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A hasty rush to judgement on demonetisation

LiveMint logoLiveMint 19-06-2017 V. Anantha Nageswaran

R. Jagannathan, the editor of Swarajya, has passed his verdict on the government’s note ban exercise announced on 8 November, 2016. He has concluded that it has failed. He is being premature. The nature of the exercise was such that the costs would be upfront and the benefits would diffuse over time. Indeed, it isn’t easy to quantify the benefits. Therefore, a definitive judgement on an exercise such as this was impossible. But human nature is such that it wants closure, one way or the other, to move on. So, a verdict has been passed.

In passing the verdict, Jagannathan has relied heavily on an article written by Harish Damodaran in The Indian Express. The article documents pervasive distressed price realization by farmers. The note ban hurt agricultural traders who were used to dealing in cash and they could not provide a market for farm produce. Even after new currency notes were issued, they remained cautious about dealing in cash, and hence, were unwilling to go back to their old ways. As a result, farmers did not have a market for their produce and prices have crashed. Farmer distress has gone national, as has the demand for waiving loans given to farmers. The resulting fiscal burden on states is a cost of the note ban exercise.

Damodaran does not provide evidence that the lack of cash and the reluctance to go back to cash as the medium of exchange were the forces at work. But he makes a good case for cash withdrawal being the cause of farmer distress. Is it necessarily bad? The old method of doing business has been disrupted. The government probably was too optimistic in expecting e-markets to substitute for old intermediaries. Hence, the pain has been felt this season.

It is a price to pay for a structural transformation of the economy. If both producers and buyers resort to transacting through banking channels next year and if that continues well into the future, would we still count the net benefits of the note ban exercise as negligible? How correct are we in overweighting near-term evidence disproportionately and in rendering judgement based on decisions whose horizons are rather long?

Damodaran then goes on to question whether poor price realizations for farmers would be a permanent feature since the Reserve Bank of India (RBI) has a formal inflation target now. Before a formal inflation target was adopted, the RBI was aiming at an unofficial inflation rate of 5%. Therefore, 4% is not too different from that. Second, one would not or should not expect the weight of food items in the consumption basket to remain as high as they are now. Third, even if they remain at 45% and if the inflation rate on them is, say, 8%, prices in the non-farm components can still rise at around 2% per annum or lower and the overall inflation rate would be contained at 4-4.5%. The answers are productivity, competition and scale in the non-farm economy. The presumption that India has permanently harmed its farming community with the inflation-targeting regime is unnecessary.

Instead, let us think harder about the financial sustainability of the various interventions in favour of farmers. State electricity boards are in the red, in large part, because of free power to farmers. Now, states are again going to bear the cost of loan waivers. Water tables are down because of excessive withdrawal of underground water thanks to free power for motors and pump sets. India overproduces wheat and rice thanks to generous price support over the years. They are water-inefficient crops. Farmers’ incomes are not taxed. Land holdings, far from consolidating, are fragmenting further.

One way or the other, it appears that the non-farm economy is paying for the produce generated by the country’s inefficiently organized farming. It is not sensible for farmers and governments to maintain it in its current state.

In short, the failure of the government lies not in the note ban exercise but in the failure to grapple seriously with the inefficiencies that inhere in the Indian way of farming. As for the note ban exercise, it failed to anticipate the collateral damage and was risk averse in its design of tax amnesty schemes. It probably should have restructured public sector banks before announcing the note ban since they largely undermined the government’s intent and goals of trapping unaccounted cash. Its caution and lack of imagination showed in the budget for 2017-18. The risk-averse mindset stopped the government from following through on its promise to reduce corporate taxes and simplify them. The same malady has resulted in a complex goods and services tax rate structure, especially for services, and it was the culprit in the high price that the government set for spectrum.


Above all, the government underestimated the economic mess it inherited in 2014 and/or backed itself too much to resolve them. It believed in the 7% growth rates that the Central Statistical Office put out just as the Congress believed that the economy grew 6.5% in 2013-14. Bad data, and hence, bad decisions. It has lost the momentum it generated after the victory in the Uttar Pradesh election.

The Prime Minister must reshuffle his cabinet with some visible changes, announce big-ticket privatizations, close a few high-profile cases of non-performing assets, consolidate some public sector banks, recapitalize some others and announce direct tax reform measures. The government has to restore a positive economic narrative.

V. Anantha Nageswaran is senior adjunct fellow (geoeconomics studies) at Gateway House: Indian Council on Global Relations, Mumbai. These are his personal views.

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