Benefits have to be really large to justify demonetisation costs: Raghuram Rajan – The Economic Times–06.09.2017

Edited excerpts:

Now that we know the damage caused by demonetisation , was it really worth it? Is it more than what you had told the government in your `cost-benefit’ report?

  • I don’t think we fully measured either the costs or the benefits. So I think it will be premature to make a judgment as to this is what it is. Our advice was on how to minimise the cost of the exercise and so weren’t really estimating costs. On benefits, until we fully know the extent of the benefits, it will be premature to say this is a good thing or a bad thing. But I would say, given the build-up of the data so far, the costs have been quite substantial. So the benefits have to be really large to justify the costs that we have seen so far.

So what are the likely benefits?

  • I think the biggest benefit has to be about a signal on tax compliance, and if this can move the economy towards greater tax compliance. You know every finance minister has complained about how few people pay taxes relative to how many luxury cars are bought or how many luxury houses are sold. Better tax compliance is certainly very important for the country and to the extent that we can move the country towards better tax compliance… that has to be the biggest benefit of any move against black money whether this, or something else.

During your time, RBI was not asked to take a decision on demonetisation . Subsequently, it was done. Would you have done what the RBI did. Would you have quit?

  • That is a hypothetical question, and is unfair to offer an answer to that because you haven’t been precisely in that situation. So you can tailor an answer to whatever you think the audience wants to hear. There have been some statements made so you can get a sense of what some central bankers think. Dr YV Reddy said he would admit himself in a hospital and then resign. I think in general most monetary economists would think that the cost of doing this without having the money printed could be quite substantial and uncertain.

A lot of blame is laid at the doors of the RBI for poor preparation…

  • I don’t think it was possible to print the money that was required to replace the entire stock that went out of circulation between the time the printing started and the time the demonetisation was announced. So, if the money was simply not there you can’t distribute it to the public. You could talk about some concerns about the distribution etc., but there wasn’t enough money printed.

Many times your speeches were seen as if you were taking on the government. There were references to Hitler, intolerance. Why were your speeches beyond what governors in the past have said in public?

  • I think if you look at the speeches with a dispassionate light, as opposed to trying to read something in them, you will see that all of them convey an economic principle. And they are all trying to perform an equivalent role of what we were trying to do as well as in some cases educational. In cases where it was more a conference or a convocation, there was more of an educational component. In case where it was a speech to the bankers association, it was more of explaining what we have done and what we are trying to do. There were no speeches on Yoga or Bharatnatyam, or whatever. So when people say you are talking about things that are beyond your remit.
  • I don’t think they understand that we are talking in general about the economy. Even the speech on tolerance which was at a convocation… so note the venue, you can’t talk monetary policy at a convocation, but you are trying to give youngsters a sense of what is good about India. It was a speech reaffirming how capable and strong India is, where it emphasises its fundamental strengths of tolerance and openness. I don’t think it went against what you can speak on and that it’s necessarily a speech against the government. In fact, I met a government minister exactly one week after that speech and he said that this is exactly what I have been saying. So the interpretation comes from the sense that oh the government was intolerant when in fact that the word government wasn’t even mentioned in the speech. And it was more about praising India’s heritage of tolerance.

But the timings and topics of such speeches… didn’t you have the government in mind at all?

  • If you hear what the Prime Minister says in his speeches you will see that he is trying to project openness and tolerance. People read into what the government ministers say and argue that there is a hidden agenda in what they say. Similarly, they argue that there is a hidden agenda in what I say. I think these people should look at what the speech actually says.

Sir, coming back to the economy….. that the damage is behind, what should the government do now?

  • I think it’s important to try and selectively look at some of those red flag accounts for evidence of black money in a fairly disciplined way so that it doesn’t become a roving expedition, and that ordinary people are not subject to harassment.., that may be worth doing. But I think it is also important to move forward. This is bygones. Two things need focus on economic problems at hand which are, one the low level of private investment which may be a function of the twin balance sheet problem which needs to be resolved as quickly as possible – cleaning up the balance sheet of companies as well as banks.


  • So, I would focus on that as the important step, I would focus on the power sector in which there is some signs of stress, the UDAY scheme needs to be moved forward from just the financial aspect to the real aspect.. to getting the line losses down, to getting the tariffs to better match what the costs are and not have the renegotiation of the PPAs that is happening, because after all a contract is a contract. The third element is to focus also on the medium term which is the education and skill building that we absolutely need. It’s important not to create new uncertainties into the process. At a time when the world economy is picking up, at a time when the oil prices are still relatively low, we need to take advantage of this good environment rather than at this point sort of let it pass by. Starting new projects will take a lot of time let’s move these stalled projects so that their full benefits can be realised. Essentially implementation is very important. The infrastructure projects that have been talked about especially the eastern freight corridor and western freight corridor, all those things need to be fast tracked.

Bankers blame the pile of bad loans and the provisioning burden to the asset quality move that you initiated. Did you go wrong?

  • Well that’s ever greening….. people were hoping that they keep kicking it down the line somebody else will take responsibility. These projects were so precarious you couldn’t kick them down the line anymore. If it is not functioning, if it is a gold plated project where the money has been over spent I think at some point you have to recognise it was a bad idea and it is not going to work. How much longer are you going to keep it in a state of suspended animation? I think the bankers were really resisting recognising reality. So the regulator just makes you recognise reality he is not interfering in the process. But then you turn around and blame the regulator. I think it’s just a travesty.

Now we have a bankruptcy law. Some blame on it for the fresh round of woes. And even RBI had to intervene… Should the regulator do such things?

  • Ultimately its important to put these assets back on track for that the banks have to take appropriate haircuts, promoters have to be thrown out if they are incompetent or if they are competent they have to put skin in the game or equity written down appropriately. For these kind of action we have been crying for the last 3 years. If the bankers are unwilling to do this if they fear being hauled up as soon as they take a hit then we are all living in la la land. The reason for the RBI being directed is that the bankers aren’t doing it. Now it’s not an ideal situation for the RBI to be making commercial decisions. Taking an entity to bankruptcy is a commercial decision. Ideally bankers should be doing it. We should create an environment that bankers are willing to do it where necessary. We need to work on that.


How do assess the performance of this government in terms of it’s the economy? Mr. Arvind Subramanian has forecast GDP in the 6.75 – 7.6 percent band?

I don’t think we can be satisfied with 5.7%, I don’t think it’s necessarily the resting place, I think economic growth will pick up. I think there have been a number of factors responsible for the slow growth but what we really need to do is also use this as a wake- up call that yes there have been a number of set backs but we cannot be satisfied by going back to the levels we were at. Remember the UPA government ended with about 7% growth. If we are still at that level, all the reforms haven’t added more. I think we are fully capable of moving to higher levels of growth and we should work very hard to ensure we change that.

PSU bank consolidation has come on top of the table for the government. You have earlier said that they almost look likes, clones. Will consolidation make a difference, or will it be just lipstick on a pig?

  • I am not saying that there is a case where consolidation is unwarranted, but you have to be very careful in asking the question what problem is consolidation going to solve?. Consolidation itself requires a whole lot of time and effort by bank CEOs and bank managers throughout the system. You have to merge IT systems, you have to merge cultures, you have to merge HR systems etc that involves a tremendous amount of work. Now are you going to add that on top of that fact that they are already weak banks because they are already weak banks and they have problems in their balance sheet. You have explain how it is going to be easy to do that. Why this is going to be helpful and not just another distraction which weakens the entire entity. The second thing to ask is, are all these plans going to be decided by the North block? If so, if they are all going to be decided by the North Block isn’t it going to instil sameness in the banks which means who haven’t really moved to the Gyan Sangam requirement that we need to have some differentiation. If North Block decides then where is the differentiation?

You have been championing professionalization of bank board. Two years have gone by and the Bank Boards Bureau is almost dormant with some member quitting and coming back? What signals do you receive?

  • There is an underlying the problem with the Bank Boards Bureau. There may be a reason to look at what it’s been entrusted with. If all we have done is replace a committee which was set up by the government to select bank CEOs by the BBB with broadly the same composition and have the same process of vetting by the appointment committee of the cabinet, then we haven’t really moved forward. I think that system might have been useful initially to get comfort but ultimately what we need is a separation between the government and the public sector banks. And that means put the PSU banks under their own board, for that appoint independent board directors who have expertise and be prepared to pay them adequate remuneration as directors of banks. Essentially the difference between public sector banks and private sector banks should be that public sector banks have more government directors who try and explain why the board should do certain things in the best interest of the bank. If the government wants certain public services it should pay for it. And anybody — public or private sector should be willing to do that. I think that is where we should be heading towards and we need to take certain steps in that direction

Now we have moved to the Monetary Policy Committee setup, but the market somehow is confused at the message sent out by policy makers. How do you read this?

  • As policy makers you have to keep working on your communication because part of the inflation targeting framework is clear communication with the public and the relevant audiences. So if there is a misinterpretation of what you are saying, or what you are trying to do, you have to try and rectify that at some point in time, in future statements or in notes that you put out that, this is what we mean and this is why we have said this. So communication is an ongoing exercise and we have to work quite hard at it.

You spoke about tax compliance and strengthening drive against black money. Is Aadhar the right way to go about ensuring compliance?

  • There is always an issue of privacy which is important that the intrusiveness which has increased so much because of big data that is available be limited, that people have access to data only on a need to know basis and that need has to be clearly established. So, all those safeguards certainly need to be put in place if they are not already there. At the same time I think the unique ID offers a lot of benefits for the individual, for example some finance companies have started to lend based on the credit history linked to the unique ID. If the credit rating bureaus base it on your address, there are so many ways you can describe address in India they have to go through various algorithms to clean up the address itself and make sure it’s a unique address. So many problems can be alleviated with Aadhaar, I think to the extent that we can satisfy the genuine and reasonable concerns of the Supreme Court we have to do that. Of course and then move forward to using it to get better compliance.

When you took over, India had negative real interest rates and now we have the highest real rates among emerging economies. But there is a disconnect between market rates and policy rates. Are we having right policy prescriptions?

  • No, you have to be careful that you are focussing not on the latest reading of inflation but the look forward to where that inflation will be. If the actual inflation looking forward, say a year ahead was 1- 1.5% and if inflation had really collapsed in India you would expect the long rate to be below where it is now. Long rate is a rate which is not managed but which at this point is more than 6%. If you thought inflation had collapsed you should see the long rate much lower. That is telling you that at least market expectations of inflation are not as low as the 1-1.5% that we are seeing in the latest readings.

But the market conditions are also impacted by what the MPC says

  • Not necessarily. If you think that the MPC is being overly tight the market expectations of inflation should be really low, and so the long rate should have collapsed.

With independent monetary policy, and a surge in flows hurting exchange rates, are we again at the impossible trinity situation?

  • More than many other economies we have a pretty good control over the extent of money coming in, so we already have a fair amount of control over flows into debt for sure.

What are the risks that are building up in the global market, with unwind of QE round the corner?

  • This is the tricky part. We don’t know where the risks are buried. We do know that there are some places where we are seeing some losses. For example, in auto loans in US there is some worry, about housing in Canada, housing in Australia. The central bank Governor has already warned about that. Wo typically places that didn’t have a problem the last time are places where you might expect to find more of a problem this time as rates are raised. That said we have had a pretty healthy warning with the global financial crisis so people are have been a little more careful since then.

You had mentioned that you and the government could not agree on terms for your another term. Can you explain?

  • Ultimately, you start discussing, and at the end of that there is an offer. And I just said that there was no offer on the table. So that’s when I left that’s it.

via Benefits have to be really large to justify demonetisation costs: Raghuram Rajan – The Economic Times

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