It was the spring of hope, it was the winter of despair

“It was the best of times, it was the worst of times” so begins the legendary novel "A Tale of Two Cities". India too is at the same point.

We have Banks flushed with liquidity but the queues are long at ATM’s to withdraw a tiny amount of that cash ocean.

Experts are saying real estate prices will come down but if it that happens, construction sector will take a hit and many daily wage labors go jobless. They do not have skills to do other jobs. While many dream of buying a new home as they become affordable, those who build it are in despair.

Interest rates will be lower and you say happier times? But wait, GDP growth will come down too and that is not good news. "This is war on corruption" says those in power. But the opposition parties are asking "What prevents the corrupt asking for Rs.100 bills or Gold instead?" Is this time to smile or sigh?

Let us punish the black money hoarders, says the PM. But the poor are helping to convert the black money into white for a commission. Who is really corrupt? India is a land of contradictions. Always, in the past, now and in the future too. Is that our pride or enemy?

The more we clean more the debris piles up. The root of this evil is in higher population competing for limited resources. We, Indians are competing with ourselves rather than cooperating. Else, the corrupt are competing with whom else? Roots of Economics lie in Sociology. If we don’t fix the population growth or increase the resource availability (most of it is not in our hands), competition will only intensify. The tendency to hoard does not whither away. But none of our leaders (and media too) are talking about this. They are rather interested in dividing us by religion, income levels, black or white money holders. 

It is the season of Light, it is the season of Darkness. Hats off to Charles Dickens!

Real reform lies elsewhere

A person’s wealth could be much more than his annual income. Similarly a nation’s wealth is much more than it’s annual income or GDP. And black wealth (acquired through black money) is multiple times the black money in cash. Cash supply in the system is at 12% of GDP (not national wealth). In the previous blog post, we have seen that the money to become scrap could be around 10% of cash supply. That means only 1% of GDP which is in the form of black money in cash is going to be destroyed. Well, that is very little achievement. So I feel banning of Rs.500 and 1,000 currencies is more of a tax reform rather than a blow on black money.

All the black money will not remain in cash. All the cash in higher denomination is not black money either. Let us evaluate the first sentence – all of black money will not remain in cash. It is because those acquired it will spend it. They go shopping, they travel and that money comes back to circulation. But the majority of that money ends up with three things: Gold, Real Estate and Private Finance. Be it a corrupt official in a key position or a mining baron, they would convert their black money into real assets over a period of time. Else real estate prices would not have become unreal. And a portion of that money gets into private finance business too. It is black money in the hands of lenders but what about borrowers? Think of a vegetable vendor, who borrows to run his or her micro-enterprise. While I am not sure about the legality, it is not immoral to borrow to earn a living. After all, money does not have a color to classify but it is who holds it matter. So those who lent money in the denominations of Rs.500 and 1,000 bills will escape from the recent action. Their money will be promptly repaid with new currency bills over a period of time. Now what is the color of that money?  So banning the currency notes cannot deliver a serious blow to black money. Then, what can be done? Here are my thoughts:

o   Limit Gold buying and selling to a determined quantity per person per year and make the ID proof (PAN/Aadhar) mandatory to track the transactions. This will help reduce Gold import and fix our trade deficit while it acts as a check on alternate money. Super rich will be annoyed but anyway their eyes are already red. Anyone willing to buy more than the fixed quantity should be made to declare their income source and ensure relevant taxes are paid.

o   Reduce the gap between guidance value and the market value during property registration. Introduce TDS for capital gains making the transaction through banks mandatory. This would be a real check against the interests of black money.

o   Kill the private finance industry by deepening the banking reach and by providing short term capital for small vendors. Though it is easier said than done, it is a necessary step to stop the black money coming back into circulation.

All these ideas are about stopping the black money coming back to circulation but how about killing it at the source? How about firing the corrupt officials in mass, cancelling the licenses of illegal entities and making more checks before PSU banks lend to the likes of Vijay Mallya? For sure, real reform does not lie in banning high denomination currencies. There are ample opportunities elsewhere. Hope and wish they would come into action sooner than later.

The corrupt machinery has been caught off-guard now and I hope that tightening continues to trigger a reversal of black money mechanism. We need not be sympathetic towards those who are losing out their wealth now. We have already paid a price for it in the form of inflation. Tables are turning, thanks to courageous Prime Minister. Let us make India great.

How much cash will really become scrap?

Long queues at Banks tell the story of changing India. At the same time, the impact from the move seems to be exaggerated too. I formed that opinion after creating the following decision tree. Take a look:

First of all, all the cash in supply is not with the public. A major share is in banks and a good amount of money is with corporate in the form of working capital and Utilities companies too are sitting on cash in the form of customer receipts. It is all unaffected by the move to ban Rs.500 and Rs. 1000 notes.

Let us come to Public holding. Salaried people have already paid tax through TDS, so they do not have issue getting the cash on hand converted. The low wage labors are unlikely to have more than Rs.2.5 lakh cash on hand per person. If they don’t have a bank account, they will get one and the cash will be converted too. Their money is unaffected.

Then we have self-employed people like Doctors, Film actors and people in many other such professions, some of them earn handsome pay while others just earn a comfortable living. These people receive their earning mostly through cash payments and if they had remained on cash, they would be in trouble. And if that money is less than Rs.10 lakhs, they will likely declare it, pay tax and rest of the money goes back to their pockets. Few celebrities may lose good money but they are very few. But yes, some of them will have to part at least with their cash.

Small businesses, like the neighborhood grocery shop keeper, who mostly operated on cash, will face serious troubles. But they can do damage control by depositing their money in the family member’s names, paying advance salaries, settling dues etc. Yet, they are the one to lose considerable money. They looked street smart until now but now their fate has changed for bad.

The real trouble is for the people in the cash-heavy businesses. They are going to lose significant cash wealth. Real Estate looked as a promising business for them but now the rules have changed. But the challenge is to know how much cash is with them.

While the data for distribution of cash is not publicly available, we can do some guess work to get an estimate. Majority of it is likely to be with Banks and utility and service provider companies which is perfect legal and valid. If we assume 1/3 rd of the cash remains with public and half of may be on its way to become scrap. Let us put this into equation:

Scrap Money = % of Rs.500 and 1,000 bills x % with public x % of likely scrap

= 87% x 33% x 50%

= 14.35%

Since this is all guess work, actual numbers might vary. But if my guess work holds good, actual cash to be destroyed will be in the range of 10% to 15% of total cash in the system. It is still huge money but rumors say it would be in the range of 30% and that seems overrated to me.

Master stroke and deflation on the way

For Indians, it was always the inflation which caused troubles. Deflation was a foreign thing for us. But the whole world is sinking into depression. Now it will be India’s turn but the reasons are different. When other central bankers are expanding their balance sheets, India is going the opposite direction. Banning Rs.500 and Rs.1000 currency notes will result in shrinking the balance sheet of RBI. It was a necessary bold step to curb black money, corruption, fake notes etc. And the impacts on the macro-economy would be as follows.

o   Drop in Interest Rates: Bank deposits and liquidity in the banking system increases (not the cash supply). This will lead to drop in interest rates both for depositors and borrowers.

o   Consumer Spending to go down: Since the unaccounted black money will disappear, cash based transactions will take a big hit. Since most transactions will happen through organized retail in the cashless economy, all of the transactions become accountable and consumers will have to pay relevant taxes. Consumers will be left with less surplus money, so their spending too will come down.

o   Widening the tax net: For the reason cited above, tax collections are set to increase. And the disappearance of a portion of black money will lead to wind-fall gains for the Govt. in this fiscal year. And that amount will be huge, may be to the tune of 30% to 50% of yearly budget of central Govt. While how the Govt. plans to spend is not known, it will lead to a situation of fiscal deficit turning into fiscal surplus this year.

o   Value of Rupee to go up against Forex, Gold and Real Estate: As Rupee is set to become a scarce commodity; its value is set to rise. Though Gold can go up momentarily for couple of months, it is likely to lose its attraction next year. Similarly lack of cash supply and absence of black money will put pressure on real estate. Same the case with forex too. While the conversion rates are also dependent upon the strength of other currency, Rupee is likely to maintain its value if it is not going to strengthen against any particularly currency. This is bad news for exporters but good news for importers.

o   Inflation to slow significantly: As cash becomes tight, and there is no need for Govt. to borrow, it means there is no need to print new money (except the replacement of existing currency notes), so inflation will come down. Both demand side and supply sides will see a drop. So forget inflation, we may have to stare at deflation.

That was the background for setting the stage for the case of deflation. Now how to handle the deflation is next part of my blog post. Since the value of cash is set to go up, you should get out of other asset classes to get onto cash. And there would be other ways too. And I suppose they are these.

o   Pre-close existing loans now and reborrow at low rates: Use cash on hand, liquidate some Gold and convert any forex you own and use the proceeds to pre-close existing loans. As rates are set to go lower, you can re-borrow at a lower rate later.

o   Avoid investing in real assets for some time: Let deflation take its course and wait for it to complete. That would take a year at least. You are likely to find the property you wished to own at a lesser price and since the interest rates will be lower, you will find it affordable to pay the EMI.

o   Economy will rebound: Though economy is rebooting now, after the initial shake-up and adjustments, it will come back to normal course probably in 2-3 years time frame. In that period, wages may go up along with GDP as money velocity is better with more money in the hands of poor and middle-class than the black money hoarders. As the Govt. will have higher tax inflows, they can use it to improve the infrastructure of the country and that will pay in the form of productivity increase. That would help wages to go up. Higher incomes and lower interest rates will keep the economy rolling at a better pace. Though it is difficult to time the changes, one can watch the economic indicators and adjust the decisions accordingly.

Modi’s Govt has given a golden opportunity and you can use it to your benefit. Don’t hurry now to get into asset classes and when things begin to turn around; don’t wait to get into them. Use the time in between to prepare for what it is needed. Clean-up your finances; improve your credit score as it will come in handy when you want to borrow big to ride the next wave of growth.

Book Review: Mein Kampf by Adolf Hitler

History has created a villain in Adolf Hitler, but he was a hero for the community he represented. After going through volumes of books on second world war and watching the movie ‘Schindler’s List’ several times (and some more movies on Holocaust too), I had stayed away from reading much about Hitler. So this book bought out of curiosity stayed in my book rack for years untouched. Now I believe History is perspectives of who wrote it, so I did put my hands on this autobiographical work of Adolf Hitler to get to know his perspectives and to understand the personality which made him a leader with an influence significant enough to cause a world war.

He was a student of Fine Arts. Along with painting, he spent considerable time in studying ‘German nationalist ideas’. From there you can find the traces of how his dis-likening towards the Jews gradually turned into hatred. He got transformed from a less talkative as a student into an effective orator who can hold on masses and impress them with his thinking and arguments. He was just a soldier in the First World War but became powerful enough to cause the Second World War.

Except in the first two chapters, there is not much info on his personal life and the rest of the book is about his ideas on Politics, German Nationalism and so on. So instead of an autobiography, this appeared to me like a textbook of Political Science. This book was published in 1925 much before significant political events happened. But this still serves an important purpose of deciphering how his thinking shaped him into what he became later. Many of his observations about history, psychology of masses, role of media, and importance of arms were so sharp which you don’t find them often in other political leaders of his time though they were deeply opinionated and skewed towards the welfare of German Society at the expense of other races. His knowledge and oratory skills were so good, he invoked pride in Germans in all his speeches and he was on the path to leading them as the book ends.

Hitler mentions in this book that the majority of population lacks ability to think and they believe whatever media or history books say is true, but there are few who have ability to critically analyze and they are outnumbered by the majority. Since the majority chooses their leader or Govt. the outcome may not be intelligent choice always. He also believed that degeneration of German society was due to the grip of Jews on that society as traders and he wanted to put an end to it. His similar arguments made him a natural leader of Germans and his rise in the political career began.

Those who write history ensure it favors them, so it is one sided. It is important to hear the other side of the story too. You like Hitler or not, it is important to hear his version of story. As I have already mentioned, this was written twenty years before the Second World War in which life of Hitler came to an end. This book do not have details of war or personal life of Hitler but is more about political ideology. If you like history or politics, this book is for you and Hitler will impress you like how he had impressed his people as an orator.