My two cents on Demonetization

If you are in India right now and have 1500 bucks in local currency in your wallet, you could still have no money at all depending on in what denomination those 1500 bucks are in your wallet. Ladies and Gentlemen, introducing to you the second trending google search term within a month in India after “surgical strike” and the phenomenon this time is called “Demonetization”. On the evening of November 8 Indian Prime Minister Mr. Narendra Modi sent shockwaves through the length and breadth of this country by announcing that Rs 1000 and Rs 500 notes would stop being legal currencies from midnight, thus absolving RBI of its promise to pay Rs 1000/500 to the bearer of those respective notes. The decision wiped out 86.4% of the currency in circulation (amounting to a total value of Rs 14,180 billion) at one go with a three-fold objective:

  1. Fighting black money accumulated in the form of cash
  2. Getting rid of fake currency circulating in the system
  3. Plugging terror funding using cash of higher denomination

The government set a 50 days deadline (until 31st December) to get the currencies either exchanged or deposited with withdrawal/ exchange limits in place throughout this period of scarcity. New Rs 2000/500 notes have been introduced to replace the old notes. It is a move that has probably affected each and every individual of a primarily cash economy. The consequences are quite apparent with long queues in front of ATMs where people frantically wait to get their hands upon their quota of cash to meet their basic day to day demands. The affects are also all over the media, with stories running about the deaths of about 70-80 people while waiting in queues or suicide due to depression resulting from lack of cash.

The jury again is divided about the promised effectiveness of this move to meet its 3 fold objective. On one side are the people supporting the move as first real step against corruption in the 69 years after independence with a short term pain and long term gain. On the other are people calling it one of the biggest blunders, which will derail a cruising economy with negligible firepower against corruption and black money. I am afraid, in this particular case, I am a skeptic on the opposite side of the establishment for very logical reasons as I perceive them. One by one I will dwell upon my reservations with the move but first I will give a background of role of cash in Indian economy.

As per a BIS 2011 data, India is the 4th most cash dependent economy measured in terms of cash to GDP ratio after Japan, Hong Kong and Russia. Thus cash is very central to Indian economy, especially in the lower rungs of Indian population where the bank, mobile and internet penetration is still very limited. Money is very essential in any economy in the sense that it is a medium of transaction for any product or service created in the economy and thus creates income, contributing to GDP. In fact the relationship between GDP and money can also be established as:

GDP = Money Supply in the economy * velocity of money in the economy, where velocity of money is the number of times money is circulated in the economy per unit time

Thus, given that a large volume of monetary transaction in the Indian economy takes place in the form of cash, cash becomes a big contributor to income generation/ GDP especially in the lesser developed areas.

The numero uno reason for this move by the present government (aka Mr Modi) have been the devils of black money and corruption that have haunted India since independence. Black money is the unaccounted money against which taxes have not been paid and is thus a loss for government as well as an unrecognized national income. This economy is thus also called shadow/parallel economy, since it is not contributing to the official GDP number.

Black money is hoarded mainly in 3 forms: in the foreign bank accounts in safe havens like Switzerland, invested in real estate or commodities like gold and stored in the form of cash. The present move by the government has been to fight the third medium of black money hoarding. This is the most contentious issue on this move. According to Professor Arun Kumar, a retired JNU professor in economics who has been studying black money in India his entire academic career, black wealth amounts to about 300 lakh crore of the Indian economy, of which only 1% i.e. 3 lakh crore is in the form of cash. This move, given the scale of execution that is required and the amount of inconvenience it is already causing, does not justify the “peanut problem” it is trying to solve.

The inconvenience that we are talking about is not only in the form of ATM or Bank queues, that is the kind of inconvenience that only middle class in India sees who have the luxury of using plastic money in lieu of paper cash. The real inconvenience is due to the disruption that it has caused in the lower strata of society. As already mentioned, it is this strata which is the most dependent on cash transactions in India. Most of the agricultural earnings and wages are in the form of cash in the villages. The small enterprises like local kirana shops (small brick and mortar shops) and other service providers are also dependent on cash payments. Also worth mentioning is that their daily earnings are not very high, and the cash is the only source for these small businessmen to invest as working capital in their businesses, so even a small disruption in cash earnings can lead to many businesses being made nonviable.

 Apart from all the inconvenience being caused, the logic of the move itself is questionable. The government is replacing the 500 and 1000 notes with new 500 and 2000 notes. It will surely disrupt the current black money market and control corruption temporarily but there is no guarantee that the same level of corruption and black money equilibrium will not be reached using the newer currency. This move can only work if either or both of the following two statements are true:

  1. this move disrupts the payment medium in India in favor of cashless digital transactions with plausible audit trails
  2. demonetization is a credible threat, and thus discourages people from stashing illegal cash in the fear of another demonetization

I do not see the first point being successful since the newer 500 and 2000 currencies are going to replace the older 500 and 1000 notes and they are going to be replaced within months. Such a payment disruption will require both technological and behavioral progress at an unprecedented scale in a country like India. The time period between the older equilibrium and the expected newer equilibrium is not long enough for this kind of progress. People are currently very comfortable with cash transaction and thus it will take time for the people to get comfortable with newer means of transaction on a large enough scale, especially the small merchants and rural consumers will find it very difficult since the mental block is accentuated by technological reach.

My concern with the second argument can be understood by using the following matrix (a game theoretical approach):

Do not demonetize Demonetize
Hoarders Hoard 1,0 (Nash Equilibrium) -1,0
Do not hoard 0,1 0,-1

Now, the government has two decisions to make in the foreseeable future, demonetize the new currency again or not do it. Similarly, the black money hoarders have two decisions to hoard or not to hoard. I have represented the pay offs for each decision combination with -1,0 and 1 where 1>0>-1. The payoffs are separated by commas with the first term representing payoff to the hoarders and the second representing payoff to the government. Given the kind of backlash government has had to face after the current demonetization decision, it is obvious that not demonetizing will be a better decision in case hoarders decide not to hoard, and the payoff of two can be assumed to be almost equal in case hoarders decide to hoard and thus the decision “do not demonetize” is weakly dominating decision of demonetization. Now, in the second iterative step, the decision to hoard is dominating decision to not hoard. Thus by iterative elimination, “Do not demonetize and hoard” cell is the weak Nash equilibrium, which rubbishes the second argument here.

In my opinion, bringing the shadow economy to the mainstream is not an objective that is achievable through this move. Thus projecting it as a move with long term gain is very questionable. On the other hand, projecting it as a short term pain is also not correct. It might be a short term pain for people whose only concern is standing in ATM queues and who have the luxury of using debit/credit card for most of their transactions. The most affected people lie outside this realm, they are the people who subsist at the bottom of pyramid with very limited access to banking and technology, in the modern usage the people who exist outside the ‘www’ network. As discussed earlier, for very obvious reasons, businesses are shutting down, credit has dried up and there are people who have even lost their lives. The effect on GDP will be anybody’s guess right now with a negative trend in most sectors, the extent and longevity of which only time will tell.

Another institution which has been very adversely affected since this move, is RBI in terms of its credibility. RBI is an institution which relies on its credibility for its policies to be effective, which is very much dependent upon expectations. These days if you are following the RBI website regularly, one constant notification you see is regarding the updation of the demonetization FAQs section or any new communication regarding the change in rules. This iterative approach of ad hoc problem solving puts the credibility of RBI under question, especially at a time when there has been a change at its helm and Urjit Patel has taken over from a popular Raghuram Rajan. This does not augur well to an institution of the caliber of RBI which has until today remained a lone institution with unquestionable integrity and reputation in a country infested with corruption at the institutional level.

On the last two objectives of this move (fake currency and terror funding which are very much related), again the disruption may be very temporary depending on the quality of safety features in place on the new currencies to curb imitation. The effectiveness of demonetization on these two fronts can only be realized with time, in lieu of any solid data on the same.

Thus, overall although I would love to see the move working wonders on cleansing and catapulting Indian economy, I am also very skeptic on the effectiveness of this move. I would love to be proven wrong though.

Long live democracy!

PS: A huff post collation of deaths due to demonetization (reported across sections of media):


[Br]eaking [Ba]d Management

Cliched Warning: Spoilers Ahead

Breaking Bad is probably one of the most popular Television series on US small screen ever. It is the story of a chemistry genius who ends up as a school teacher due to some of his choices in life only to realize that he has cancer, with a teenager son and a pregnant wife to care for. At this phase of life he comes into contact with an ex-student of his, named Jesse, whose own choices in life have led him to meth addiction. This seeds in his mind an idea to use his chemistry skills to produce the purest methamphetamine available in USA so that he leaves behind enough for his family to lead a comfortable life after him. The whole series is about this chemistry teacher’s path to becoming one of the most feared drug lords “Heisenberg”, a path that leads him to commit myriad serious crimes leading to death and destruction around him culminating into his own demise.

So basically the story is all about a chemistry teacher’s journey to building a business empire while working underground, literally. And building a business empire while also evading the law enforcement agencies sure involves some kick-ass business lessons. Each character in the show has his/her own personality, and own way of handling situations, thus leading to valuable business lessons. I am going to list a few that comes at the top of my mind:


The aspect of leadership is the most important part that comes out of the show and the two people who show the best and at times the worst qualities of leadership are Gus Fring and Walter White.

Gus is as relentless and inflexible as a leader can be. His way of dealing with things is all about “my way or highway”. This was shown in the way he deals with Walter, Jesse, the two Mexican brothers and many such instances. He is also relentless with the people who cross him like the way he disseminates the Mexican brothers and the Mexican gang he had dealings with. Although these abilities are good to an extent in a leader, these also cost him and people around him at times. For example too much pressure and threats to Walter leads to the deaths of Gale, his own men and that even brings about his own downfall.

Walter on the other hand is also a very relentless personality but tempered with some level of flexibility. He is ready to negotiate in case of adverse circumstances but with some level of authoritative control. He is also a leader who stands up for his associate, Jesse, during several circumstances. He goes to the extent of murdering people to save his associate’s life. This wins him the trust and respect of several people including Jesse and Todd which he leverages several times during critical circumstances. His own demise is caused by the mishandling of his personal life and the way he messes up his work-life balance by the end of it all.


As already mentioned, Walter is a kick-ass negotiator. There are several instances when we see the glimpse of this personality in Walter. Starting when he talks Jesse into starting the business with him until when he negotiates the supply of methyl amine with a contact of Mike. He has an uncanny ability of knowing that optimum point where the opposing party will break down in accepting his offer which is on his own terms without losing his own control on the situation.

Another example of negotiation that we saw was by Skyler when she was buying the car wash from Bogdan. Her initial offer was rejected by Bogdan, who also had a mouthful to say about Walter while rejecting the offer. In this case Skyler uses a hook or crook tactics to force Bogdan into selling the car wash at even a lower price than what was initially offered by Skyler. Though unethical, this was a very effective means of forcing a negotiation out of the opponent.

Team Work/ Partnership:

Another brilliant quality of management we see in the whole series is the team-work and partnership that developed between individuals. The central to all this was the Walter-Jesse pair. In most of the series they stand by each other, which saves both their lives on several occasions. There is also this mutual camaraderie that they develop where Jesse looks up to Walter with respect while Walter is like a father figure to him. But there are also times when this relationship reach the lows of distrust and manipulation. It is this distrust that finally gets both Walter and Jesse in problem, finally leading to Walter’s demise.

Gus-Mike pair is another great and different example of team work. The best example of their work style and understanding of each other is evident when the two team up to get rid of the whole Mexican gang at one go by poisoning them. The relationship is based on trust and respect for each other again.

Another partnership Walter enters into is interestingly with his wife Skyler. In this case we see an example of well-defined work structure where Walter’s job involves handling the Meth business while Skyler launders the money. This partnership and Skyler’s backing of his husband helps Walter run this show for so long even after having a DEA agent as brother in law.

Fool proofing the plans:

One of the best planning I personally consider in this series was the way Walter manipulated Jesse into thinking that Brock was poisoned to manipulate Jesse into thinking that Walter did it so that Jesse would kill Walter for Gus. This leads Jesse into agreeing to side Walter in the plan to kill Gus.

Another such fool proof planning was seen in the way Walter plans to kill Gus. He had his fallback options even when he botched his first attempt at it.


One of the best examples of marketing we see in the show is the way Walter uses his own reputation to sell his product. His product becomes synonymous with his own reputation as “Heisenberg” which is again a catchy and authoritative name. His reputation and association itself creates the pull for the product.

Another example of marketing we see, and this time the push strategy, is the way Saul markets himself. He has a catchy slogan “Better call Saul” which he keeps repeating on TV, bill boards etc. and he is all over the place, very difficult to miss. He also serves a very niche segment, generally criminals, and thus has a good word of mouth advertisement within a small crime world.


We also see a brilliant example of getting the 4Ps (Product, Price, Placement, Promotion) right to establish a business “big enough that it could be listed on NASDAQ”. There is a constant obsession in Walter for the quality of his product, which peaks at the time when he becomes obsessed with killing a fly that entered his lab before starting production. He is also very particular about pricing his product in a premium range for the value he is providing compared to the competitors. He is not ready to settle for anything lesser in a conversation with Jesse. He also has a partnership with Gus for distributing his product to the target customers and leverages his network to do so. We have already talked about the way he leverages his reputation to promote his product thus completing the 4th and final tick in the 4Ps of marketing.

“Doing what you love”:

And finally this is the main mantra of it all. This is why Steve Jobs was successful, this is why Elon Musk is successful and this is why Walter White aka “Heisenberg” was successful. He sums it up pretty well in the end- “I did it for me. I liked it. I was good at it. And I was really — I was alive.”

The Uberonomics

The transportation industry has recently seen a disruption. The phenomena to have hit this otherwise quite unsexy industry has been the digitization it has undergone. It has pioneered aggregation in the services industry and its lead in this concept can be realized by the common use of the word “uberization” which is fast replacing the word “aggregation” in the services industry.

One of the major plays for its pioneers has shifted to developing countries which has the advantage of a growing middle class, large population and lackluster existing transportation infrastructure. Especially India and China have become two major arenas for these players in a race to gain market share and a captive customer base.

If you search the web-space, umpteen articles already exist analyzing various aspects of this competition and there is only so much you can add to the topic. In my present article I will specifically touch upon the economic aspects of this phenomena and what may be its implications for the customers and the companies themselves.

One of the most interesting things about this phenomena has been the positioning of these “aggregators” in this value chain. For them, both, the service providers, in this case the drivers, and the consumers, in this case the riders, are customers and a ‘network effect’ is in play here in the sense that the more the number of drivers on the platform, more riders will be attracted due to seamless supply and more the number of riders on the platform, more drivers will be attracted due to enough demand and access to the consumers. ‘Network Effect’ as you would have already guessed is a phenomena in which increase in number of users on a particular platform attracts more users to it. Examples also include telecom and Operating System of a computer.

Since number of cabs available on the platform is a scarce resource which is limited, the forces of supply-demand come into play here. These forces of supply and demand has actually led to one of the most controversial concepts related to ‘taxi aggregators’ which is the ‘surge pricing’. The two sides of the argument on this concept are:

  1. On the defense side, the argument is that the forces of supply-demand is at play in deciding the ‘surge’ prices during the peak times and it helps supply meet demand while benefiting drivers through extra earnings.
  2. On the offense side, the argument goes that the ‘surge’ pricing is very random and is nowhere close to being determined by the supply-demand dynamics. It reduces consumer surplus, to the extent that even during emergency situations the companies try to look for opportunities to earn profit at the expense of the consumer.

I will first explain this supply demand dynamics and then move to a research by a group of professors from University of Chicago on the surge pricing and argue its applicability in Indian context.

Microeconomics 101 tells us that prices in a free market without government intervention is decided by the intersection of the supply-demand curve. A demand curve is a price-quantity curve where each point represents the quantity demanded by the consumer at a particular price level and since it will decrease with increase in price so the curve is downward sloping. A supply curve is a price-quantity curve where each point represents the quantity supplied by the producer/ service provider at a particular price level and since it will increase with increase in price, so the curve is upward sloping.

In the case of ‘taxi aggregators’, the demand in any particular geography is the number of riders willing to use the platform to book a cab and the supply is the number of drivers online at that particular instant in that geography. To simplify we can represent it in the form of a supply demand curve.


Figure 1: Illustrative Supply-Demand Curve

The figure represents the typical supply-demand curve for any good/service. In our case it represents the supply-demand dynamics for the cab service. The intersection of the supply-demand curve gives the equilibrium price and quantity represented by P* and Q* respectively.

In the following diagram we see what happens in the case of demand surge:


Figure 2: Demand Shift

The figure shows the situation of surged demand during peak hours when curve shifts from orange to the grey curve. As the demand increases, we also see that the corresponding price and quantity both increase to P** and Q** respectively. This is the theory which comes into play in surge pricing where a dynamic pricing model is used to adjust the price-quantity pair to the new equilibrium. The rationale behind the surge pricing is thus to bring more number of drivers on road lured by higher prices during peak demand, thus pushing up both the price as well as quantity supplied.

A very interesting study has been done on the effectiveness of surge pricing by a team of professor from Chicago Booth and Uber employees. In this particular study Jonathan Hull, Cory Kendrick and Chris Nosko used the internal data from Uber and chose the surge time after an Ariana Grande concert at Madison Square Garden in New York. For this day they first studied the surge in demand using the data on number of people opening the app each minute and the number of people requesting the app every 15 minute period during the day. Then they also studied the response of the drivers using the data on the number of drivers online each minute during the day.

The observation is represented in the following figure which is straight taken from the paper:


Figure 3: Supply-demand study during surge perion (Source: Hall, Jonathan; Kendrick, Cory; Nosko, Chris. The effects of Uber’s surge pricing: A Case Study)

The surge period is shown in the shaded region, and we can see that the users opening the app goes up by up to 4 times during this period. We can also see a surge in the actual ride requests (blue dots) which is interestingly almost exactly fulfilled by the surge in the number of drivers on road during the surge period. According to the paper the pricing during this period varied from 1 to 1.8 times the normal price.

The paper as a conclusion argues that the surge pricing is thus successful in bringing more drivers on road and in an efficient allocation of rides among the limited number of riders whose outside options are worse than the Uber surge price. To further justify the success they have used the following charts:


Figure 4: Vital Signs of Surge Pricing in Action (Source: Hall, Jonathan; Kendrick, Cory; Nosko, Chris. The effects of Uber’s surge pricing: A Case Study)

The charts show that the surge in the requests did not affect the ETA (Estimated Time of Arrival) much and also the completion rate (number of completed rides/ number of requests) remained at 1. Thus, not only were all the requests met through surge pricing but they were also met with a decent ETA. The study thus vindicates Uber’s claim that surge pricing is an efficient way to allocate the rides to the riders who are ready to pay a higher fare for the rides during surge period. The study though has been carried out in American context and thus some of the results may not hold in a developing country’s context. I will discuss that in the next section.

One of the main assumptions behind the surge pricing is that it lures more drivers on the road in the area where demand surge is existent. This particular assumption may not be applicable in Indian context since the traffic is not very smooth and the road infrastructure is not comparable to developed countries. In fact, 3 of the Indian cities appear on the list of top 10 cities most vulnerable to traffic problems in the world according to World Economic Forum. In such a situation it will be inefficient for a driver to rush to the surge area since it might become very difficult to reach the area in time to take advantage of the surge.

Another problem facing a country like India is the huge population and a lackluster transportation infrastructure limiting outside options for the riders. This may accentuate the insufficient increase in driver supply, leading to huge surges (sometimes 4X or 5X) which has been the reason for the recent public debate/ outcry on this issue.

In spite of all its shortcomings, these ride hailing services are a blessing in disguise for a country like India. Both the leading players in the Indian market, Ola and Uber, have introduced ride sharing services which have the potential of decreasing the traffic congestion and being environmentally sustainable. Once people get used to sharing/ pooling it also has the potential of changing the car ownership habits with lesser number of people owning cars and thus reducing number of cars on road further. The gravest problem facing this industry is how the economics will work out for these companies since making losses year after year will not be sustainable in the long term. Thus, given the benefits, such services should be encouraged and supported by the government, although it has to ensure that the competition is not strangled so that the interest of the consumer is protected.


A Nation at Crossroads?

It has been a long time since I came out with a promise of regular blogs on economics in my introductory blog. One of the reasons for this delay has been an internal block which prevents most of us from writing. The fear of whether one will be able to produce the expected perfection, it is more about meeting your own expectations rather than anyone else’s though. And this block is mostly prevalent in very occasional writers like me. Probably it will go away with time and currently I don’t know to what final result it will vanish into. Will it get better of me and I will stop writing forever, or will I get over it and come out as the conqueror? For now I am ready to fight and, here it goes, my second blog.

Only recently the NDA government celebrated its two years in office to much pomp from the media. It is a government which came with a lot of promise to take the economy of the country out of the lurches it had fallen into during the UPA-2. The voters of the country showed confidence in the promise and handed BJP a landslide victory, the biggest one since there has been any major party challenging congress after its initial dominant status after independence.

Another development that took place around the same time was appointment of a proverbial “rock star” to the 18th floor of RBI’s office, another silver lining among the dark clouds surrounding the Indian economy around the time. Dr Raghuram Rajan had earlier come into limelight during the 2008 financial crisis just before which he had presented a paper on how the world financial system was becoming riskier, in which, many experts claim, Dr Rajan had predicted the lurking financial crisis. Most recently, he was covering 80% space of all the leading national business newspapers after his reluctance to extend his term in RBI office. Many blame it on the government’s lukewarm attitude towards the issue of his term extension.

It is in these contexts that I am writing here and I am going to make this blog as objective as possible. I am not going to write anything for or against any political party, and will only let the data do the talking. Data, if used properly, and in the right context, can be the biggest instrument of truth. But it is obviously a double edged sword, where data can as well be cleverly used to hide facts. I will try my best to use it as an agent for the former. In case anyone feels that the case is otherwise, I am open to criticism so that I am careful the next time, if there is ever one.

The data I have used here is from 2004Q1 to 2015Q4 since I wanted to do this analysis over 3 phases: UPA-1, UPA-2 and NDA. The reason for this kind of analysis is that, it is important to understand the failures of the UPA-2 government in context of the world economy at that stage, which was itself struggling to pull through from the 2008 crisis and then there were unwarranted fears created by the US fed about tapering. Thus I want to break this analysis into different parts and see how each relevant facet of the economy behaved in the 3 phases.

GDP growth: We start with the most talked about economic indicator. It has been talked about so much that now even laymen can look at the number and be able to decide what it speaks about the economy, although it is too dangerous to do that independent of its context. The growth rates have been considered from 2005Q1 to 2015Q4.


Chart 1: GDP growth rates historical data

In this particular chart we can clearly see a clear demarcation between the three phases. The UPA-1 was mostly a pre-2008 world where India was reaping the benefits of being a growing consumption economy with an expanding middle class. It clocked a consistent 9-9.5% growth rates which was quite commendable, riding on a strong foreign investment growth and a competition to tap into the large middle class population of India.

Then the 2008 crisis struck, biggest recent divide in the world economy which surely affected India, as noticed in the sharp decline in the growth rates to sub-4% level by the end of 2008. Monetary policy came to the rescue at this stage and nimbleness of the RBI to counter the fall with an injection of money into the economy shot up the growth rates to pre-2008 levels, even touching 11% at one stage.

This was around the beginning of the UPA-2 in which Congress had been able to form the government with the support from its allies. But the recovery did not last long and the economy saw a sharp fall in growth rates by the end of 2011. The growth rate hit lows of sub-5% by this time. But this phase was also a time when world economy was facing a crisis situation with grim situations in USA and Europe. Only China had been acting as an engine, pulling through the world economy on its own.

And then the last four digits of the calendar changed and it was the election year, bringing with itself a new hope of a fresh government taking over the mantle and rescuing the economy. The result was as expected although the massiveness of it was unexpected. People gave mandate to an NDA government which had come with a promise of rowing the sinking boat to safety. If we look at the curves post 2014, it tends to validate the fact that the government has fulfilled the mandates of pulling through the growth rates but then this phase was also dominated by shockingly low crude oil prices which is a major import for India, a slow China which competes with India for foreign investment and a change in calculation method of GDP. These contexts also need to be considered before concluding the success of the NDA government.

IIP: Another interesting data to analyze is the IIP. It is an index for the industrial production in the country. India has traditionally been a services led economy with manufacturing sector facing a neglect due to some of the left of center thought process that was prevalent after independence and also the wrath of the license raj fell mostly on the manufacturing sector. The NDA government came with a promise of strengthening the manufacturing sector and making it the growth engine for the economy launching the ‘Make in India’ campaign. Thus it will be interesting to see how much of a success the campaign has been until now. The IIP and manufacturing data runs from 2006Q1 to 2015Q4.

Chart 2: IIP and Manufacturing data (Data Source:

As seen from the charts, the IIP and Manufacturing trace similar curves, which must not be surprising since about 70% of the weightage in IIP index comes from manufacturing. Both the charts show that the manufacturing sector had been growing at an express pace, IIP even crossing 15% (with manufacturing crossing 20% mark) mark pre-2008. The financial crisis pushed it into the negative zone but it again picked up helped by the progressive monetary policies of the central bank. But again, since 2012, the numbers have been very disappointing helped by the policy bottlenecks during UPA-2. But even after 2014 change of guard, the numbers have not picked up drastically and most recently it has been back to the static zone.

FDI: Another measure of health of a developing economy of India is the net FDI inflow into the country. It shows the investor interest in the country and also the global outlook about the country. FDI is a better measure than FII because these are long term investments and some rational long term analysis goes into it rather than a relatively very volatile FIIs. FDI data is from 2004 to 2015.


Chart 3: FDI data for India (data source:

The FDI chart clearly shows a steady growth since 2004, but the break here again came in 2008 when USA, which is the second largest FDI investor in India, went bust. The growth again picked up during the later years after financial crisis but faced a similar decline during 2012-13 when the world seemed to have lost confidence in India’s growth story with a lot of bottlenecks haunting the Indian economy during UPA-2. The NDA government has seen a steady growth in FDI, reaching the highs of pre-2008 recently. The investors have apparently regained confidence in the robustness of the economy which has been able to pull through even after the grim outlook for world economy including China. Prime Minister’s personal interest in wooing the global investors through incessant foreign visits also seem to have brought rewards.

Inflation vs Growth: Economics-101 will tell you that there is always a trade-off between inflation and growth. A higher economic growth leads to more money in the pockets of customer and thus an increase in demand leading to supply-demand intersecting at a higher price and thus inflation results. This is though true only under the assumption that the resources are unlimited and there is no supply side constraint. This theory is very much validated by the chart with growth and inflation of the last few years. The data for the same is from 2006Q1 to 2015Q4.


Chart 4: GDP growth rate and Inflation (data source for inflation:

As we can see in the chart, pre-2008, as already discussed, the growth rates were high and the inflation was a bit higher than moderate, around the 6.5-7% mark. Post the crisis the inflation started hitting the highs, ranging 10%-15% mostly riding on the back of a progressive monetary policy. The interesting part of the theory came to the surface only during the UPA-2 era, which was a period of stagflation. The growth was stagnant, while the inflation soared near the 10-12% range. As we have already discussed, the period was marked by policy bottlenecks in getting the projects passed. The period was also marked by supply constraints which led to an economy with high inflation and low growth which is a tricky situation to come out from. The inflation does not allow monetary policy intervention, while low growth calls for it, a haunting contradiction for the decision makers sitting in RBI office.

Thankfully, then ushered the Dr Raghuram Rajan era at the central bank. The interest rates were anchored to inflation targeting and CPI number was made the anchor for the monetary policy. The rewards were visible since at least one of the two numbers (inflation) was brought under control by 2014. The NDA period was marked by higher than average growth rates, with the lowest inflation rates in the last 10 years due to the prudent policies of the ‘rock star’.

Repo rate: Repo rate is a policy instrument with the central bank to influence the money supply in the economy. Very simply explaining, it is the rate at which the central bank lends to your nearby bank. Thus as the cost of credit will decrease for the bank due to decrease in repo rate, the lending bank will also reduce its rate, thus pushing more money into economy for higher infrastructure development as well as higher demand by the customers, thus driving growth. The vice versa happens on decreasing repo rate. The lower repo rate leads to more money in your pocket, making you able to buy more thus pushing up demand. The demand curve thus now intersects supply at higher price and thus it causes inflation and vice versa.

One of the reasons I am discussing repo rate here is that it is an important variable in the country’s GDP growth numbers as already explained and secondly it is also worth discussing because one of the criticism of Dr Raghuram Rajan by one of the BJP MPs was that he kept the repo rates high thus hurting country’s economy. The data for repo rates is from 2004Q1 to 2015Q4


Chart 5: Repo Rates Historical data (Data Source:

The instrument has been traditionally used very carefully by the central bank, with small incremental changes being made and then keeping a close watch on the effect before taking the next decision. Currently the rate is at 6.5% which is one of the lowest attained in the last ten years, if the 2008-09 era is neglected since it was a desperate measure during that time to prevent any crisis resulting from the meltdown.

Dr Rajan took a very prudent step to make inflation the target of monetary policy so that the inflation does not spiral out of control which could lead to ‘stagflationary’ conditions similar to 2012-13. The following graph, although, clearly shows that the repo rates have been informally always tied to inflation although formalizing it makes the repo rate more predictable which is very important for rational decision making. The data is from 2006Q1 to 2015Q4.

Repo Inflation

Chart 6: Repo rate vs Inflation

The curve clearly shows that the repo rate has an inverse relation with the CPI numbers. The relationship is also statistically significant thus proving the fact that Inflation control has been a primary focus of repo rate policies of the Central bank. Under Mr. Rajan’s governance of RBI, it has only been formalized.


Thus we see that there is a clear demarcation between the three periods but one of the reasons for the stark difference between the two UPA governments has been the 2008 crisis which coincided with the general elections. India, although it recovered from the crisis for a short period due to injection of money into the economy, but fell back into the low growth zone soon helped by some inherent structural problems during the UPA-2 and a sluggish global growth.

This was the time when NDA government came to power with a single party having the absolute majority in the lower house of parliament after a long time. Thus expectations were very high from the government to deliver the results, a coalition could not because of its natural constraints. The government does seem to be delivering but it has been helped by many external factors too that were adverse during the UPA-2 government. The promise of picking up the manufacturing sector has not been brought to fruition yet though and it will be interesting to see how the ambitious ‘Make in India’ campaign pans out. Prime Minister’s personal interest in attracting foreign investment though seems to be working with FDI touching new highs, but it has also been helped by the slowdown in Chinese economy which competes with India for FDIs. The inflation has been brought under control due to effective monetary policies of the RBI in the recent past which has carefully handled the repo rates to strike a right balance between growth and inflation.

One area where this government deserves criticism has been its handling of Dr Rajan’s extension. It has been under the leadership of Dr Rajan that so much has been achieved in such a less time. In 2 years, RBI’s prudent policies have pulled India out of a dangerous ‘stagflationary’ conditions and controlled a freely falling Rupee. The repo rates have been lowest since the 2008 crisis, and still criticizing Dr Rajan for hurting the economy by keeping repo high is misleading and not expected of a fellow economist himself. Dr Rajan handled the situation very well though, with a letter to the government about his reluctance to extend term and his intention to go back to academia. It gives government the time to choose the right woman/man to put on his shoe. Taking right decisions is anyways a habit of the man because “he is Raghuram Rajan and he does what he does.”

Gloom Gloom Boom Gloom Gloom!

As I start writing this blog, world is going through a transition. The mantle of growth is being transferred, rather it has already been transferred, from the west to the east. The jolt that the economies of the world faced from the Global Financial Crisis of 2008 with its epicenter in the United States has still not subsided and as with an earthquake, the effects have been felt most by the economies in the west which were coupled more closely to the US economy. The US economy is still reeling under low growth and high unemployment with a near zero interest rate. Europe, on the other hand, is trying its best to recover from the debt crisis which has put a question mark on the existence of a single currency zone itself. Japan has been now in crisis for over two decades with negative growth combined with deflationary conditions and the most talked about Abenomics is seemingly failing in achieving what it was meant to.

Shifting focus 180 degrees, we have the emerging Asian economies (also Brazil and South Africa) led by China and India. If we look at the very recent, China is reeling under structural problems in its economy which has led to its growth rate being slowed down to 6.7% in the most recent quarter which is a sharp drop from the 9+% mark which had been consistently achieved over two decades. The problem is that the growth until now had been investment led and so it has been limited by the demand for the infrastructure which has waned since the global financial crisis. India, on the other hand, has been the only bright spot in these dark times of global economy with healthy growth numbers of around 7.4%, thus overtaking China for the first time. In India the growth has been mostly consumption led which is considered more sustainable but one has to realize that investments are also necessary in tandem with demand so that there is no supply side constraint on growth. Thus India too needs to weed out some structural bottlenecks which makes it difficult to carry out infrastructural projects in the country.

Brazil and South Africa had been other bright spots in the world economy until recently but with fall in the commodity prices these economies have slowed down to a large extent due to over reliance on export of these commodities for growth. This actually has been the story of most of the oil exporting economies including Middle East and Russia. The fall in crude prices due to demand crisis and supply glut has adversely affected these economies.

If we look at the overall picture there is generally a gloom everywhere in the world economy except very rare bright spots. It is under the shadow of this gloom surrounding the global economy that I am starting this blogpost. In this blogpost my attempt will be to link the recent events and trends of the world economy through theoretical concepts of economics and to link theory and practice to gaze how applicable most popular economic theories are even in these volatile times for the world economy. As someone said “In theory there is no difference between theory and practice. In practice there is.”