Nov 12, 2016

Demonetization - The Missing Link

Indian PM made a highly risky political & economic move by removing 500/- & 1000/- rupee notes from circulation. The move aimed at curbing black money & fake currency seems to be getting equal amount of support & criticism from different quarters at the time of writing.

Currency is the lubricating factor on which economy runs. The Indian currency base as of Mar'16 is represented in the table below

Currency Note     Value ( In Rs Billion)    Volume(In Billion)  Value%     Volume% 
   10                            320                               32                            1.95%       40.8%
   20                              98                                 5                            0.6 %          6.2%
   50                            194                                4                             1.2%           4.9%
 100                          1578                              16                             9.6%         20.1%
 500                          7854                              16                            48%             20%  
1000                         6326                               6                            38.6%          8.1% 

This brings an interesting reading .  The volume of 100 & 500 rupee notes in circulation is almost identical . Assuming that demand for various denominations is a key factor behind printing decisions, there is a huge demand for 500/- rupee notes.  As per the classical economic 'equation of exchange'  ( MV = PQ ) , Monetary base ( It could be M0/M1/M2/M3 )   X velocity of money ( equals GDP .  Over the last few years, velocity of money in India has been decreasing in India, inspite of increase in monetary base.  Government doesn't publish stats as to what is the velocity of money for different currency denominations. But the increased demand of 500/- rupee note coupled with overall decreasing velocity of currency is most likely to be due to the hoarding potential of 500/-  ( and similar case with 1000/-  )  . So, Modi has a justified case - 500/-  & 1000/-  are one of the means in which unaccounted money is stashed away.

Now, how is removing 500/- and 1000/-  going to affect economy. This is where I think the planners did not get their act together. If you remove 500/- and 1000/-  , you are going to remove close to 87% of the monetary base by value & 28% by volume.  You are going to supplant that part of economy by 2000/-  and an increased circulation of 100/-  rupee notes.  Now how many 2000/- and extra 100/- rupee notes are you going to need to get back the monetary base to the same level ?

If you assume that all of the present 1000 rupee notes and say one-half of 500/- rupee notes are going to be replaced with 2000/- , the number of 2000/- rupee notes to be printed works out to be about 5.13 billion notes

The case for extra 100/- is a bit more trickier.  If half of the monetary base of 500/- is converted into 100/-  , the replacement print is going to be about 39.3 billion notes (  current circulation of 100/- as you can see from the table is 16 billion )  .  But this is not so straightforward either.  If someone goes to a shop and gives a 2000/- rupee note for an 800/- rupee product, the shopkeeper needs to give 12 hundred rupee notes in balance.  Now, this is going to put a huge demand for 100/- rupee notes. And it won't be easy for banks /Govt / RBI to cope up with the increased demand for 100/- rupee notes.

Imagine the below red-line ( volume ) as an air-pocket ( economic activities ) trapped under a semi flexible structure.  You are going to pinch the 500 & 1000 into zero, but by opening a 2000/- band and an increased band of 100/- .. The trapped air under the 500/-  and 1000/- would manifest as pressures at 2000/- & 100/-  . The increased pressure on those bands could be equated as a need to print more notes.  Unless the circulation of 100/- notes is dramatically improved , economic activity is going to get hampered seriously .

This is where I feel Government should have acted differently- It should have simultaneously come up with denominations of say 250/-  , 400/- , 750/-  along with recalibrating of ATM's.  Otherwise, doesn't matter how much ever 2000/-  they are going to print. it'll just manifest as increased scarcity of 100/- to the common man & small time traders.  Already the impacts are seen in the economy  where inspite of  the availability of 2000/- , business is not smooth as usual.

Hence, I think this is going to put a serious deflationary effect on economy at the grass root level. On the positive side, real estate prices are going to come down,  cash-less ( cards / wallets ) businesses are going to get a boost .


Aug 5, 2016

Money, Credit & Banking in Rural India

Excerpts from a conversation with a person who works as a cleaning staff in Dubai. Actual conversation happened in Hindi. 

Me: So how do you save money in India?
Him: I transfer money to my uncle’s bank account. He takes it and gives it to my father. He keeps it.

Me: So, a person keeps the all the money of earning members in your family?
Him: Yeah, and he lends out money at 2% interest to our immediate & extended family members & friends when someone needs it

Me: (My finance mind starts to work) Well, why don’t you open an NRE account? You get 4% interest tax free on savings account and 7.5% on fixed deposit (Thank God, I didn't advise Stocks & Mutual Funds)
Him: Banking doesn’t work for us Sir. Our financial needs are different

Me: Can you explain?
Him: Sometimes for my daughter’s school fees, I need some money urgently. Maybe for some agricultural expenses, I may have some unanticipated need. If I go to banks, they ask for many paperwork.  Not at all easy.  Not fast.  

Me: So, your family based financing model works for you in these situations?
Him: Mostly yes. The lending is not based on my savings. It is based on need

Me: So, how does your family system ensure that the people whom you lend to, return the money back with interest?
Him: Sometimes people make delays in payments. But, no one defaults. We don’t lend to everyone. It is within a circle of extended family & friends in village.

Me: But does this lending business make profit? Lending at 2% won’t make much money.
Him: Sir, this is not done for profit. This is a system to manage our financial needs of everyone in the family with the little money that we save. If everyone puts money in their individual bank accounts, when need comes, no one in the family can raise a huge sum quickly

Me: So, is this how most of the savings are done in your area?
Him: Yes. Wherever these kind of arrangements are not there, commercial money lenders exploit people.

As I sat bank and thought about that, I felt it made eminent sense. Modern banking works on the basis of “individual”. And all economic theories over that are fundamentally based on the concept of maximizing profit. When the capital available with individual is limited, and the needs are very much basic like health, education & food, you cannot really work on the basis of a person-based banking. A collective usage of capital, even though the returns are limited works best to satisfy the needs of an extended group of people, who otherwise might not be eligible for normal bank credit. The extended group factor is another way of ensuring low probability of default as the defaulter will have much more to lose in an extended family setup.  As profit maximization on lender’s side is not the objective, he doesn’t jack up the lending rates, doesn’t go after new customers and so on. Probably this is the reason why modern banking is yet to take a strong foothold in rural India. Rural India will get financial inclusion when some business model emerges to tap into this kind of credit functioning. I can think of Co-Operative banking prevalent in some parts of India as a close-by model. But that’s a bit higher on the value chain where the needs addressed are for starting a business, setting up a shop, buying a vehicle etc.. This is a problem where needs are much more basic and the time to raise money is quite limited.

Aug 2, 2016

Travelogue - Cyprus

Let me start with a caveat. We could not even cover one-third of Cyprus. The country, even though it looks to be a tiny island in Mediterranean, has a lot to offer for more than a week. We were there just for 4 days including the travel dates.

We landed at Larnaca on a Wednesday morning. Took our rental car and drove straight to our wonderful hotel @ Latchi  .. The cross country drive from South East of Island to the Western side took about 4+ hours ( 170 odd KM ).  Cyprus represents a unique fusion of Greek, Turkish & Continental European cultures. Its cuisine is distinctively Mediterranean. Not just fish & squid, but the European influenced beef & pork as well.  You drive on the left side of the road ( i.e, British system ) .

One of the many view-points in Cyprus
Cypriot beach areas are of two-three distinct kinds . If you are a party-hopper , would suggest you to look for options near Aiya Napa  . Cities like Larnaca & Limassol offer good beaches, but often crowded as per reviews. If you are looking for a reasonably quiet & calm place, I would suggest Paphos / Latchi / Polis areas ( where we stayed ) .  

Legend says that Aphrodite and Adonis met in the beaches of Cyprus. There is an area which is kept as Baths of Aphrodite. Interesting thing is that there are many nearby areas which has the Geological formations similar to the Aphrodite rocks.  But when you have an interesting story in mythology, why not market it and make a hype  :)

The specialty of many of these beaches is that these are pebble filled beaches.You take a dip and lie down on the shore, there is virtually no sand that sticks on to your body. The salt content of the water is very high. In general, Mediterranean has high rates of evaporation thereby making the water much more saltier. So, when you swim, if you are not wearing goggles, you'll experience a strong burning sensation in your eyes because of the high-saline nature. This feeling is much more than any of the beaches that I've been to.  But doesn't make the experience bad.  Infact, I'd rate Cyprus beaches perhaps as the best that I've been to.
Blue Lagoon @ Latchi - Best place to swim in Cyprus

Donkeys are valued very much in Cyprus. There is a Donkey sanctuary, a soap that the locals produce out of Donkey milk and lot of other handicrafts centered around Donkey.  Cyprus being a mountainous terrain, locals used donkeys to transport the cultivation into different parts of the island. Donkey's importance is highlighted in many of the wineries that you come across. We visited one in the quaint surroundings of a village

Modern day Cyprus is a financial & legal center which gained fame as a base of many investment funds,but which came crashing in the infamous Cyprus financial crisis a few years back. It is a classic case study for anyone interested in Macro-Economics as to what would happen when banks become much more financially large than the country's economy itself.

The scars of the financial crisis still remain. As you exit Larnaca, you see a notice stating that Cypriots are allowed to take out only 1000 Euros when they go out.  But you can see plenty of signs indicating that the economy is picking up. Many Property Ads, Villas under construction, latest BMW models in Limassol, restaurants & hotels filled with tourists even in the blazing July climate and much more.  It is not a cheap place to holiday either .

Cyprus is a divided nation. Those scars still remain. We didn't go to Nicosia. But from what we heard, it is a very different world on the other side of the border.

Cyprus is perhaps one of the few small-islands which has something to offer on history , culture, partying, cuisine. What you have on offer is not a deep historical or profound cultural experience like Rome and Berlin.  You should not expect depth in anything, but those glimpses itself would leave plenty of pleasant memories for a lifetime :)

Read My Travel Posts

Cyprus,  Budapest , Rome, Bali, Hamburg, Berlin,  Prague, Cairo,  Alexandria,  Hallstatt,   Salzburg, Vienna,  Dachau,  St Petersburg,  Moscow, Istanbul,  Seychelles, Vizag