Raghuram Rajan speaks on demonetisation, economy and life after RBI: Full text of interview
Economist and former RBI governor Raghuram Rajan speaks to HT about the impact of demonetisation, the benefits of GST, Indians’ knack for ‘jugaad’ and working on building a liberal arts university in India.
Q: Many congratulations on your new book. Already a lot of debate has been generated, specifically on demonetisation. I know you want to talk about a lot of things, but a few questions that still remain unanswered...
A: That will remain unanswered.
Q. You have talked about an RBI note to government on the preparations and the time required for demonetisation. Can you share the details?
A. I have a duty not to reveal specific communications. Let me step back from whatever note was given and not represent what was said there. As a monetary economist, what you would like to see in any such exercise is that the day you do it you should be ready to replace all the currency withdrawn. We have seen the cash demand is now tapering off, but you should have been ready with that sort of cash on the day we did it. The less you are ready, the more you have to print in order to roll out the currency, the more economic life is disrupted.
Q: We saw the cash situation getting somewhat normalised around end of March. You are suggesting that’s the kind of time the government should have kept in mind.
A: Exactly. Remember that RBI mints and government mints were working double pace, triple pace, over this period. So that time was compressed relative to what would have happened hadn’t there been this sense of emergency.
Q: Were there ways to prevent some of the people who held illegal cash but managed to put it into the system?
A. I think one could have thought of and figure out ways to prevent that, perhaps. But human ingenuity is pretty significant in India. We are a very clever people, especially I think when it comes to jugaad. The real question you have to ask is how easy is it to prevent all this? And if it’s not, what is the amount you are going to cash in through this process.
Q. Some learning would come.
A. Some learning would come. You would figure that there are loopholes you would try and close. That goes with the territory of it being new--I don’t want to opine on that particularly.
Q. You said there were other alternatives to achieve the goals of demonetisation. What could have been those alternatives?
A. First, the intent of getting greater tax compliance is important, worthwhile, noble intent. How do you do that? In the longer run you may want to deal with the stock, but it is also as important to deal with the flow. You want to create much less incentive to create the black money and much less ability to hide the money that comes. One way is to reduce the space in the financial sector for hiding this black money -- for example, seeding all deposit accounts with Aadhaar, which the government is doing.
Q. You necessarily don’t need a move like demonetisation to achieve this.
A. I think if you are dealing with the flows, then you don’t need to work on the stock as much.
Q. This addresses the stock question primarily. And there also we haven’t’ seen much of success…
A. We have to wait and see what the Income Tax Department does with this kind of information about where the money has come in, into which accounts. Now given that an amnesty scheme was also proposed and the money came in despite that amnesty scheme, presumably some amount of hiding has gone on. That is not as obvious as you see the money in the account and the fellow confesses that this was all illegal money. So some effort will be required.
The other thing is how much can it withstand court battles and so on, at the end of it what comes back. It remains to be seen.
Q. You felt the short-term economic costs of demonetisation might outweigh possible longer-term benefits. Aside from slower GDP growth, what are the other costs?
A. One of the costs which people haven’t paid enough attention to is (that) this was money sitting, if you believe it was black money, it was sitting in people’s safes or in their basement. It wasn’t earning any interest. Once it gets into the formal system, if you haven’t identified it as bad money, there are people gaining interest on it. So you are paying people for now their black money because they have put it back in the system.
Q. If the expectation was that Rs 3-4 lakh crore were held in dodgy cash, you probably ended up paying Rs 10,000-12,000 crore at a savings bank interest rate of about 4%?
A. Four per cent would be Rs 16,000 crore on Rs 4 lakh crore. But remember the RBI is sucking this excess liquidity out at 6%, so it’s about Rs 24, 000 crore then. That’s what you have to pay every year if it stays in the system ... The fact that the RBI surplus has come down by Rs 30,000 crore-plus suggests that this is not an insignificant cost and over and above note printing and note cleaning up. So when people thump on the table and say we have formalised this, I think they misunderstand what cash actually is.
Q. What were the possible longer-term benefits?
A. I think tax compliance has to be the biggest benefit. If you can get better tax compliance… I mean every finance minister complains about all these Mercedes floating around and nobody actually paying taxes or nobody paying large amounts of taxes. And better tax compliance in this country would give us more sort of resources to make the kinds of investments that we actually need. That has to be the single biggest benefit. The others are more minor, I mean digitisation is a good thing but would happen. Digital transaction growth has been happening quite strongly.
Q. Is there a psychological impact possible? People would be less inclined to hold large amounts of cash now?
A. There can be positive and negative. Positive is if they avoid hiding income. Negative is if they are worried about spending or investing because they fear the tax authorities. And we are at a point where we have fairly weak growth. So, better that we incentivise the positive aspects rather than the negative aspects.
Q. Do you think the timing of demonetisation could have been different to yield different results? There has been a suggestion that the Indian economy was in a very healthy state to take on such a measure. Was it the other way round?
A. Look, I’ll just make a common point -- not on demonetisation but whether the economy was healthy, given the GDP numbers at that point. Remember we had a re-evaluation of growth based on the new GDP numbers from the old GDP numbers. What was 5% in the old went up to 7%. In the quarter before demonetisation, which would have been about the last quarter reading, it was about 7.5%-7.6%. So 7.6% was about 5.6% in the old reading, which few people would have said is hugely strong. So I think... to say that we were back to the old strength, which was 7% or 8% in the old numbers. Again, you can’t do this exercise as crudely as I am saying it... but would require, I think, a stronger growth than 7.6%. So I don’t know what people mean by healthy. Private investment has been falling for some time. So until we see private investment pick up, our industrialists are not voting with their rupees on the health of the economy in a positive way. They are holding back. I think that would be a true test of health when we see the private investment picking up strongly again.
Q. How do you see the Indian economy doing? What’s the way forward?
A. On the positive side, a number of reforms have been undertaken, some of which, like GST, may have a short-term negative effect, but hopefully in the longer run, will have a very positive effect. We have established a little bit of a reputation for doing the reforms.
Going forward, there are three areas of concern. First, the twin balance sheet problem -- of the corporate and that of the banks. The second sector I worry about is the (debt-ridden) power sector. The other concern is why are we not doing better when the rest of the world is picking up on its exports.
Q. What is your understanding or assessment of why we are not able to get exports back on track?
A: I don’t know…I mean one of the areas of success in the past was engineering exports…I don’t know why they are not picking up as strongly. Maybe part of the reason is that we are not part of the global supply chain to the extent that we ought to be. But that’s not an entire…it’s not a compelling explanation. So, the answer is I don’t know and I think it’s important to find out. But exports has been area of weakness and underperformance.
Also, remember that in terms of growth we haven’t had any further benefits from lower commodity prices, which have been a big benefit over the last few years.
So, ultimately for the medium term, we have to improve the quality of our education system, of our skill building system. Without that, 10% growth is a dream, which we will find hard to achieve. We need to accelerate the process by which our children learn and learn in an effective way.
Q. As we speak, you know private investment remains sluggish. Gross fixed capital formation in the last quarter grew at 1.6% compared to 7.9% a year ago. How early do you see a turnaround in that, as you said, if investment demand doesn’t pick up?
A. The good news is that it can’t stay low forever. At some point, people have to start replacing old capital and so on. Ultimately, it’s the strength of demand. Remember, cash utilization is also not that strong. The strength of demand will define whether people will start investing once again. But that’s just one fact. The second is confidence. That in fact that there are no surprises left, that in fact, you know, as they invest they will get support and things will become better. I would say perhaps some efforts there are still warranted.
Q. Do you have concerns on the inflation front?
A. I don’t know enough and I don’t want to comment on the monetary policy itself. So I think on inflation it’s better that I keep quiet.
Q. But are you concerned about the food price deflation that we saw over the summer?
A. I think I’ll just avoid talking about the entire issue.
Q. How has it been going back to teaching, Professor Rajan?
A. See, research and teaching is my profession (laughs). It’s fundamentally what I do. And it’s been fun re-engaging with students. I have a lot of Indian students in Chicago. Some people say, why don’t you teach Indian students? Well, I’m teaching Indian students except I’m teaching them in Chicago.
But also working on a new university in India, building out a new liberal arts university and some of my time here I’ve spent on that. I am very excited about the possibility.