Thursday, December 1, 2016

Rich will lose wealth and Poor will lose jobs

Debates on the effects of demonetization dominate every kind of media. Economists are rolling out all kinds of numbers from -0.25% to -3.5% of GDP growth slow down. While no one questions the intentions of this master stroke but the effectiveness of its implementation is where the opinions are divided. Look at following points and then you can form your opinions.

Time to Digtial Economy: This may look good as a slogan but do you know how much is the penetration of Internet and Smart Phones in our economy to go cashless? How will those living below the poverty line buy a smart phone and get a data pack to use mobile phone as their wallet? We do not have consistent power supply in many villages and when it rains, the mobile towers do not function for days. When villagers are struggling to get clean drinking water and primary health facilities, going for a cashless system will force them to migrate to towns but the cost of living in towns and the availability of jobs would put them into helpless situations for a long time to come. Our former PM Man Mohan Singh reminded us ‘In the long term, we all will be dead’. Yes, both the poor and rich, all of us die in the long term. But this move will likely make the poor move closer to their death prematurely. Short term impact can really be devastating. If the situation is not handled well, the same people who hail Modi now will begin to criticize him.

Self-Defeating mechanism kicks in: When Real Estate transactions reduce, construction activity reduces which employs unskilled labor in big numbers. And the consumption of Cement and Steel would come down. That would mean the mining activity will also see a slowdown. What will happen to the new investments in these sectors? How about the new jobs which were supposed to be created in these sectors? Automobile industry is cutting down their production levels. If the situation continues for some more time, how much will be the job loss resulting from it? When GDP growth begins to slow and deflation begins to hurt, rich will lose their wealth and poor will lose their jobs.

Pressure on banking system increases: We thought liquidity will drive down the interest rates but RBI has a different plan. It sucked out the liquidity, may be for a good reason. But this will push out the timing to reduce lending rates for banks. When the revenues are going down, profits will slide at a higher pace and this will put a dent on many companies ability to service their loans. Bad loans will raise again. Most of the existing bad loans are in Infrastructure space and that sector will see a significant headwind (as demand for cement, steel drops), so the pressure on banking system will intensify.

If relief measures (such as reducing taxes) are brought in, it may compensate for the damage partially but how soon they will roll it out and what would be the magnitude of it is not known yet. But the long queues at Banks show the struggle for a common man to get the cash to spend on the necessities. The behavior of Indian is going to change for sure, but will it be for good? It depends on further steps the Govt. will take. Acid test has begun for them. If they cannot manage it, they will learn a big lesson themselves despite good intentions.