In his article (“Making of a mammoth tragedy”, The Hindu, December 9), Dr. Manmohan Singh attacked the demonetisation of high denomination notes (HDNs) by the National Democratic Alliance (NDA) government as the “making of a mammoth tragedy”. In his prose, Dr. Singh speaks less as an economist in which capacity he is respected more than as the former Prime Minister, the role which has actually dented his image. Yet it is best to respond to him on economic issues which he has kept away from, not to his political verses. Undisputed facts, not alluring rhetoric, should decide whether demonetisation is a tragedy or a remedy. Is it a monumental mismanagement of the economy as Dr. Singh charges? Or is it a remedy for the accumulated filth as Prime Minister Narendra Modi claims? To know the answer, the story of the Indian economy from 1999 to 2004 under the NDA and from 2004 to 2014 under the United Progressive Alliance (UPA) needs to be recalled.
Real versus statistic
During the NDA rule (1999-2004), real GDP grew by 27.8 per cent, annually 5.5 percentage points. Annual money supply, that fuels inflation, by 15.3 per cent. Prices by 23 per cent, annually 4.6 per cent. Asset prices rose only moderately in those five years. Stocks rose by 32 per cent; gold by 38 per cent. Taking Chennai as an illustration, land prices by 32 per cent. Jobs rose phenomenally, by almost 60 million. The NDA also turned in a surplus of $20 billion in 2002-04 in the external sector, after decades of unending deficits, save in two years in the late 1970s.
Now come to the UPA rule under Dr. Singh, the economist Prime Minister. In the first and best six years of the UPA (2004-05 to 2009-10), before it was hit by scams, real GDP grew by 50.8 per cent, annually 8.4 percentage points — one-and-a-half times NDA’s. The world celebrated Dr. Singh. The UPA was intoxicated by the “high growth” story. But how many jobs did UPA’s high growth produce? Believe it or not, just 27 lakhs against 600 lakhs during NDA’s five years, according to NSSO data. UPA achieved one-and-a-half times NDA’s GDP growth, but just 5 per cent of its job growth. Dr. Singh now bemoans that Mr. Modi’s demonetisation will stifle jobs!
Move on. In the six years, prices rose by 6.5 per cent (4.6 per cent under NDA). The external sector deficit was $100 billion (against NDA’s $20 billion surplus). Did high petroleum prices force it? No. Zero-rated customs duty-led capital goods imports which topped petroleum imports was the culprit.
Why was the UPA’s high growth jobless? The well-kept secret is that huge asset price inflation, not production, passed off as high growth. In the first six years of the UPA, stock and gold prices jumped by three times — annually by 60 per cent. Property prices doubled every two-three years. In Gurgaon, not on the property map in 1999, land prices rose by 10-20 times. Asset inflation in six years was three times the annual nominal GDP growth. The asset inflation not the result but the cause of the UPA’s “high growth”! How? Modern economics deducts the non-asset price inflation from nominal growth to know the real growth. But it sees asset price rise as wealth and prosperity and adds it to GDP. See how this economics worked for the UPA.
Unmonitored Rs.500/1,000 notes
Economics says money, growth, prices and jobs are inter-related. Apply this rule to the NDA and UPA periods. During 2004-10, average money supply grew annually 18 per cent (15.3 per cent under the NDA). But asset prices rose by several multiples of it. The moderate rise in money supply over the NDA’s number does not explain the huge asset inflation. The clue hides in the rising unmonitored HDN cash stock with the public which made black money deals easy. In 1999, the cash with the public was 9.4 per cent of nominal GDP. By 2007-08, instead of falling due to rising bank and digital payments, it jumped to 13 per cent of nominal GDP. Later it began hovering around 12 per cent. More critically, the HDNs with the public more than doubled from 34 per cent in 2004 to 79 per cent in 2010. On November 8, 2016, it was 87 per cent. The average annual rise in HDNs was 51 per cent between 2004 and 2010 and the annual rise was 63 per cent by 2013-14. The Reserve Bank of India noted that two-thirds of the Rs.1,000 notes and one-third of the Rs.500 notes — that is over Rs. 6 lakh crore now — never returned to banks after they were issued. The unmonitored HDNs roaming outside banks began driving up the gold and land prices by black cash and the stock prices through Participatory Notes (PNs) — which are largely hawala transfers out of India — that came back pretending as foreign investment in stocks. The PNs rose from Rs.68,000 crore in 2004 to Rs.3.81 lakh crore in 2007.
How did the asset inflation lead to the UPA’s “high growth”? Inflated asset prices to the extent realised by sale got accounted as part of income and included in GDP. Large part of the gains on stock sale got added to GDP with very little tax under Securities Transaction Tax. The spurious wealth effect also led to high-end consumption. The annual private consumption growth averaged 18 per cent till six years to 2009-10 — 80 per cent over the NDA average. The fake wealth effect, powered by HDN cash, scripted the UPA’s “high growth” story. HDNs outside banks took refuge in stocks, gold and land, produced capital gains-led growth and consumption. Had the HDNs circulated through the banking system, it would have multiplied through the fractional reserve model, reduced the inflation and interest, and funded the small-and-medium enterprises starved of organised funding.
The curse — asset inflation inspired jobless growth — seems irreversible till unmonitored HDNs roam and fuel fake growth. Dr. Singh had had enough wake-up calls when the share of HDN cash was escalating year after year from 2004. He could have de-escalated the hugely growing cash economy had he remonetised the HDNs by lesser denominations without demonetisation — sparing the people of discomfort and economy of short-term damage. Of course, he would have lost the “high growth” brand that made UPA rule an economic success. To unmask this deception and revive job productive growth, the unmonitored HDNs needed to be brought to account forcibly. By his inaction, undeniably, Dr. Singh had landed the economy in a Catch-22 situation. The Modi government could either opt to continue the status quo of jobless growth or force temporary decline in growth to reinstate real growth and jobs. It opted for the latter. Even an undergraduate student in economics will tell you that it will cause hardship and hit growth in the short run. A Cambridge economist is not needed to write a column on that. It is already late. If the status quo of unmonitored HDNs were to last for another five-six years, the size of HDNs would have become so huge that no government may have been able to act against it — inevitably inviting a huge crisis, both internal and external. Prime Minister Modi has rightly called the demonetisation as “kadak chai” (bitter pill). That HDNs promoted high bribery and helped terror funding through fake HDNs cannot be disputed at all. Far from doing a monumental misappropriation or making a “mammoth tragedy”, Mr. Modi is correcting the monumental mismanagement of the economy by the economist Dr. Singh.
Courtesy – The Hindu