New perspective on the Great Calcutta killings of 1946

Calcutta (as the city was then called) descended into an orgy of what has been perceived as communal riots in 1946. The killings were seen as an important factor that made Partition inevitable- it seemed to suggest that Hindus and Muslims would find it difficult to live together in one country.

It was fascinating, therefore, to get a quite different perspective on the killings in a book on the subject reviewed recently in EPW. The author contests the idea that the killings were primarily communal in nature. Rather, he's inclined to give more weight to the famine of 1943 inflicted - that's the right word, as it was entirely avoidable in terms of the supply of and demand for foodgrains- on the city by the British.

The author of the book, the reviewer points out, is of the view that the scorched earth policy pursued by the British following the threatened invasion of Bengal by Japan in World War II was by far the more important factor in fuelling the rights. The British emptied the rural areas of foodgrain stocks to prevent these from falling into Japanese hands. They also destroyed transportation by boats by impounding the boats, again to prevent these from falling into Japanese hands. Both these resulted in an artificial scarcity of foodgrains in the countryside. ( I have read elsewhere that inflated estimates of food output caused the British to export large amounts to support the war in other parts of the world).

Calcutta was treated differently because it was the epicentre of the war effort in the region. Workers had to be fed in order to maintain production for the war, so ration shops were set up to ensure availability of food. The two factors together- scarcity of food in the countryside and relative abundance in Calcutta- caused people to flock to Calcutta putting enormous pressure on those staying in the city for long. It was the battle for territory between those resident in Calcutta for long and the migrants that primarily resulted in riots, the author contends, the riots were not communal in origin.

This communal single-mindedness that Das speaks of in the Great Calcutta Killings, Mukherjee shows, is simply not borne out by the historical record. Instead, the violence was chaotic and driven by a range of factors. First, the fact that British targets came under attack in the bedlam has fallen through the cracks in this rush to prise a communal angle from the violence. On Chowringhee, the Main Street of White Calcutta, several European shops and business were plundered, as was an Enfield motorcycle showroom on Park Street. The Statesman House, which housed the main newspaper of White Calcutta, also came under attack but was saved by prompt police action. In Dharamtolla, a Bata showroom, a Czech company, was similarly saved from the mob by the police.

Does widespread looting—of European and Indian targets—fit the mould of the crowds having a sense of “moral duty”? Again, here the looting has been explained in terms of Hindus looting Muslim shops and vice versa—a theory little backed up by data. In the chaos, very little of who attacked whom was actually recorded. Driven by a concurrent cloth famine, cloth merchants were targeted. And of course, the authorities were wary of food stocks being ransacked, so the civil supplies department was heavily guarded. Given this data, Das’ dismissal of the riot having an economic component falls under heavy strain.

This indeed casts new light not just on the Great Killings but on the Partition that followed. The author also suggests that Bengal PM Suhrawardy has been unfairly maligned. Britian's role in bringing about the Partition of India is far greater than one had thought.

This communal single-mindedness that Das speaks of in the Great Calcutta Killings, Mukherjee shows, is simply not borne out by the historical record. Instead, the violence was chaotic and driven by a range of factors. First, the fact that British targets came under attack in the bedlam has fallen through the cracks in this rush to prise a communal angle from the violence. On Chowringhee, the Main Street of White Calcutta, several European shops and business were plundered, as was an Enfield motorcycle showroom on Park Street. The Statesman House, which housed the main newspaper of White Calcutta, also came under attack but was saved by prompt police action. In Dharamtolla, a Bata showroom, a Czech company, was similarly saved from the mob by the police.
Does widespread looting—of European and Indian targets—fit the mould of the crowds having a sense of “moral duty”? Again, here the looting has been explained in terms of Hindus looting Muslim shops and vice versa—a theory little backed up by data. In the chaos, very little of who attacked whom was actually recorded. Driven by a concurrent cloth famine, cloth merchants were targeted. And of course, the authorities were wary of food stocks being ransacked, so the civil supplies department was heavily guarded. Given this data, Das’ dismissal of the riot having an economic component falls under heavy strain.
- See more at: http://www.epw.in/journal/2017/8/book-reviews/revisiting-our-narratives-great-calcutta-killings.html#sthash.1VAOCo0Y.dpuf

This communal single-mindedness that Das speaks of in the Great Calcutta Killings, Mukherjee shows, is simply not borne out by the historical record. Instead, the violence was chaotic and driven by a range of factors. First, the fact that British targets came under attack in the bedlam has fallen through the cracks in this rush to prise a communal angle from the violence. On Chowringhee, the Main Street of White Calcutta, several European shops and business were plundered, as was an Enfield motorcycle showroom on Park Street. The Statesman House, which housed the main newspaper of White Calcutta, also came under attack but was saved by prompt police action. In Dharamtolla, a Bata showroom, a Czech company, was similarly saved from the mob by the police.
Does widespread looting—of European and Indian targets—fit the mould of the crowds having a sense of “moral duty”? Again, here the looting has been explained in terms of Hindus looting Muslim shops and vice versa—a theory little backed up by data. In the chaos, very little of who attacked whom was actually recorded. Driven by a concurrent cloth famine, cloth merchants were targeted. And of course, the authorities were wary of food stocks being ransacked, so the civil supplies department was heavily guarded. Given this data, Das’ dismissal of the riot having an economic component falls under heavy strain.
- See more at: http://www.epw.in/journal/2017/8/book-reviews/revisiting-our-narratives-great-calcutta-killings.html#sthash.1VAOCo0Y.dpuf

This communal single-mindedness that Das speaks of in the Great Calcutta Killings, Mukherjee shows, is simply not borne out by the historical record. Instead, the violence was chaotic and driven by a range of factors. First, the fact that British targets came under attack in the bedlam has fallen through the cracks in this rush to prise a communal angle from the violence. On Chowringhee, the Main Street of White Calcutta, several European shops and business were plundered, as was an Enfield motorcycle showroom on Park Street. The Statesman House, which housed the main newspaper of White Calcutta, also came under attack but was saved by prompt police action. In Dharamtolla, a Bata showroom, a Czech company, was similarly saved from the mob by the police.
Does widespread looting—of European and Indian targets—fit the mould of the crowds having a sense of “moral duty”? Again, here the looting has been explained in terms of Hindus looting Muslim shops and vice versa—a theory little backed up by data. In the chaos, very little of who attacked whom was actually recorded. Driven by a concurrent cloth famine, cloth merchants were targeted. And of course, the authorities were wary of food stocks being ransacked, so the civil supplies department was heavily guarded. Given this data, Das’ dismissal of the riot having an economic component falls under heavy strain.
- See more at: http://www.epw.in/journal/2017/8/book-reviews/revisiting-our-narratives-great-calcutta-killings.html#sthash.1VAOCo0Y.dpuf

This communal single-mindedness that Das speaks of in the Great Calcutta Killings, Mukherjee shows, is simply not borne out by the historical record. Instead, the violence was chaotic and driven by a range of factors. First, the fact that British targets came under attack in the bedlam has fallen through the cracks in this rush to prise a communal angle from the violence. On Chowringhee, the Main Street of White Calcutta, several European shops and business were plundered, as was an Enfield motorcycle showroom on Park Street. The Statesman House, which housed the main newspaper of White Calcutta, also came under attack but was saved by prompt police action. In Dharamtolla, a Bata showroom, a Czech company, was similarly saved from the mob by the police.
Does widespread looting—of European and Indian targets—fit the mould of the crowds having a sense of “moral duty”? Again, here the looting has been explained in terms of Hindus looting Muslim shops and vice versa—a theory little backed up by data. In the chaos, very little of who attacked whom was actually recorded. Driven by a concurrent cloth famine, cloth merchants were targeted. And of course, the authorities were wary of food stocks being ransacked, so the civil supplies department was heavily guarded. Given this data, Das’ dismissal of the riot having an economic component falls under heavy strain.
- See more at: http://www.epw.in/journal/2017/8/book-reviews/revisiting-our-narratives-great-calcutta-killings.html#sthash.1VAOCo0Y.dpuf

Indian army's deployment in Kashmir

About a third of the Indian army - or nearly half a million men- is bogged down in Kashmir. The army sees this as helpful to keeping the forces combat ready. An article in EPW points out, however, that there are significant negatives to the army's deployment in Kashmir.

One, army excesses sully the army's name.

Two, the infantry gains in importance at the expense of other arms- witness the supercession by General Rawat of seniors with a distinguished record in other arms (although this may not be the only reason for the supercession).

Three, the need to contain China, given that a significant chunk of the army is tied up in Kashmir, has necessitated creation of fresh divisions. This, in turn, has led to revenue expenditure eating into capital expenditure and coming in the way of the army being able to implement its Cold Start doctrine- a quick, short war on the Western front- in retaliation for cross-border terrorism practised by Pakistan.

Four, the expansion of the office cadre has been fuelled mainly by recruits from UP, Uttarakhand and Haryana. This has implications for the overall composition of the army. The article also mentions that these are areas in which aggressive nationalism has wide acceptance and those joining the army would not be exempt from these influences. This could have implications for the army' s overall philosophy.

Army deployment in Kashmir, the author argues, has thus had a corrosive act on the army. But the big question which such analysts are not able to address suitably is: can we afford to pull the army out of Kashmir given that we have not been able to make much headway either with the people of Kashmir or with Pakistan?

North Korean flash point

North Korea was flagged among the foreign policy priorities for President Trump. The advice was well-placed. Tensions in the Korean peninsula have been rising, with North Korea testing long-range missiles and the US responding with a sophisticated air defence system for South Korea.

Among the options being considered is all-out war, aimed at taking out North Korea's nuclear armoury. The argument is that North Korean leader Kim Jong Un is crazy. As an article in the FT points out, he's a rational leader focused on survival. It's the war option that is crazy:

The North Korean nuclear and missile programmes are widely dispersed, including underground and underwater. It is unlikely that the whole programme could be destroyed in a single wave of strikes, which would immediately raise the prospect of nuclear retaliation by the North. Even if the US was miraculously able to take out the whole nuclear programme in one swoop, the North Koreans still have formidable conventional artillery. They could launch devastating barrages aimed at Seoul, the South Korean capital, a city of 10m people 35 miles from the North Korean border. Japan would also be vulnerable to missile strikes, as would US bases in the region. 

...  the better route, in the long run, would be to search for a deal that freezes the country’s nuclear programme, in return for economic assistance and a guarantee that the US will not seek to overthrow the regime. 

And what if such a 'grand bargain' can't be struck? Well, it would be best for the US to live with a nuclear North Korea, as it has lived with a nuclear Russia. The alternatives are too horrifying to contemplate. 

Demonetisation and other forecasts: the pundits got it wrong

Well, it doesn't look as though the Indian economy has collapsed after demonetisation. The impact on GDP growth for 2016-17, as estimated by the CSO and the RBI, is less than 50 basis points. We will, of course, know for sure after the Q4 numbers are out.

Demonetisation is one of many glaring instances of pundits having got things wrong. Some of the others are: the potential impact of Raghuram Rajan now staying on as RBI governor, Brexit and Trump's victory.

More in my BS column, Lean times for pundits.

The article is behind a pay wall, so the full article is reproduced below:

Following the demonetisation move last November, the pundits -- academics, economists, media commentators and others -- were quick to pronounce judgment: Narendra Modi had blundered. 

The withdrawal of high-denomination currency notes, they said, had caused enormous economic hardship. The prime minister should have known better. He should have consulted experts before embarking on such a radical measure. Mr Modi would pay the price in the state elections that were to follow.

It’s now clear that the pundits got it wrong. Demonetisation did not work against the BJP in the recent polls and may have even contributed to its huge victory in UP.

Some pundits argue that it was the political narrative of demonetisation that mattered, not the economic content. Demonetisation did cause hardship to the poor. But they didn’t mind because they could see that the rich would suffer more.   

One can go along with this view if the hardship amounted to putting up with long lines in banks. But not if the hardship meant a sharp slowdown in economic growth and losses in jobs and incomes. When people lose their jobs in an economic slowdown, they don’t go out and celebrate because multi-millionaires have lost even more on the stock exchange! 

The truth is simple enough but the pundits don’t seem to get it. Demonetisation has not derailed growth as much as they had predicted. Two agencies respected for their independence and professionalism, the Central Statistics Office (CSO) and the Reserve Bank of India (RBI), have estimated the impact of demonetisation on the gross domestic product (GDP) growth for 2016-17.  

Using the Gross Value Added (GVA) approach, the RBI estimates the impact on the GDP growth at 33 basis points in its monetary policy statement of February 8. Again, going by GVA, the CSO estimates the impact at 30 basis points in its second advance estimates released on February 28.  

Economists may have difficulty in accepting these numbers but bankers seem to think they reflect the ground reality. Bankers did not see any significant increase in stress in their loan book in respect of large corporates and small and medium enterprises. They say that some stress was evident only in respect of micro-enterprises. Repayments of agricultural and micro-finance loans were surprisingly resilient. 

Many of those who had warned that the third quarter (Q3) numbers for 2016-17 would show up the impact of demonetisation have since changed their tune. Wait for the Q4 numbers, they say.  We’ll know soon. In the meantime, we have the recent election results to go by. Voters don’t seem to have found the short-term costs of demonetisation very steep. And they believe the PM when he says it will deliver long-term gains.

This is not the only glaring instance in recent times of the pundits having got things badly wrong. In June 2016, when Raghuram Rajan announced that he would not seek a second term as RBI governor, the Modi government drew a barrage of negative comment. The pundits warned that India’s image abroad would be badly dented, foreign investors would flee, the combination of Brexit and Rexit could cause a currency crisis, the RBI’s autonomy was in peril… some of us may have been pardoned for supposing that the end of the world was in sight. None of these dire outcomes has materialised.  

Our pundits are in good company. Following the British vote on Brexit, many foreign commentators predicted a sharp slowdown for the British economy and enormous uncertainty for the world economy. Among the doomsayers was Mark Carney, the governor of the Bank of England (BoE).

Ahead of the vote on Brexit, the BoE issued warnings about the potential effects of a vote for Brexit. After the vote, it moved to cut interest rates and boost stimulus measures to contain the adverse impact. Mr Carney has since revised his forecast for 2017 upwards. The world economy is also doing better than was forecast in 2016. Nobody talks about the impact of Brexit any more.

Then, we have the Donald Trump phenomenon. The liberal media in the US did its damndest to stop Mr Trump in his tracks in the run-up to elections. They forecast ruin for the US economy and the world at large given his hostility to some aspects of globalisation. Paul Krugman famously wrote that the stock market would “never” recover from a Trump victory. The Dow Jones Index went on to touch an all-time high after Mr Trump won. 

In all these cases, the pundits got it wrong because many were hopelessly prejudiced. They did not like Mr Modi, so they were quick to fault demonetisation and the exit of Mr Rajan. They did not want to see the European Union unravelling, so they viewed Brexit as a disaster for the UK. They hated Mr Trump as an individual (and favoured Hillary Clinton), so they predicted a setback to the US economy. By forsaking objectivity in assessing policy outcomes, the pundits have ended up undermining their own credibility and standing.

India's twin balance sheet problem

High corporate debt and a high level of bad loans at banks are stifling private investment and growth. How did the twin balance sheet problem come about, how has its impact been relatively muted compared to that in other countries and how do we get out of it? The latest Economic Survey has a chapter on it. My analysis and comments in EPW.

India's private universities fail to make a mark

Shiv Nadar, Aziz Premji, O P Jindal, Munjal, Bennett.... we have quite a few universities started by private industrialists. Yet, none has made a mark thus far as a quality institution, notes Anjuli Bhargava in BS.

That's true of professional colleges as well. There's no engineering institution that can match the IITs, hardly any that match the IIMs and the AIIMS or even other prominent government medical colleges.

Why so? One reason that Bhargava mentions is the lack of high quality admission standards. Indeed, many of these universities go all out to woo student candidates, something no self-respecting institution would do. Another is that they are far too focused on hardware and too little on software, namely, faculty and research. And a third is that promoters run them as they do their own businesses- by calling the shots and not giving enough leeway to professional educators.

I guess all of this is true. But another crucial factor is that most private universities have a profit motive in mind- they are looking for returns, preferably quick returns. Whereas the striking thing about private universities in the US and some other places is that these are non-profit in orientation and are sustained by large endowments.

No educational institution that aims to generate surpluses out of its operations- mostly running degree programmes and, in some cases, consultancy and executive training- can be expected to produce high quality in the long run. There's a view that, ever since the IIMs have been left to set their own fee, they too are focused on revenue generation. Their reputation was built in a period when they were sustained by government funding and did not have think about surpluses.

Worldwide, the combination of quality and access is possible only when there's a large element of subsidy built into higher education. In India, it's public universities that conform to this model. The worry about IIMs now must be whether they will end up in the same bracket as private universities.

Budget for FY 2017-18

I was amongst those who produced instant wisdom on the budget this year- wrote up my piece by 5 pm after the budget speech was announced. Quite an experience because it was hard to access the details until about 2:30 pm at the finance ministry website, perhaps due to the heavy load on the server.

To do justice, you need to have the budget estimates for the previous year, revised estimates and budget estimates for the current year on a spreadsheet. This is next to impossible when you are writing to a tight deadline.However, one can get a sense of whether the budget got it right on the whole.

Here's my analysis in the Hindu, A budget few can quarrel over.

Can a public asset reconstruction company resolve India's bad debt?

I have a piece in Business Standard today.

Since the article is behind a pay wall, it's reproduced in full below:

The Economic Survey has proposed a Public Asset Rehabilitation Agency (PARA) – a so-called “bad bank” – for tackling bad loans in the Indian banking system. We already have several Asset Reconstruction Companies (ARCs). So what’s new?

PARA will be much bigger in scale and will have substantial government equity. Besides, a big chunk of bad loans relates to valuable projects in infrastructure and related areas. Many of these projects need to be completed through further infusion of capital from promoters. Some of the debt has to be written off and some restructured in order to restore viability.

The existing ARCs are just not equipped for such a role, at least on the scale required. They are mainly in the business of effecting recoveries through liquidation of assets.

The Survey argues that leaving it to banks to resolve bad loans has not worked. At public sector banks (PSBs), management is unable to write off debt for fear of inviting investigation. In many bad loans, several banks, public and private, are involved. This gives rise to problems of coordination. Banks can’t agree on the write-off required in a given case.

Transferring some of the biggest bad loans to a well-capitalised PARA could help resolve the coordination problem. As the government stake in PARA will be 49 per cent, managers can resolve loans without fear of inviting scrutiny.

This sounds fine — until you get down to the details. One challenge is the prices at which bad loans will be sold to PARA. Determining the market prices for bad loans is not easy. Getting banks to agree on a sale price could pose its own problems of coordination.

If the sale of bad loans to PARA were perceived to be under-priced, PSB management would be exposed to the wrath of the CAG, CVC and CBI. If they were over-priced, private investors in the proposed PARA would begin to fret.

The challenge of writing off debt remains. Managers at PARA may be able to exercise their discretion a little more freely. But the government is ultimately accountable for decisions taken by an entity in which it is the dominant investor. Every resolution will be closely watched. Expect howls of “scam” to be raised given that high-profile corporates are involved.

The Survey estimates that of the top 100 stressed debtors, 10 would need debt reductions of 51-75 per cent and 57 would need reductions of 75 per cent or more! Over 40 per cent of the debt is owed by companies with an interest coverage ratio of less than one. As the top 50 companies in this category owe an average of ~20,000 crore, the write-offs required are of staggering proportions.

Unlike many of the shrill critics of the public sector, the Survey doesn’t see recapitalising PSBs as throwing good money after bad. Even more striking, the Chief Economic Advisor doesn’t believe that finding the necessary capital for PSBs is a big deal- he thinks it’s “the easiest part” of the loan resolution problem. (“Rehab for the balance sheet”, <i>Indian Express<p>, February 8). Only, the Survey doesn’t favour promising large infusion of capital to PSBs <i>before<p> bad loans are resolved. This, it believes, would create incentives for unduly large write-offs.

So, none of the issues associated with bad loan resolution in the present scheme of things goes away with the creation of PARA: Coordination amongst banks; large write-offs and the potential for controversy; and the substantial capital that would have to be infused into PSBs.

If anything, we stand to lose two advantages we have with the present system. One, banks’ intimate knowledge of projects and hence the ability to arrive at the right resolution. Two, banks’ ability to use the leverage they have with large corporate groups to ensure that they restore viability to troubled projects within the groups.

If the primary motivations for PARA are to have the right incentives for write-offs and to get resolution going, there’s a simpler option: create an oversight mechanism for vetting bad loans. The Survey mentions that the Banks Board Bureau has created such a mechanism — we don’t know whether it’s operational. We need to merely strengthen the mechanism by getting one created through an Act of Parliament.

In sum, it’s not clear that setting up a new agency is a superior way to address the issues that bedevil bad loan resolution. Giving PSB management statutory backing to resolve bad loans and the capital infusion to cover write-offs could achieve superior outcomes.

Still, there’s merit in trying out competing models. Let’s walk on two legs: facilitate better resolution under the present system and set up PARA as well by transferring loans amounting to, say, ~1 lakh crore. Let’s see which model does better. There could be useful lessons to be learnt.

Has demonetisation compromised RBI's autonomy?

I don't think so, contrary to what many have been saying.

Here's the link to my article in BS, Much ado about RBI autonomy.

As the article is behind a pay wall, I reproduce it below:

Much ado about RBI autonomy

These are not the happiest of times for India’s central bank. The Reserve Bank of India (RBI) has faced unprecedented criticism over its handling of the demonetisation of high-value currency notes.
Some allege that the RBI governor and its board of directors caved in to pressure from the government. Others contend that the RBI stumbled on implementation. Yet others see the episode as another sign of the Narendra Modi government’s penchant for undermining the autonomy of institutions. The critics are getting carried away.
Let’s begin with the decision to demonetise. The RBI has outlined the sequence of events in its response to Parliament’s Standing Committee on Finance. The government advised the RBI of its intention to demonetise on November 7. The RBI Board met the next day and approved the measure. This was followed by Prime Minister Modi’s address to the nation. Aha, say the RBI’s critics- here's proof that the decision to demonetise was that of the government and that the RBI tamely fell in line.  
Not so fast. It’s not as if the advice on demonetisation was sprung on an unsuspecting RBI. Reports in the media indicate that the sequence mentioned above is not the whole story. It relates only to the formalisation of the decision to demonetise. It had been preceded by consultations on the subject during the tenure of the previous governor, Raghuram Rajan. These consultations are said to have commenced as early as in May-June 2016.  
Nor is there reason to believe that RBI management had reservations about the decision or the timing of it. RBI has told the Standing Committee that last November when it was presented with the government’s advice on demonetisation, it felt that the time was opportune as it coincided with the planned introduction of a new series of notes.  
Let’s turn now to the role of RBI’s central board of directors. Critics say that the board failed to satisfy itself about the decision and its likely impact. They point out that that since a large number of non-official positions on the board (ten, according to some reports) have not been filled, the board was not well placed to take an independent decision in the matter.
If the suggestion is that the board of RBI could have stopped the government from going ahead with demonetisation, it is completely untenable. Any decision to demonetise is the prerogative of the government- and the government is accountable to Parliament and the people.
Whether demonetisation was an unsound decision and whether it caused economic dislocation without any compensatory benefit are matters that must be decided at the next general elections. It is not for the RBI board to judge. At best, the RBI board can satisfy itself that the government’s advice in the matter does not constitute any infringement of the RBI Act.
It is also not true that an independent RBI board can overrule the RBI governor in such a matter. The position of the board of directors of RBI in relation to the Governor is not the same as that of the board of directors of a company in relation to a CEO -and we all know how good corporate boards are at standing up to the CEO despite the fiduciary obligations that board members have.
It is almost unheard of for the board of RBI to oppose the governor or even to actively question the Governor’s decisions — most members would not even be competent to do so.  In practice, the board of RBI is a sounding board for the Governor. It can provide advice or feedback but it does not overrule. The idea that a fully-manned RBI board could have somehow resisted the government’s advice on demonetisation verges on the ludicrous.
It’s possible to suggest that the RBI might have done a better job of implementation.   Maybe the RBI could have ensured that there was an adequate stock of ~500 notes. Maybe it was unwise to issue ~2000 notes. Given time and better planning, the dislocation might have been better contained. But all this is sheer speculation. We don’t know whether better planning would have been consistent with the need for secrecy. And we don’t yet know the extent of dislocation caused either.
Former RBI governor Y V Reddy thinks RBI could have done a better job of communicating with the public as demonetisation unfolded.  He suggests that if a governor is not comfortable communicating himself, he should let one of his deputies do so. This could be useful advice for the reticent Urjit Patel who will soon acquire an articulate professor from Stern School of Business as his deputy.
Demonetisation hasn’t quite evoked the public anger its critics had hoped for. It does appear that they have latched on to the supposed erosion of autonomy of RBI as an instrument for Modi-bashing.
The challenge for RBI is not any erosion of autonomy caused by demonetisation. It’s the whole attempt to reduce the stature and role of RBI that has been under way consequent to the report of the Financial Sector Legislative Reforms Commission submitted in March 2013. The attempt commenced in the time of the United Progressive Alliance government and has merely continued under the present government.
The moves to create an independent agency for public debt, hand over the supervision of the government bond market to Securities and Exchange Board of India and give statutory powers to the Financial Stability Development Council are all part of a larger design to cut the RBI to size. The RBI governor used to head the panel to select a deputy governor. He is now a member of a panel headed by the Cabinet secretary.
Resentment of the RBI’s stature runs deep in the political class and the bureaucracy — and it has nothing to do with the complexion of a particular government. Dr Reddy is right in urging a national debate on the role of RBI.

Demonetisation could transform Indian banking

Demonetisation, in my view, is not primarily about black money and corruption nor  about moving to cashless economy. It's about financial deepening. This could transform Indian banking and boost the Indian economy.

Here's my article in today's BS, 

Since the article is behind a pay wall, it's reproduced below:

Way back in 1969, Indira Gandhi decided to nationalise private banks.  She summoned I G Patel, then special secretary in the ministry of finance, and gave him 24 hours to prepare a Bill for Parliament, a Cabinet note and a speech Mrs Gandhi would make to the nation. Patel dutifully carried out madam’s orders.

In his memoirs, Patel records that he would have liked the move to have been better planned. Nationalisation should have been accompanied by restructuring to produce  one or two large national banks and multiple regional banks. Little of this has happened to this day. Mrs Gandhi judged correctly that planning every detail would take her nowhere.

Mrs Gandhi’s detractors denounced the move as politically motivated. They saw it as part of her battle against the old guard in the Congress and an attempt to weaken the Swatantra Party which was backed by the private owners of the banks. They said it was an effort on Mrs Gandhi’s part to portray herself as pro-poor and anti-rich — exactly what Prime Minister Modi’s critics are saying today.

All this was, of course, true. But, then, politicians will always be driven by political motives. The most important motivation is to acquire and hold on to power. The right question to ask is whether their political motivations are married to the larger good. Bank nationalisation passes this test — and there is every prospect that so will demonetisation.

Bank nationalisation marked a watershed in India’s post-independence history. Government-owned banks spread their branch network into the interior and mopped up small savings of millions. As a result, the household saving rate jumped from 8.1 per cent of GDP in 1968-69 to 14.4 per cent in 1978-79, causing the overall saving rate to jump from 12 per cent to 21 per cent. The rise in the saving rate set the stage for an increase in the growth rate from the Hindu rate of 3.5 per cent of the previous decades to 5.5-6 per cent in the eighties.

Public sector banks’ (PSBs) access to low-cost savings in the seventies and eighties enabled them to become profitable in the post-liberalisation era. Exposing PSBs to private competition while keeping over 70 per cent of banking in the public sector allowed efficiency to improve while maintaining banking stability.

Mrs Gandhi thus created a serious disruption that yielded benefits over a long period, thanks to financial deepening. Mr Modi has done exactly the same with demonetisation — and the outcomes are likely to be very similar.

Demonetisation is not primarily a drive against black money or even a change to a less-cash economy, although it has been packaged as such. Observers are right to be sceptical on both counts. Without follow-up measures, demonetisation is unlikely to make a big dent on black money. The role of cash can come down only over a long period.

Demonetisation is best seen as carrying forward the agenda of financial deepening that commenced with bank nationalisation. The gains to banking  promise to be  substantial.

Bank nationalisation brought a large number of individuals into banking on the liabilities side. It also brought in SMEs on the asset side. Demonetisation promises to deepen individual relationships on the liabilities side. It also promises to bring a large number of merchants, traders and SMEs into banking on both the liability and asset sides. It’s a great leap forward in terms of financial inclusion.

This has the potential to transform Indian banking and revitalise it precisely at a time when a large chunk of it is moribund. Banks will have access to more deposits and a larger proportion of low-cost deposits. This should cause interest rates to decline. The fall in interest rates will be gradual, given that we cannot afford a flight of foreign funds invested in the financial markets.

Once cash flows of small businesses begin to get routed through the banking system, their accounts will become far more transparent. This will translate into more lending to small businesses which carries higher yields than corporate loans. Banks have already woken up to the potential of microfinance. The two together will give a big boost to profitability in banking.

The decline in interest rates will lead to capital gains on banks’ holdings of government securities and help recapitalise PSBs. K V Kamath estimates that the banks have gained ~1 lakh crore in the last quarter. He thinks they will gain another ~1.5 lakh crore through a one per cent decline in interest rates in the next six months. This seems too optimistic but the basic point is valid: A fall in interest rates makes the job of recapitalising PSBs easier.  No wonder bankers are upbeat about demonetisation even as economists are divided on it.

Mr Modi’s critics say he should have planned better: More notes printed in advance, more of small-denomination notes, faster recalibration of ATMs, etc. Many of the criticisms are valid. The short-term distress is very real.

But the critics miss the larger point: The most serious distress the nation faces today is not creating new jobs. Two of the most important constraints to job creation are global economic conditions and the state of Indian banking. There isn't much we can do about the first. By revitalising banking, demonetisation promises to ease the second constraint and open a path to faster growth in the medium term.

For some two-and-a-half years now, Mr Modi has proceeded cautiously, allowing himself to be guided by those familiar with the Delhi durbar. He seems to have sensed that plodding along the familiar path would not yield much — in political or economic terms. A game-changer was required. This is the risk-taking Mr Modi of the Gujarat days.

The insight of the gifted politician can often bring about a transformation in ways that cannot be arrived at through a strictly analytical process. So it was with Mrs Gandhi and bank nationalisation. So it could well turn out to be with Mr Modi and demonetisation.

Demonetisation and interest rates

Demonetisation was widely expected to bring about a sharp fall in lending rates on account of the surge in deposits in the system. The RBI's move to impound 100 per cent of incremental deposits starting from September 16 to November 11 has raised doubts over such a decline.

The RBI has said it will review its decision on December 9 (when it announces its quarterly monetary policy). The removal of currency is hugely deflationary and the economy could do with a monetary stimulus. However, we're seeing an exit of FIIs from the debt market and the currency has fallen. Given the knock to GDP and earnings and a forecast increase in the Fed rate mid-December, the RBI will have to be careful about dropping the policy rate. It would be a surprise if it cut the rate by 50 basis points as analysts had forecast and it would not surprise me if held firm.

Over a long period, however, we can expect demonetisation to usher in lower rates. Various other benefits will also kick in, notably greater financial inclusion and a reduced use of cash. I cannot resist noting how many respected bankers are upbeat about the  move in a way in which economists are not.

My guess is that more measures to attack black money will be forthcoming after December 31. What's being attempted is a paradigm shift- or, if you like, Big Bang reform. This is what economists have long been clamouring for but they couldn't have imagined it would happen this way.

More in my article in the Hindu, Dashed expectations.

Larry Summers thinks costs of demonetisation outweigh benefits

Larry Summers, the well-known economist and former US Treasury secretary, thinks that India's demonetisation  drive is ill-judged. It penalises honest users of cash without being able to flush out black money in a meaningful way. And the costs imposed on the economy may outweigh the benefits. In the American and European context, he argues that the right way forward is to stop fresh issue of high denomination notes, not declaring existing high denomination notes illegal:

There are also questions of equity and efficacy. We strongly suspect that those with the largest amount of ill-gotten gain do not hold their wealth in cash but instead have long since converted it into foreign exchange, gold, bitcoin or other store of value. So it is petty fortunes, not the hugest and most problematic ones, that are being targeted.
Without new measures to combat corruption, we doubt that these currency reforms will have lasting benefits. Corruption will continue, albeit with slightly different arrangements.
Nothing in the Indian experience gives us pause in saying that no more large notes should be created in the United States, Europe, and around the world. We were not enthusiastic previously about the idea of withdrawing existing notes from circulation because we judged the costs to exceed the benefits. The ongoing chaos in India and the resulting loss of trust in government fortifies this judgement.

Trump presidency and its economic impact

I am not persuaded that Trump as president spells disaster for the economy, as his critics would like us to believe.

The betting now is that the extreme proposals on protectionism and regulation won't happen. The tax cuts and spending on infrastructure will happen. I also think that most commentators have not given enough importance to the significance of his intention to revive detente with Russia. We've had a  revival of the Cold War in recent years and it's been threatening to get hot of late with the Americans siding the rebels in Syria and NATO's big push towards Russian borders. The peace dividend of a foreign policy could be very considerable and is something to look forward to.

Now, why would liberal commentators want to overlook something as significant as that?

My piece in today's BS on the subject:

Trump and tragedy? Not quite

In early November, a group of 370 economists, including eight Nobel Laureates, signed a letter that called Mr Trump a “dangerous, destructive choice for the country”. As the stock markets plunged ahead of Donald Trump’s victory in the US presidential polls, Paul Krugman wrote, “If the question is when markets will recover, a first-pass answer is never….we are very probably looking at a global recession, with no end in sight.”

Mr Krugman has already been proved wrong in respect of his first forecast. Following Mr Trump’s victory, the Dow Jones Industrial Average recorded its best weekly performance since 2011 and the S&P 500 its best since 2013.  Mr Krugman– and many others in the economics fraternity- could be proved wrong on his second forecast as well. The pundits, who failed to grasp the scale of Mr Trump’s electoral appeal, may turn out to have been prejudiced in respect of his economic agenda too.  

Mr Trump’s economic agenda is a mixed bag. His detractors have focused resolutely on his anti-globalisation stance while ignoring significant positives. The potentially biggest positive is not even part of his economic agenda. It arises from his resolve to rewrite US foreign policy: a reduction in geo-political risks and its economic benefits if he is able to follow through on his proposed rapprochement with Russia. 

Mr Trump’s campaign promise to change the rules on trade and immigration is a legitimate cause for worry. He has threatened to withdraw from trade agreements and to scrap ones under discussion. He has said that he will raise tariffs steeply on Chinese and Mexican imports. He wants to impose tariffs on American companies that relocate jobs overseas. He has also said that he will deport illegal immigrants and clamp down on H1-B visas.

Mr Trump cannot be expected to backtrack entirely on these promises- he has to meet the expectations of his core constituency. But his campaign rhetoric need not translate fully into action. American presidents don’t have a free hand on trade matters, they need to work closely with Congress. The general reckoning now is that pragmatism will prevail.

Tariffs on Chinese imports may be raised, for instance, but not to 45 per cent, as threatened. Some increases may be introduced as anti-dumping duties. Warren Buffett thinks higher tariffs are a bad idea but “I’m not going to say it will cause a recession”. 

Another big area of concern is the promised rollback of regulation. Mr Trump thinks that the thicket of regulations created in recent years is killing American business.  He has said that he will dismantle the Dodd-Frank Act, enacted after the financial crisis. It’s one thing to substitute Dodd- Frank with simpler and more effective regulations as serious economists have urged. It’s quite another not to regulate the financial sector at all- that’s sure to bring on another financial crisis. 

Turn now to the positives in Mr Trump’s agenda. Mr Trump plans to cut both personal and business taxes and steeply increase infrastructure spending. These would amount to the most ambitious fiscal expansion in the US in years. 

And fiscal expansion is just what the doctors – Larry Summers, Paul Krugman, the IMF, the Economist and several others- have ordered. They have all argued that monetary policy can only take us thus far. Low and negative interest rates have failed to deliver growth even as they have increased the risk of financial instability. Fiscal policy will come into its own will happen with a vengeance with Trump as president.

Increased government spending and tax cuts together are inflationary. That would give the Fed the opportunity to raise interest rates- just what it’s been looking to do. Higher rates will position the Fed to respond to a future recession with a cut in rates rather than through unconventional policies such as Quantitative Easing. QE was intended strictly as a response to the extraordinary financial crisis of 2007, it wasn’t meant to last this long.    

Many will carp about the increase in government debt on account of fiscal expansion. But we do know that there’s no better way to lower the debt to GDP ratio than to have strong growth. Mr Trump is a seasoned businessman. He thinks a cut in corporate tax rates will induce US businesses, who have stashed away trillions abroad, to bring these home. He intends to charge a one-time 10 per cent repatriation fee on profits that are brought back. 

It’s Mr Trump’s approach to foreign policy that promises some of the biggest rewards for the world economy. Mr Trump is, perhaps, the first American president since World War II to view Russia as a partner rather than an adversary. He has questioned the need for NATO. He has promised to work closely with Putin in dealing with ISIS in Syria. 

Such a radical change in US foreign policy would be excellent news for the world economy. Not only has the Cold War been revived in recent years, there’s the spectre of a conflagration in the Middle East and elsewhere with all its implications for the world economy. American and European sanctions have hurt Russia and Russian counter-sanctions have hurt the EU. Economic growth remains weak years after the financial crisis. A heightening of geo-political risks is the last thing we need at the moment. 

Mr Trump’s critics lament the possible demise of the liberal economic order. They seem strangely unconcerned about the steady erosion of the international political order that has underwritten global growth and prosperity since World War II. If they see any merit at all in Mr Trump’s proposed reset of foreign policy, they are not showing it.  

Protectionism and a rollback of regulation. Looser fiscal policy and tighter monetary policy.  Defusion of tensions with a Russia and a lowering of geo-political risks. Mr Trump’s agenda might be more attractive but it falls well short of being a disaster. At least he can’t be faulted for not trying something different where the existing policies have disappointed. 

(T T Ram Mohan is  a professor at IIM Ahmedabad. ttr@iima.ac.in)

Demonetisation won't by itself make a difference to black money

I should have provided this link earlier- I was among the first to comment on this subject in BS.

BS has a pay wall for opinion pieces, so here's the text:

Many have called the decision to demonetise ~500 and ~1,000 notes a “surgical strike”. They were, of course, using for best effect an expression that’s the flavour of the moment.
It’s, however, an incorrect characterisation of the government’s intent. A surgical strike is an operation with limited tactical objectives. The intent behind demonetisation is a frontal assault on black money, with a view to eradicating the problem. However, the expression could turn out to be correct in describing the eventual outcome. Demonetisation is a good initiative but, in itself, cannot be expected to make a big difference to black money in the Indian economy.
The scheme is expected to work as follows. It will render useless large amounts of cash held by black money operators. They will have to come forward, put their cash in legitimate channels and get exposed or they would have to simply discard their hoards.
There are several problems with this formulation. First, it assumes that black money is held overwhelmingly in cash. It’s not. Currency in circulation in the Indian economy is about 10 per cent of gross domestic product (GDP) — in the US, it’s about seven per cent. Black money goes into a variety of assets — business assets, real estate, gold, etc.-  and a relatively small proportion is held as cash. The proportion is higher in real estate than in other businesses. Cash is generated from businesses as required using a variety of means such as under-invoicing and over-invoicing, evasion of excise duties, etc.
Secondly, it assumes that the only means available for people to use their black money hoards is to bring them into the open by depositing these in banks. This again is not entirely true. There is a well-developed parallel mechanism for converting black money into white through the use of trusts and bogus companies. Those who have availed of it will tell you how astonishingly smooth and reliable its working is.  
Thirdly, we are assuming that black money operators are seriously at risk if they bring their money out into the open. This may be true of small businesses and self-employed professionals such as doctors and lawyers. Big-time operators, however, will find ways of handling the problem using their contacts with the bureaucracy and the political class. That’s how they have operated all these years. To expect that things will change radically overnight is to repose a degree in faith in the tax and law enforcement authorities that’s not warranted by past experience.
For many who have black money, the immediate effects could be unsettling. They may face temporary losses. However, once the new notes come into use, it will be business as usual. In other words, any destruction of black money that takes place could be a one-off effect. If it becomes difficult to keep more than a certain amount of black money within the economy, more of it will find its way out than before through the hawala route. It will come back as foreign institutional investment (FII), foreign direct investment (FDI) or private equity flows. Unless, there is a significant breakthrough in unearthing black money abroad – and this is still very much work in progress at the moment – the current measures may merely alter the proportion of black money held in India and abroad.
(The fact of the matter is that- pl delete)  Black money flourishes because it is part of the well-established nexus between business and politics. It is the biggest source of finance for elections and a significant source of income for politicians and bureaucrats. It is there because it suits the interests of the principal players in the system — businessmen, <i>netas and <i>babus. Seriously disturbing this equilibrium would call for changes that go well beyond demonetisation.
There will be consequences for the economy in the short-run, mostly negative.  Consumption will be adversely impacted. Stock market volumes can be expected to fall. Real estate activities will be hurt and there could be a fall in prices. The inflation rate can be expected to decline in the short-run because of the impact on aggregate demand.
Again, these will be strictly short-term effects. It is not clear that real estate prices will fall to a lower level even if the proportion of black money used in real estate comes down. Sellers will now have to pay more by way of capital gains taxes and they will factor this into the sales price. This could well offset the impact of lower demand.
Banks will be flush with deposits in the months ahead. But this need not translate into higher growth in credit. Public sector banks, which account for 70 per cent of bank assets, are averse to lending today because of the pile-up of non-performing loans and for want of adequate capital. They are unlikely to step up lending because deposits have gone up. More likely, they could reduce their dependence on bulk deposits and hence their cost of funds.
It’s interesting that the Reserve Bank of India has portrayed the move to remove higher denomination notes as an attempt to check the use of fake notes, not as an assault on black money. That’s perhaps a more accurate way of describing the initiative. It has all the makings of a surgical strike, not so much an all-out war.

More on independent directors

I have a piece in the Wire on independent directors in the context of the Tata ruckus.

Indian Hotels independent directors' move is a first of sorts

The unanimous support that independent directors of Indian Hotels Ltd have given to Cyrus Mistry is a first of sorts- so far a I can recall- and it adds to the damage done to the Tata group done in recent weeks. The six independent directors said:

After deliberations, the independent directors came to a view that being a listed company, it was imperative for the independent directors to state their views to the investors and public at large, such that those who trade in securities of the company make an informed decision,

Taking into account board assessments and performance evaluations carried out over the years, the independent directors unanimously expressed their full confidence in the chairman, Cyrus Mistry, and praised the steps taken by him in providing strategic direction and leadership to the company.

The independent directors have thus gone against the preferences of the dominant shareholder, an act of defiance that is entirely welcome, given that independent directors in India are widely perceived as chamchas of the promoters, often backing them to the detriment of the interests of minority shareholders.

It would be premature, however, to conclude that this marks the beginning of a trend. For one thing, we do not know how many of the independent directors were appointees of the Tata group and how many were appointees of Mr Mistry. Independent directors need to be independent of both promoters and management (although often the two are the same in Indian companies).

Secondly, I fear that promoters will now become even more circumspect in their choice of independent directors- they will only pick independent directors of whose loyalties they can be entirely certain. Perhaps, we will see more distant relatives and ex-employees as independent directors. The outcome of the Indian Hotels' independent directors could thus be turn out to be quite perverse in the long run. We need radical changes in the process of appointment of independent directors of the sort I have long advocated (see my earlier post on the Tata controversy).

Meanwhile, the blog post of Nirmalya Kumar, the former London Business School professor, who was advising Mr Mistry on strategy and was asked to go along with Mr Mistry, has elicited widespread sympathy.

It's not just the summary removal that is the issue. Prof Kumar joined the Tata group, he did not join Mr Mistry in a personal capacity. It is not that he was implicated in any improper decisions. Is it the contention of the Tata group that when a Chairman or CEO is removed, those around him must leave because they were "close" to him? I know this happens all the time in many places. Somehow, one expected things to be a little different at the Tatas.

Goodbye to central bank independence?

Central bank independence is an idea that came out of the stagflation in advanced economies of the 1970s. High inflation did not lead to reduced unemployment- the world discovered the truth that the Philipps curve trade-off exists only in the short-run. If you keep boosting money supply for too long, you get only inflation without the associated benefits of reduced unemployment.

So politicians decided they would leave it to central banks to decide monetary policy as a means of imposing overall macroeconomic discipline. Central banks would then no longer underwrite unlimited government borrowings and this was good for the economy.

Now central bank independence is under threat- and it's not on account of politicians, the Economist points out. The problem is the steady decline in interest rates in recent years, culminating in negative interest rates in many countries. Monetary policy no longer appears effective and this undermines the authority of central banks.

Moreover, the tool that some banks have resorted to, Quantitative Easing, which involves massive purchases of government bonds, amounts to the purchase of government debt using newly printed money- precisely what central bank independence was intended to avoid!

At the same time, there's a general sense that fiscal stimulus has a key role to play in the present situation:

Although economists remain broadly in favour of central-bank independence, the amount of new research affirming the importance of stimulatory fiscal policy is growing. The continued economic doldrums are also creating a political opening for more aggressive fiscal action. On August 2nd the Japanese government announced new stimulus measures worth ¥4.6 trillion ($45 billion) this year. Both American presidential contenders have plans that will raise government deficits, and the British government has abandoned its target of balancing the budget by 2020. Low interest rates have emboldened politicians who might otherwise have ignored the calls of frustrated voters for fear of the bond-market vigilantes.

As monetary policy wanes in influence relative to fiscal policy, so will the importance of central banks.

Here in India, we have seen a movement away from the commitment to a 4 per cent inflation target on the part of the RBI. This has at least partly to do with the perception of the political authority that rigidity in respect of the inflation target of 4 per cent was coming in the way of higher economic growth.

Central bank independence is not ordained by the gods. It was a mechanism devised by politicians in response to a particular economic situation. You can count of politicians to reduce its importance in a different economic situation.

Quote of the day

"Ratlike cunning, a plausible manner and a little literary ability".

Qualities of a successful journalist, according to Nicholas Tomalin, a member of the breed. (The Economist, September 20, 2016)