Two reasons why Mr. Surjit Bhalla is wrong on Demonetisation

I am a big fan of Mr. Surjit Bhalla. He uses numbers extensively and uses them quite wisely. He has been wrong a few times but by and large, he has been right. As a recognition of his knowledgeable, practical and data-driven approach to the economy, he was recently chosen to be a part-time member of the PM's economic advisory council. My choice of the headline is not to target him personally at all. Instead, it is to repeatedly question the prevalent belief in the Government and its advisory circles that demonetization was a success.

Mr. Bhalla makes numerous arguments in favor of Demonetisation. I will focus my attention on 2 of his critical arguments and comment on the rest in brief

1. On employment, to quote him

Fortunately, the CMIE data (posted on their website) allows one to compare like with like, that is, employment (and unemployment etc.) between January-August 2016 (pre DM) and January-August 2017 (post DM). Employment actually increased at a healthy rate post-DM — for the population aged 15-24, employment increased by 7 million, and for the age group 25-64, a healthy 12.7 million, or a rate of growth of 3.7 per cent, the highest over the last 35 years (previous years, NSS data).

But that is not the end of it. Mr Bhalla claimed 15-24 employment increased by 7 million. Perhaps, it was an oversight but employment actually fell by 7 million for this age group. Further, amongst those greater 64 years, fall in employment was 4.4 million. While 13 million were added in the 25-64 years, the 11.4 million losses in the older and younger demographic meant that the net additions in the workforce were minimal. (see chart below)

On August 2016, some 403 million people were employed, by August 2017, 404.6 million people were employed. That is a net of 1.6 million jobs created in 12 months. During the same period, some 10-12 million new job seekers entered the market.

2. On Direct Tax Collections, to quote him

Unfortunately, and helped by the ultra-tight monetary policy, nominal y-o-y GDP growth (GVA growth at basic prices) during April-June 2017 was only 7.9 per cent, one of the six lowest on record (since 1996). Even with this low, low income growth, direct tax revenues have increased at a 13.5 per cent pace, very close to the targeted 15.6 per cent. This close correspondence is only possible because of a large increase in tax compliance.

Mr. Bhalla is right that direct tax revenues have done quite well in spite of lower nominal growth. However, to suggest that demonetization has had no impact is a difficult argument to make. In fact, the issue is more complicated. Let me present data for direct taxes split by Personal Income and Corporate taxes. The data is weird

As nominal GVA (Current) fell by 0.8% points from 2016 to 2017, personal income tax growth fell from 53.4% to 10.6%. However, the reverse happened with corporate tax growth which jumped from 3.9% to 24.3%. The first thing that is clear is that the correlation in itself is weak given the opposite trends in corporate and income tax growth. Perhaps there are other extraneous factors. Second, I can put forth a hypothesis that many individuals who were not paying taxes earlier have now started showing that income in the name of companies. The problem with this hypothesis is that in the second quarter of this financial year, corporate tax growth has grown by just 6% whereas personal income taxes have grown by a whopping 21.7%. So the new hypothesis is that post demonetization, some taxpayers are playing games by paying taxes personally in one quarter and through their companies in another quarter and they are all doing it in the same quarter, like a plan (I am being sarcastic).

Looking at the above crazily swinging data, one cannot make a definite argument that Demonetisation has driven compliance. Some have argued that increase in income tax payees may be evidence of this growth but that is not the argument Mr. Bhalla is making.

Mr. Bhalla's other critical point was on wage growth

First, is the pattern of real wage growth in rural India. Real agricultural wages (Ministry of Labour nominal wage minus rural CPI inflation) grew at 0.1 per cent in 2016 (January-July) and a robust 4.9 per cent in 2017; non-agricultural rural wages show the same pattern — a 1.3 per cent decline in 2016 and a 3.4 per cent increase in 2017.

This data is undeniable but what is missing is context, let us look at what happened in rural employment during that period (CMIE)

Two distinct trends are visible. Employment overall has fallen, even if marginally. This is at a time when potentially working population is being added at about 0.7 million a month in rural India. The scary thing to know is how many are giving up. In January-April 2016, some 49.5 million people were willing to work but did not have a job. With no improvement in the job situation, by Jan-April of 2017, this number came down to 21 million and further to 15 million in August 2017.

So the question is, while the average wages have definitely gone up, employment hasn't though there are a large number of people who were willing to work. The question is why did wages go up? Numerous hypothesis exist - Record Kharif Production in 2016 after two years of bad monsoons and low MSP increases, change in minimum wages for non-agricultural labour in August 2016 or even tightening of labour supply as many dropped out of the labour force altogether. The irony is that if the last hypothesis is true, wage increases are indeed due to Demonetisation as it led to numerous people just giving up on employment altogether.

I am in complete agreement with Mr. Bhalla on digital payments which has benefitted due to Demonetisation My own estimate is that about 2 lakh crores of cash has been taken out of the system, mostly due to Debit Card transactions.

Lastly, Mr. Bhalla has made a strong argument that deteriorating GDP numbers are owing to interest rates. I am sure interest rates have a role to play but the question to him is how is that unsecured personal loans are booming even with rates being high? In my view, interest rates are not the only problem. There are a host of other equally serious issues like value addition in exports (both merchandise and services), the pace of growth of indirect taxes (Mr. Jaitley is addicted to increasing the tax rates), allocation of funds on wasteful Government programs like Food Security and last but not the least, inefficient management of Public Sector Enterprises. While the economy will recover over the next 12 months due to low base effect and hopefully favorable commodity prices, long term recovery will depend on improving on the above 4 areas of non-performance. On each of the 4, Government initiatives are weak or absent altogether.

Coming back to Demonetisation, I repeat, it is a success as far as Digital payments and electoral wins for the BJP are concerned. As far as the economy is concerned, we have lost a year. Time now to move on I guess.

Sources of Data: CMIE employment reports, CGA and MOSPI