-term thing. It’s not going to address the short term problem that exists in the real estate sector.
So therefore, this is my problem with what the Ministry of Finance has been doing over the last three months: announcing one package after the other. First what this shows is panic. Because they have been in denial for the last three years that the economy is in recession. They have been claiming that the economy is the fastest growing large economy in the world. So they have been in denial and therefore they have delayed it. And the recession is deepening and it has affected the organised sector also. Once the organised sector, the corporates, started complaining then they started giving concessions. But the point is: that is not the solution.
On this note, let me ask you about the corporate tax cuts…
That is not going to increase expenditure because they consume what they consume. The problem started with the unorganised sector and you are doing very little for them. Except for the PM Kisan scheme and the pension in the unorganised sector. But when you give money to the corporates, they are not going to increase expenditures, investment they could increase but if demand is not there why would they increase investment?
So I have been giving the example that suppose Maruti can produce 100 cars but selling only 70 cars then you tell Maruti to increase capacity to 120 but sales are only 70 so its losses will increase. Because now it has spare capacity for 50 cars. So therefore, unless demand increases, and to increase demand you have to pump in purchasing power into the unorganised sector and then the increased expenditure could lead to rise in food prices and then the farmers’ incomes will rise. And then the demand will rise.
The problem is coming from demand, from lack of incomes in the unorganised sector, in the farming sector, that is what needs to be addressed.
If we had Rs 1.45 lakh crore for the corporates plus for the real estate sector, plus for the banking sector about Rs 3 lakh crores to spend, which will increase our fiscal deficit, if that had been pumped into the unorganised sector, demand would have immediately increased. But somehow the government is focused only on the organised sector and the corporate sectors, not where the problem really began.
I want to come back to the issue of demonetisation. In your book, you mention that demonetisation failed because the understanding that cash equals black money that the government as well as people at large had was wrong. Instead, you explain that black money is created through a process run by a triad of corrupt businessmen, politicians and the executive. Could you elaborate and explain this?
There are several misperceptions about black economy. One was that black equals cash. But that is not true because black works in a variety of ways. Cash is held by businesses for working capital and is held by households for their daily requirements plus for precautions etc. So all clash is not black. Only a tiny percentage of cash is really black because it is in circulation. So that’s one misperception.
Second misperception of the black economy is that all black money is held abroad. Now, if all the money is held abroad then demonetisation of the Rupee does not help. Then you have to demonetise where it is held; suppose it is held in dollars, then you have to demonetise the dollar; if it is held in the Swiss banks, you have to demonetise the Swiss Franc. But 90% of the black income generated stays here. Only 10% goes abroad and off that also, 30-40% is recycled back through round tripping. So it comes back.
There are a lot of misperceptions like these.
Black means cash was one of the misperceptions because of which the government went for this step. And the public also thought something positive is being done on this score. This was a complete misperception on the part of the government and people and that is why all cash came back in the banking system within 60 days...
But we got diverted. There was a second part to your question.
Yes, it was about the triad that helps people create black money in India.
The point is: what is the cause of generation of black income? So the cause lies in the fact that there is a black economy, which is illegal. Doctors not showing their true output, businessmen not showing the true amount of trading, factory owner not showing true amount of production. So therefore, you’re not measuring that.
So how is illegality possible on a large scale in legal activities? If I am doing smuggling, that’s completely illegal; if I am doing theft, that’s completely illegal; if I am doing sex work, that’s completely illegal.
When I commit illegality in legal sectors on a large scale, then it’s only possible if those who are a part of the state are party to it. So therefore, the policymaker, the politician, the executive, you know, the bureaucrat, the police, the judiciary, they are a part. So that’s why I say it’s a triad consisting of the corrupt businessman, the corrupt politician and the corrupt executive.
If this triad is not formed and if the policymaker says, “I’m not going to accept this kind of corruption”, then the triad will collapse. If the executive says, “We’re not going to be bound by this corruption, you’re not going to take a cut, we’re going to enforce the law strictly then also it will collapse”. If the businessman says, “We are not going to bribe anymore, we are not going to do this illegal activity”, then it will collapse. So it is this triad which is running the black economy.
It is not, as some people say, things like high tax rate or high degree of controls are reasons for corruption because controls cannot be the reason for their own violation.
In 1971 when Mrs. Gandhi was the Finance Minister, we had 97.5% tax here and the black economy then measured by the Justice Wanchoo Committee was 7%. Now, the black economy has come up to 62% but tax rate has come down to 30%. So tax rates have systematically come down for the last 50 years, black income generation has increased.
I want to move to a point you make in the book which is not as widely recognised, this is that demonetisation generated new black incomes. So that would sound to most people as a contradiction right? Because the whole point of demonetisation was to curb black economy, if not completely do away with it. So what is this new black income you talk about?
So, as I said earlier, this idea of demonetisation was based on black means cash, which is incorrect. So it is not designed to tackle the black economy at all.
But what happened was people went to the banks and changed their old notes in collusion with the bankers and the police and RBI, and some of them were even arrested. During that period, raids were being held, where large sums of new cash were caught with other people. So, this is why I said, the new black income generation, because the 1000 rupee and 500 rupee were going at 30% discount.
That means some people were taking their own notes and converting into new notes and generating fresh black income. Then there were many businessmen who had shown cash in hand especially in real estate. And they converted again at 30% discount and then because they had cash in hand, they needed the old notes.
So, in the last 15 days there was a premium on the 1000 rupee note. So the 1000 rupee note earlier was going for 700 then started going for 1300. So, that was another black income generation process that was taking place.
In the book, you take a detailed look at demonetisations held in other countries over the past one century and more. One clear conclusion you arrive at is that India is probably the only nation state which had an unplanned demonetisation and now it is a case study for economists the world over. So, the sense I got from what you wrote there is that you would have preferred a well-planned demonetisation. It’s not as if you are opposed to the idea of demonetisation per se.
It’s very clear that I don’t think demonetisation solved the problems that the Prime Minister attacked. Demonetisation wasn’t called for, it damaged the unorganised sector so it damaged the economy as a whole. So demonetisation doesn’t solve problems, but creates additional problems...
Now if the note shortage was not there, and if you had done replacement of the old currency with the new currency, then there would not have been a problem. I gave the example of the Euro. it was introduced to replace the Mark in Germany and Franc in France, among others, and conversation was done over three years. And for five years after that, you could change your currency in Germany. It was planned. So there was no problem, no shortage of currency.
In other countries where demonetisation was introduced, it was done either with full preparation or there was a crisis, the local currency had collapsed. Like Ruble in Russia, Mark in Germany after the Second World War. In India we had no crisis like that. Therefore, it becomes a case study.
So you are saying if the Prime Minister was intent on doing it, he should have planned it and done it.
Planned it in terms of he should have had enough of new currency to replace the old currency so there would have been no cash shortage. If you wanted to do that in secrecy, then you should have got the RBI to print the notes and change the ATMs so that the new currency could fit into them, have the new trays ready etc.
When there is hyper-inflation, war, economic crisis, there you need to do demonetisation but not in a well functioning economy. Therefore it cannot be the silver bullet that it was thought to be. You need to have movements against black economy, strengthen your democracy, strengthen your accountability—that is what is needed.