Since 97 per cent of the value of demonetised currency has returned to the banks, causing, contrary to the government’s expectations, very little extinction of currency, it is obvious that demonetisation has totally failed to achieve its purported objective of denting the black economy. It has, however, contracted aggregate demand, slowing overall growth and particularly damaging the informal sector where the poor are congregated.
It has done so by transferring a vast amount of purchasing power from people’s pockets, from where it would have been spent, to the vaults of banks where it is lying idle.
The budget, coming in its wake, was an opportunity to partially undo the damage caused by demonetisation, by boosting demand in the economy through larger government expenditure, and doing so in a manner that augmented the welfare of those most hurt. The government was even rumoured to be toying with such an idea; many saw a hint of it in the Economic Survey’s talk of a basic minimum income for all (though this can have disastrous effects if it becomes a substitute for, rather than a complement to, existing programmes like the MGNREGS, subsidised public distribution of foodgrains and public provisioning of services). The budget, however, instead of countering the recessionary effects of demonetisation, has actually added to them.
The rate of growth of total government expenditure has been halved, from about 12 per cent between 2015-16 and 2016-17 (RE) to just 6 per cent between 2016-17 (RE) to 2017-18 (BE). As a proportion of GDP, total expenditure is slated to fall between 2016-17 and 2017-18. True, since the current budget has been presented at the beginning and not the end of February, the data for the third quarter of 2016-17 are incomplete. This, together with the effects of demonetisation, makes all the budget figures dubious. But no matter what the precise figures, the fact that the budget, far from countering the recession, will contribute towards its persistence is quite clear.
What is remarkable is not just that the budget does nothing to offset recession, but that it could have done so quite easily if only it had wished to. The means for doing so were literally in the government’s hands. The banks are awash with deposits forced out of the public, on which they have to pay interest. On the other hand, borrowers whom they consider “creditworthy” are not exactly knocking on their doors for loans, so that they literally earn nothing on these deposits. Their profitability is thus threatened, because of which the Reserve Bank is placing government securities out of the stock in its possession with banks in return for their idle cash, thereby lowering its own profitability.
The RBI, in short, is shoring up the profits of banks, awash with idle cash, at its own expense, which also means at the expense of the government (since RBI profits are the government’s income). Lest the RBI run out of securities, the government is selling “fictitious” securities to banks, on which it pays interest but whose proceeds it cannot use for spending. In short, the profits of banks, awash with cash, are being shored up by the government’s budget. Demonetisation has caused both a recession by shifting purchasing power to banks where it lies idle, and a drain on the budget by paying an interest, in different ways, on this idle cash.
Now, suppose the government had actually sold fresh securities to banks and used the proceeds of such sales for enlarged spending; its interest payments to banks would have remained the same, while additional expenditure would have been generated for countering the recession.
Put simply, the purchasing power transferred from the people to the banks could have been transferred from the banks to the government, so that total spending in the economy could have been maintained, and recession countered. Since the “despotism” involved in forcing people to deposit cash with banks has already occurred, and has not been undone, no matter how these deposits are used, the government could have used them for spending, instead of letting them remain idle. Doing so would have had no adverse consequences; indeed, it would have been no different from the “compulsory deposit” schemes of yore that India used to have.
True, as new money got printed and people moved from holding bank deposits to holding new cash, the amount available for such borrowing by the government would have decreased. But the government itself has announced that it would not print new notes equivalent in value to the demonetised ones; it would leave a gap of about Rs 1.5 to 2 lakh crore, in order to push people towards cashless transactions. This “ill-gotten” amount at least could have been tapped for government borrowing.
This opportunity, however, has been foregone in deference to the whims of global finance: Such spending financed by fresh government securities that mop up banks’ idle cash would have counted as fiscal deficit (though with no actual adverse consequences). Global finance disapproves of fiscal deficits.
Donald Trump is busy imposing trade restrictions, and hence snatching employment through a “beggar-my-neighbour” policy from other countries, including India.
Our country should be countering Trump’s protectionism and preventing job losses by imposing trade restrictions of its own, and in the shadow of such restrictions, increasing the domestic market through larger fiscal deficits, backed by requisite capital controls.
The Modi government, ironically, is doing the exact opposite. The job losses caused by the world economic slowdown that is hitting us rather belatedly, by Trump’s protectionism, and, above all, by Modi’s demonetisation, could have been somewhat mitigated by an expansionary budget. The current budget, alas, threatens further contraction.