Towards A More Formal Indian Economy: A Conversation With V Anantha Nageswaran

The Jan Dhan Yojana, demonetisation, goods and services tax (GST). All part of a bigger gameplan where the Indian government is making the first serious attempt to bring a larger part of the economy into the formal sector. That’s the pitch coming from the Narendra Modi backed government, which has found itself in a position where it needs to explain a dramatic move to swap 86 percent of the country’s currency in circulation.

“The increasing formalization of the economy, nudged by policy, can improve medium-term potential growth,” said the macro economic framework statement released as part of the Union Budget for financial year 2017-18. Finance Minister Arun Jaitley, too, had promised “bigger cleaner GDP (gross domestic product)” once the system adjusts to policy moves like demonetisation.

Should we buy this pitch?

V Anantha Nageswaran, independent analyst and author, told BloombergQuint in a conversation on Monday that he would give the government the benefit of the doubt and, on balance, buy that argument.

Anantha Nageswaran, however, agreed that you can question whether the sequencing of reforms aimed at formalization is appropriate. A number of economists have argued that the proper implementation of the GST would itself have helped in achieving this goal to an extent.

Why then was a dramatic move like demonetisation needed?

Nageswaran’s theory on this is one which is often cited in the case of India or, for that matter, in the case of many economies. We need a good crisis to reform.

More than three months after the demonetisation decision was announced, the jury of economists is still out on whether to call it a success or a failure. In fact, the jury is still undecided on what parameters must be used to judge the move. Should it be judged by the amount of old currency that was returned (which is being pegged at over Rs 15 lakh crore suggesting that most of the money have been returned)? Should it be judged by the GDP hit or how quickly it dissipates? Or should be it judged over a much longer period of time?

Nageswaran does not think that the success of the currency exchange programme can be judged by the amount of currency that has returned to banks. He also feels the criticism of the Reserve Bank of India has been overdone.

“I personally think that too much of a controversy has been generated by the seeming meekness or compliance of the Reserve Bank (of India, or RBI) with the desires of the government,” he said, adding that parts of the RBI Act make it clear that the government can give directives to the central bank from time to time.

Will A Stronger Chinese Yuan Be The Next Crisis?

On the same day that the Indian government announced the dramatic decision to withdraw notes of Rs 500 and Rs 1000, an equally dramatic change in power took place in the U.S. with the election of Donald Trump as the President.

Nageswaran, in his writings, had supported the candidature of Trump and holds on that view.

For the rest of the world, however, there may be collateral damage in the form of abruptly shifting trade policies and Nageswaran acknowledges that. The U.S. have been the key consumer of exports from Asian nations and policies that restrict these exports will hurt domestic economies in Asia.

There is another danger too.

If a slowdown in exports due to adverse trade policies adds to China’s domestic concerns, a significant devaluation in the yuan may be in the offing. If that happens, India could be at the losing end since the Indian rupee is unlikely to depreciate at a pace which tracks the Chinese yuan.

Nageswaran believes a steeper yuan devaluation is inevitable, based just on domestic economic conditions in the Chinese economy.