Demonetisation: We are seeing costs without seeing benefits, says Gita Gopinath

Q: At the end of 40 days what we have is that of the Rs 15.5 trillion notes in value about Rs 12.5-13 trillion has comeback. Does it look like an exercise in futility if it was intended to catch black money?

A: I am in favour of the principle of moving to a low cash usage economy. The harder thing to swallow is this rather dramatic overnight making 86 percent of the currency in circulation illegal tender -- now the argument was that this is one way to get the hoarders, because they would have a harder time recycling their money, but clearly that not been the case the people are fairly imaginative and they found very creative way to bringing the money back in, so I say exposed it does feel like exposed, we have seen a lot of the cost without any of the benefits of doing this in a shock and awe manner.

Q: This had to be done in a shock and awe manner obviously, it couldn't have been leaked. Are you amazed at the level of corruption both among the tax evaders and even some members of the banking system? The opinion from outside was that probably a large part of the tax authorities are not very uncorrupt are corrupt and therefore the prime minister chose to attack through the banking system, but that is not looking very good either?

A: To come back to your point whether this have to be shock and awe that I am less sympathetic to because I think there was ways of putting this in gradually -- I mean all of the money would have comeback in the banking system in the exact same way, but it would have been far less disruptive.

Q: It was about Rs 8 trillion of Rs 500 notes, Reserve Bank sources told us that 30 percent of that was not coming back to the banking system, so they thought that was hoarded cash and of the Rs 1000 note which in value was about Rs 6.2 trillion as of March, maybe Rs 6.5 trillion as of September 60 percent of that was not coming back, so probably hoarded cash. Would it have been wiser to only stick to Rs 1,000 maybe it would have a better chance of success and less disruption?

A: I do think that having started out with only Rs 1000 notes, if it had to be done in this particular or the surgical strike way - I mean starting with Rs 1000 note would have been the right thing. I think getting rid of Rs 500 notes and introducing Rs 2000 note that is much harder to transact with clearly wasn't the best of strategy.

Q: So what led to its bumbling along probably was the currency printing in lack of capacity you think, where would you put your finger in terms of its poor execution?

A: I don't think it is surprised that it takes long to print currency when you take 86 percent of the currency out of circulation, it would take you a while 8 months to a year to print that whole thing and if you decided not to wait that long and go faster than you are going to be stuck with very little.

I mean the expectation that people will very quickly switch to cashless ways of transacting maybe that was a bit too much of over optimism about that and secondly there was over optimism of how much the money would stay out and we truly be kind of burnt cash, which it hasn't been the case.

Q: What's your estimate of the short term hiccup and how short is the short term?

A: I don't want to a put a number on it right now it is very hard, because a lot of this is happening in formal economy and our estimates of the informal economy are at best guesstimates - so it is kind of hard to say, we don't measure it very well. I don't have a number to give you, but there is a lot of the indicators that are pointing towards a reduction in demand in the economy and 1 percentage point decline would not be surprising of GDP.

Q: As you said, if you are taking out 85 percent of the economy it is reasonable to assume that it will take 6-8 months to print that much amount of cash, so are we looking at another quarter of crunch in demand?

A: It seems like that, it doesn't seem like the cash crunch will end anytime soon. It is going to take a while -- the hope is that people would have move to non-cash forms of payment but that might be a bit overambitious in expecting a little too much and the cash crunch will stay for a little while longer for sure.

Q: The Reserve Bank's estimate was about 15 basis points of shaving off of the GDP is that estimation you would agree with?

A: I find it hard I suspect that there are pretty large standard errors around those estimates, so that might be an upper end in terms of optimism.

Q: What is the international view? Does this give the rupee a knock, we had ambitions because of the stability of the rupee that eventually it will be little more internationally accepted -- we launched a masala bond after all rupee denominated bonds globally. Is all that process going to get a knock?

A: The initial reaction internationally was that it is a good thing that India is trying to move towards a cashless economy. It is a good thing that they are trying catch tax evaders, but the whole execution and the fact that there was not enough cash printed in advance has basically kind of brought into a lot of questionable chaos, who is running the show here and what the policy, how well was it thought out of. The current narrative is now that it is not so much about tax evasion and black money, but it is about going towards a digital cashless economy and that could have been accomplished in a much far less costly manner without having done the demonetisation, but doing all the incentive mechanism that the government is trying to put in place now.

The initial reaction was that this is certainly a pretty bold move - - I think the execution in the implementation putting pause on appreciating what is going on here.

Q: You are an adviser to the state of Kerala, are you getting a sense that this is going to probably erode or at least fray the fledgling cooperation we saw between centres and states on goods and services tax (GST)?

A: Certainly, this is complicated with especially in Kerala where cooperative banks play very important role -- cooperative banks in general cater to rural demand, which a lot of the standard commercial banks don't and they have taken a hit, so this is being costly. There is going to be a lot of pain for a lot of people who are in rural areas who are not connected to banks and ATMs and so yes there could be a bit of a trust deficit there.

Q: You are intermittently connected as an adviser to one state government, but even otherwise as a long watcher of the Indian economy. Do you think that we are going to lose out on the 7 percent growth not just this year, but maybe the impact is going to stretch to next year?

A: It is going to depend upon how quickly they are able to put the cash out -- this is the thing that I am less certain about. I had anticipated they would have been better prepared when they rolled out the plan, so I am a bit surprised by how much of a deficit it has been in terms of cash. It is going to depend upon how that plays out and I would not be surprised if this thing lasted at least couple of quarters.

Q: Let me to come you what can pump up the economy, the two familiar weapons or monetary measures and fiscal measures, do you think the Reserve Bank has space considering that we are also having Federal Reserve that started to raise rates?

A: Yes, I think there wasn't this demonetisation that had happened in India -- India was certainly viewed as amongst the most stable of the emerging market. Right now there is a little more apprehension about what going on here and so India got hit just as badly as lot of the other emerging market with this expectation the Fed raising rates -- with the Trump victory and what is going to happen to fiscal spending there and what is going to happen to interest rates over there.

That is something that RBI Governor will obviously worry about, because they certainly don't want the rupee to depreciate too much. There are all these additional concerns that have now come up along with the demonetisation.

Q: What about fiscal spending in that case, initially there was a hope that whatever notes didn't comeback would be cancelled liabilities in the Reserve Bank' balance sheet and that could be gifted to government as a dividend, but the RBI Governor put paid to that expectation at least legally. Your thoughts on fiscal pump priming this time around?

A: With the expected decline in GDP growth rate that obviously going to have an effect on their revenue collection. There is some expectation that some of the money that they recover from the tax evades would helped, but I don't see a source of big revenue for the government that they have access with which they can use to stimulate the economy and it would be rather conclave set of policy that you demonetise and then have to do a fiscal expansion. I am not optimistic about that.

Q: The original plan was to bring the fiscal deficit down from 3.5 percent to 3 percent for FY18, for FY17 the number is 3.5 percent. If the government were to renege on it in some fashion or take liberties, how would that is perceived by the financial community and by the global community?

A: If it is a small variation of 10 or 15 basis points -- the markets would be sympathetic because the big picture is that everybody does look to India as one of the emerging market that has good growth potential, that is one of the emerging market where the government is reformed minded. It does have that going for it, but it does have a breakaway with 50 basis point difference then I think that would be viewed with more suspicion.Q: I have a couple of questions on the behavioural and institutional side of economics. How might tax evaders behave? After such a shock and awe treatment, do you expect that people would think it is pointless going through this trouble of trying to evade tax? As well, there is the goods and services tax (GST) on us. Do you think you are going to see better tax compliance in the years to come?A: I was hopeful with the GST. GST is the good forcing mechanism to pay taxes. So, that for me, was a good policy intervention that was going to work. I do not know about the demonetisation part of things. Sure, there is going to be at least for the short term there is going to be a negative incentive to hold cash because you are concerned over what the government can do. The government has certainly very strongly signalled that it is going to go after tax evaders. So, that gives it another reason for people to put paws on it. But as long as the income tax rates are what they are, the corporate tax rates are what they are, people will find ways of trying to evade taxes. GST, for me is a much better way of making sure compliances happens.Q: Our attitude to the banking system has changed. We were amazed by the amount of work bankers put in. But in the past few days, we are also amazed by the few bad eggs that have rendered the policy toothless. What is your sense of how banks will come out, out of this. They were just recovering from the downturn and the non-performing asset (NPA) issues. How might the bankers come out of this?A: What the banks now have is certainly a lot more funding. They have got the deposits, but that is obviously not enough. The problem was they had bad assets, they had to get a way to solve that problem. And all this money that is sitting that is now come in to them. They have to find ways of investing it. Given that investment is not really recovering that much in India, we are still quite weak. I do not know where the sources of high revenue for the banks will come by. You have to have good projects to invest in to make this all work out really well.Q: Also worried about the psychological impact of bankers, of investigation. Do you think that might also crimp lending?A: It is happening, but it is obviously not widespread enough that people are going to worry about that particular phenomenon. I am reading in the press about some people being caught for this. I would not put too much weight on that particular factor as being a dampening one for the banks.Q: Let me come to what the Fed did in terms of the rate hike and what was mentioned in terms of slightly better than expected economic growth as well as slightly lower than expected unemployment. This rate hike, there, does it look at all like Greenspan saying accommodation will be removed at a modest pace? Does it look like ringing in good times?A: The Fed is very sensitive to the indicators. So, it is going to follow very closely what is happening to inflation. It is going to follow very closely what is happening to employment. There is a huge amount of uncertainty in the US. It has been a long time since we have had that kind of uncertainty in the US. With the new administration, it is very unclear what policies are going to be put in place, or policies are going to be removed. So, I think they are going to take a fairly cautious approach.Q: How do you see 2017? For the global economy, is it a better year in terms of economic growth? Emerging markets, China, US?A: It is a mixed bag. I would say that the US is right now in a fairly strong place. But huge amounts of uncertainty again coming in with what is going to happen with a Trump administration. China is the one place I do worry about. China, the sources of growth look less than promising and there are lots of concerns with the debt problems. Other emerging markets, with commodity prices turning around, there is a prospect of recovery, but I do not see any big green shoots at this point. So, it is not looking like this is going to – I do not get the sense that there is going to be a huge turnaround anywhere. The Euro area still has its problems, Japan still has its problems. So, probably the brightest spot at this point in advanced economies is the US. But again there, there is a fair amount of uncertainty.Q: What do you expect from ‘Trumponomics’? Are you expecting fiscal spending and therefore an improvement in growth?A: We certainly are. If they actually follow through on the policies, then it would be a fiscal expansion of a kind that has not been seen in many years in the US. It will be both cutting tax rates and increasing spending. And that would be a big fiscal boost. I do not know if that is what is needed at this time. Certainly, there has always been a need for infrastructure investment. But the Trump policy and the way they are actually going to make that happen is through tax credits and so, I would not be surprised by a fiscal expansion that adds a few more points to the US growth rates. I am just more concerned about what that all translates to in the long run.Q: We spoke about the global economy. What about global markets? Last time around, when the Fed raised rates, in December, 2015, there was almost 40 days of instability in January and February with the Chinese devaluation. Will there be any follow through of financial instability in 2017 for whatever reason?A: Oh yes, we can take that as a given right now that there will probably be financial instability given that there are still many parts of the world that are reeling from low growth and high debt. There is a lots of bad news that may come out of Italy. There is lot of bad news that may come out of China. How that plays back into the US and what they want to do with interest rates, what is going to happen with the Trump administration. I am totally expecting to see tantrums of different kinds.Q: How does India look like in 2017 as an economy? Better than 2016? Much better than 2016?A: I am hopeful that with the GST, that would be a good transformative event for India. I do not have a sense of saying that this is going to be much better for the reason that again, it has been two and a half years where we have not seen investment recover and we are not seeing it happen. And there is nothing that gives me the sense that that is going to change anytime soon.