Will bringing black money back help India?

Nowadays there is a big hue and cry over bringing back black money stashed in Swiss bank accounts. Looks a no-brainer to get this money back where it really deserves to be. However, is it really that simple? Specially the economics part of it?

Won't it devalue INR and the big flush into the market create inflation? Are we prepared for this? Perhaps not. How is it any different from printing more INR domestically? Some very interesting questions indeed raised on Linkedin.

Surely for me the biggest benefit of bringing back black money would be the identification of account holders from which money would be siphoned off. It's important to identify and punish the culprits. But what about the economics of this activity? It will not be easy to stop Rupee from devaluating untill and unless money is put into appropriate (value generating) activities. So it's very important how do we bring it back to India.

The good thing about the black money stashed abroad is that it's in USD (I doubt it to be in Euro) and not INR. It can simply become part of our foreign reserves. This takes the pressure off INR and domestic inflation. Now forex can be used to fund costly oil imports but I will come to it later as there is an even safer way of using forex (from the point of view of INR devaluation and domestic inflation). Excess Forex can be used as soverign fund to invest in foreign assets thus avoiding any conversion to INR and no direct issue of inflation. 

Forex can otherwise be used to fund imports which still shouldn't have a direct impact on INR and domestic inflation. Our oil and gas PSUs, the biggest importers, will be cushioned from the foreign exchange fluctuations as the Gov. would be able to fund them from gov. treasury. Bigger forex will also give RBI greater muscle to flex in the money market. However, under normal circumstances if the black money is coverted to INR without much thought behind it then it will surely cause INR devaluation and domestic inflation. 

Personally, I would be more concerned about domestic inflation rather than INR devaluation because if we can control inflation then INR devaluation will be short lived. Now, how will that be achieved? You are trying to increase money supply without calls to inflation. Well, it can be achieved (in a perfect world with honest and competent leaders and beureaucrats). If there is enough infrastructure (of businesses and entrpreneurs) waiting for injection of capital to convert it into products and services worth more than the capital that has been injected then inflation will be averted and the growth in economy will ultimately support the INR. Thus the capacity of domestic businesses should determine at what rate should the black money be injected into the market and ideally the gov. should help the businesses to build the apetite for the capital beforehand (through conducive policies, support for MSMEs, etc, etc). 

Now getting back to other half of the question. Why can't it be done by printing more INR? Well, surely, you will appreciate that the first two ways that I suggested wouldn't be possible through printing INR as the option of forex will not be there. What if we want to inject more money in the economy? Well, again it can be done but it will cause serious inflation if not done in the way suggested in para 5. If done without putting in much thought behind it, although it will not directly impact exchange rate but exchage rate will be affected indirectly through inflation. Also, practically we will have to look into the national account statements to account for the pritning of money. US, for example, prints it frequently but it reflects in its foregn debt (ultimately, the printed money has to come from domestic funds or foreign funds or currency devaluation) But US can do it because it has a global currrency (without much effect on exchange rate). It is not easy for other countries to copy it without jeopardising their currency and that is why central banks around the world have such a critical role to play (balancing between domestic money supply and exchange rate). 

I hope Baba Ramdev has a plan in place on what to do when he succeeds to get the black money back :) Of course he doesn't have one but he is smart enough to know that no black money is coming back and thus he is happy till his political ambitions is getting the right support through this cause!

Why Japan is able to sustain massive debts while Greece and Italy can't?

This is another interesting question I came across on Linkedin. The question touched upon two topics:

1. Why is Japan in massive debt in spite of a hard working, technologically strong economy?

2. More importantly, why Japan doesn't seem to be in that much pain as compared to Greece or Italy who are facing a similar debt (or even lower debt levels?

Why is Japanese gov. in debt? Simple and easy answer: Japanese Gov. is in debt because they have spent more than what they have collected in taxes. 

Why has that been so? Multiple reasons but few of the popularly known ones are: years of stagflation and the "lost decade" (and gov. spending to support the economy), demographics (decreasing working force and increasing pressure of non-earning old age pop.), and relatively strong Yen. 

But how come they are more comfortable than some of the other European countries with big debts? One of the primary reasons cited for Japanese lost decade and deflation is not that they didn't work hard enough but because they didn't consume as much and saved a lot. 

The massive domestic savings meant that the Japanese gov. could take all that public debt from domestic funds (national savings) and thus their debt is all domestic debt (debt in Yen, domestic currency) rather than foreign debt (debt in foreign currency) as in the case of European nations. European countries didn’t enjoy the luxury of domestic savings! 

The problem with Greece or Italy is that when they have to pay their debt they have to convert Euro in to some foreign currency which has negative impact on Euro and they do not have control over Euro as any other country would have on their currency. So Greece or Italy can’t pay off their debt at the expense of their currency (although it’s not that straight forward) as compared to some other nations like Brazil with control over their domestic currency. Individual European nations have very limited control over their monetary policy. 

Note: Japan will not have this problem at all as their debt is primarily domestic (in Yen). Japanese Gov. don’t have a problem in paying off their loan and particularly the interest as they can simply print more yen. 

Of course it will affect Japanese interest rate and exchange rate but it can be managed and at least they have greater control over it. So they can hold off any panic from their debtors for a longer duration. The same principle actually applies to US as well who have been able to hold off the debtors from panicking for all this while because of the status of USD as the international currency! So the foreign debts of the USA are also in USD! (local currency) :) 

Hope you found this helpful but in case you have any queries please feel free to drop me a note.

Rupee breaches the $56 mark (23/05/12) Why?

Rupee is on a slide and it's sliding fast against all major currencies. This is particularly interesting asnot so long ago (Aug'11) Rs was $45 and RBI was pressured to intervene and sell $ in the open market to relieve the exporters. Looks like we are at the other half of the cycle and it's for RBI to intervene again, albeit this time from the other direction. (I personally don't support the role of central bank as exchange rate stabilizer).

Any ways looking at the sliding Rupee I would like to focus on few things which could have had worked together in past few months to manifest what we are witnessing today. 

1. After strong first few months of FII investment in 2012 we are now seeing a dip. The FII investment in the debt market saw net outflow of Rs. 6500+ Crore in the month of March and another ~Rs. 4000 Crore withdrawn in April'12. Similarly, FIIs withdrew from Indian equity in the tune of over Rs.1000Crore in the month of April and their net investment is in negative in the month of May. All this selling has put tremendous pressure on Rupee. 

2. Oil, India's biggest import, saw its prices increase again to $100+ level and remained so till end of April'12 which has again put Rs under pressure. 

I believe these are the two important factors for the recent drop in Rs. exchange rate. However, there can be other reasons as well including: 

1. Inflation: Gov. has struggled to put prices under control and continued periods of high inflation is bound to put pressure on the exchange rate. 

2. RBI has been forced to loosen monetary policy but at inflation still at 7+% plus recent hike in petrol prices can push the inflation up again eroding the value of investors. 

3. As the aftermath of financial crisis refuses to subside and in the wake of rekindled Greece crisis investors are looking for safer bets. 

What comes first money or demand?

I recently came across a question on Linkedin regarding the relationship between money and demand.
"What comes first money or demand? Did we not see money creating demand in some of the profound turnarounds of the biggest economies since the turn of this century?"

I think demand should precede money. However, since the beginning of 2000 this has been proven incorrect by the biggest economies of the world (US/EU). Greenspan's (in?)famous decision to parcel out monies to households to prop up demand and lift the economy from recession actually succeeded. This simply fails the idea of demand preceding money. So is this old school notion incorrect? 

Perhaps not. We need to take a step back and analyse this activity in global perspective and not in isolated US economy. What we have seen recently is a special case of loosening monetary policy to create demand. This demand actually helped economies to resurrect because someone, somewhere (outside) was producing to meet this demand. Had it not been the case, Greenspan's idea would have triggered inflation and nothing else. 
This is one explanation but this is still incomplete. 

We need to take another step back. 
The whole idea of Greenspan printing money worked because US$ bill is an asset which has a demand in the rest of the world. It's the demand of US$ globally that allowed Greenspan to produce more of it and it was exchanged for cheaper products from rest of the world. 
Say a country like India or Uganda can't even dream of such turnarounds during recession as they might end up like Asian tigers in the 90s. Perhaps also, it is partially the reason why EU is not able to sustain the same monetary policy for as long as US has been able to (evident of Euro still has a far way to go to replace USD as a global currency).

Thus the demand has always reigned supreme and will be so in times to come.