Deflationary effect should give RBI confidence to bring down rates: Naushad Forbes

Naushad Forbes, President of Confederation of Indian Industy (CII)
With the government demonetising Rs 500 and Rs 1,000 currency notes, the Reserve Bank of India (RBI) may bring down interest rates, while the economy stands to gain on multiple counts, Confederation of Indian Industry (CII) President Subhayan Chakraborty. Excerpts: 

Do you feel RBI will slash interest rates because of demonetisation and, if so, how soon will that happen?
When you remove a significant proportion of cash from the system, in the short run, it should have a deflationary impact. That should give RBI the confidence to bring rates down in the short run. The central bank’s effectiveness in changing rates is entirely on the basis of whether or not they confound expectations. If they meet expectations, then they have no effect. If you have a significant expectation that no one is expecting, it’ll have a tremendous positive effect. If everyone’s expecting it, it will have no effect. 

Economists say the informal part of the economy, which deals mostly in cash, will be badly hit due to reduced cash availability. With most businesses not ready to adopt digital technology as yet, how and when do you think they would recover?
I don’t think anyone has the answer to that. The demonetisation move might trigger a move towards more electronic forms of payment. That will start changing the nature of the informal economy in a substantial way. However, it’ll require a very wide diffusion of this trend. We’ve seen rapid growth but it’s from a small base. It has to grow rapidly. And, that requires people having access to a smartphone.

CII expects the demonetisation move would boost economic growth. However, economists are divided over the issue, with some saying the damage far outstrips the benefits. How do you feel it will help the economy and to what degree?
We’re not saying it will boost economic growth and certainly not in the short run. It will improve the economy in the long run and it will improve India in the long run. One could argue that it will also improve India in the short run. There is this widespread sense that things should be transparent and the economy should be completely based on legitimate transactions and not based on cash transactions that are outside of the legitimate economy. The move caters to this sentiment in the short run. Also, although there’s nothing to stop people from holding their assets in cash, it doesn’t help the economy since that makes it a dead asset. But, if you deposit cash in a bank account, then it is available for investment. An improvement in the availability of official cash in the economy will be a direct short-term benefit.

And, in the long run?
The benefits to the economy are greater from more and more transactions being done in an official and transparent way. Take, for instance, real estate, where the usual practice is to pay a significant portion of the total purchase in cash. But, over the past few years, we’ve seen the rise of many real estate companies that thrive on the basis of transparency. Companies like that will be strengthened as a result of the demonetisation move.

As an industry body, by when do you see these benefits playing out?
You’ll see the short-term benefits by December. The practice of educational institutions charging capitation fees in cash would go away. But, the benefits of such change will take a year or two to show up in the economy.

Earlier, the Janata Party government had also tried demonetisation of high-denomination notes. How is it different this time?
In 1978, they had demonetised Rs 1,000 notes. That was under very different circumstances; at that time, such notes were rare. Since it was worth much more, it was like demonetising a note worth Rs 15,000. If I remember correctly, a note worth Rs 1,000 represented less than 15 per cent of the total cash in circulation by value. So, no one even noticed who were carrying such high currency. Today, we are talking about 85 per cent of all cash in circulation. Now, everyone cares. So, I don’t think the comparison is a valid one.

Do you think the government should bring back the Rs 1,000 note?
Yes. We’ve new Rs 500 and Rs 2,000 notes. It makes sense to have a Rs 1,000 note as well. People find it difficult to use Rs 2,000 notes for small transactions because it’s hard to get loose change.

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