India demonetisation was a dud

“Truth is light and eventually surfaces after the heavy weight of lies sinks to the bottom of the cesspool.”

Demonetisation was a dud.

The data is out. Those who believe that demonetization was a well-thought out and well-planned economic policy, they are not reading the data. Every claim of the Prime Minister and his loyal ministers has proved to be wrong. Cleansing the system of black money was a noble objective which must be supported, but the tool was wrong.

IndiaSpend tracked the usage of key phrases by Modi during his aggressive national campaign in the weeks after he announced that “high-value notes” of Rs 500 and Rs. 1,000 were being eliminated – this in an economy that uses 98% of cash for purchase of consumer goods.

Initially, the demonetization was sold as a way to wipe out black money and weed out fake currency – allegedly being used by India’s enemies (read Pakistan) to fund terrorism in Kashmir by giving students a Rs 500 note to throw stones on the security forces. Well, the objectives failed.

The amount of black money that returned to the banking channels amounted to 98.96% of the “high value” notes. The government had spread whispers that more than 50% of the high value notes outstanding would be black money. Much of this would turn “white” by paying taxes. A chunk would be burnt, giving the government a windfall to spend on rural infrastructure. They were wildly off the mark.

The second narrative was that fake currency would be eliminated and India would be safer because the misguided youth in Kashmir would not be paid their Rs. 500 to disrupt the peace by throwing stones at security forces.

The RBI has now confessed that the value of fake currency notes was estimated to be Rs. 410 million. This is 0.000027% of the Rs. 500 and Rs. 1,000 notes that were in circulation.

So, to catch the very, very, very few who had fake currency notes, the Modi government (with not a whimper of protest from a highly compromised Reserve Bank of India, which issues the currency notes) risked the livelihoods of tens of millions of Indians and their lives.

Catchpost has documented 90 deaths as of December 9, 2016 – within 31 days of demonetization. There may have been many more.

And all for nothing, there has been a spurt in border issues, mostly in Kashmir, suggesting that money is a medium of exchange and not the reason why people wage war – however, wrong that reason may be. A 12th grade student would know that fact.

As the data for December 2016 rolled in to show that and money was heading back to the banks, the government got the first hint that the disastrous demonetization would be exposed before the crucial state elections in UP, scheduled for March, 2017.

To ensure that the embarrassment of a failure of demonetization would not have an impact on polling day, the RBI conveniently stopped publishing data on notes returned from the end of December 2016. (The RBI has gone on record saying they ran out of note-counting machines. This from a central bank that has over USD 400 billion in fx reserves!)

The artful dodgers in Modi’s social media brigade, changed the narrative of demonetization to “making India a digital economy” .  This caught the fancy of the urban elite and the upwardly ambitious youth in smaller towns.

The poor in villages – where there is one bank branch for every 9,000 people and one ATM for every 11,000 people – were still standing in line to collect usable money to survive on a daily basis.

The digital economy needs consistent power supply. So the digital narrative, too, was a failure. Data points indicate that the use of cash has clawed back to levels before the demonic demonetization.

The secondary and tertiary impact is still being felt.

For those who love the India story and have placed Prime Minister Modi on an elevated platform of economic leadership, please note these facts:

1) GDP has slipped to a level that is equal to or lower than the GDP during the previous, corrupt and inefficient regime led by Prime Minister Manmohan Singh and run by the mafia of the Congress-led UPA alliance and their crony capitalists,  it is good the Congress is kicked out, but the BJP still needs to deliver;

2) India has been a huge beneficiary of low oil prices (50% lower than during the final years of the previous government); the lower oil import bill and local oil subsidies have given the government an estimated 1.0% of GDP windfall, annually, for the past 3 years! Nothing has come of it;

3) Earnings of Indian companies that constitute the various stock market indices are lower by 5% to 10% from the time when Prime Minister Modi rode to power on a plank of economic development in a well-deserved, stunning majority in May, 2014. With EPS declining and flows ensuring a surge in stock markets, the outcome is a higher PER – nearing an all-time peak!

4) While the election-winning promise of higher development and GDP is in tatters, the “minimum government, maximum governance” social media hype has been torn to shreds. The government is using the digital id codes of Aadhar for every conceivable transaction, allegedly with a view to target their critics. The council of ministers has now topped 75 – nearing the 77 in the coalition-infested mentality of the Congress-led, UPA government. The BJP is a majority on its own within the NDA coalition so it does not need to hand out so many cabinet seats and slots – but is doing so to ensure successive electoral victories.

Pinch – and feel the reality.

There is another fact that is worth noting. Actually five:

1) Prime Minister Modi, charioted by the very efficient Amit Shah, continues to win elections for the BJP; there is no opposition within his party and there is no one from any political party who can even dream of challenging him today;

2) If you are a minority today in India – and as Indian as any other Indian – you don’t feel safe;

3) If you speak up against this government – even if you are as Indian as any other Indian in India – you are not safe;

4) Prime Minister Modi and his charioteers will do anything to stay on in power – even willingly experiment with the fragile economy and destroy the earnings capacity of tens of millions of poorer Indians;

5) Not only is there no one to hold a light on Prime Minister Modi, but there is no one to light the match to honour Prime Minister Modi’s self-proclaimed wish at the time he announced demonetization. Prime Minister Modi was voted in as a much-needed change from decades of decadent Congress-led regimes. But he has failed to light a torch and has ignited passions.

Sadly, India is not Exhibit “A” for a country that is on a solid course of 8% to 10% annual growth in real GDP.

We nailed that myth when Goldman published their piece of child’s fiction into a BRIC report.

We nailed the myth when Barron’s – and other media – praised an unproven Gujarat Model fiction as the basis of expecting a rejuvenated India under the leadership of Modi.

We have called out the inflated earnings emanating from sell side analysts since 2014.

A 6.5% respectable rate of growth of GDP.

Our struggle is not with the thesis that India is a great place to invest over the long term, but an argument over what valuation levels to invest at – and how much to allocate to India at current valuation levels. We are the ‘original India bulls’ with a history that spans 27 years but, somewhere along the line, we have been contaminated with the disease of adhering to a disciplined thought-process and that, too, (alas) of the “value” kind!

While there is no shortage of catalysts for the “break-out” rate of 8% rate of long term growth in GDP, we continue to believe that successive governments have failed the test of taking on true policy reforms to lay the foundation for that break-out.

The BJP were the Last Saffron Hope. But they are so focused on their religious colours and wiping out the opposition parties (already decimated by non-performance) to win state elections and the big federal election to be held by mid-2019 (don’t be surprised if there is an early federal election!), that economic reforms have taken a back seat while religious causes and social handouts have taken the limelight.

Despite this “bear case” for an 8% growth rate, we are strong believers in the “bull case” for a solid 6.5% growth rate.

India has a wonderful internal consumption pattern that has offset the miserable performance of many governments over the past three decades. It is this domestic consumption story that makes us bullish.

The export and infrastructure themes require policy direction and action which India is woefully inadequate on: a point that hit home again, when Mumbai was shut down by 300 mm of rain over a 24-hour period in August 2017.

In July 2005,  it took over 1,000 mm of rain over a 24-hour period to shut down the city. I guess we follow Moore’s law: it takes less time to cause the same physical damage. The BJP, like previous governments, has been great at slogan mongering but overall poor on delivery.

Our company-level valuation models assume a 6.5% rate of real growth – and we value the businesses of Indian companies against this macro environment.

New risks to assess.

While highlighting the opportunities, we need to note the near term risks, many of which are not priced in.

1) There is a risk that the recently launched GST, a national sales tax, will lead to a slowdown in demand and economic activity and/or the economy (and tax collections) may feel the impact of a technological glitch of the new and untested software that is expected to handle 3.5 billion filings every month. Investors are dismissing this as a “J” curve effect in the run-up to a more robust economy. The problem is that the economy is already feeling from the “J” curve effect of a questionable demonetization policy. A GST stall could lead to a “double-dip”.

2) The monsoon has begun well. While the impact of the quantity of rainfall, the location of the rainfall, and the timing of the rainfall on agricultural income (which affects 60% of India’s population) will be known by October, 2017 the water levels in the reservoir are looking good.  This is essential for water supply and also for irrigation

3) The Jammu & Kashmir issue between India and Pakistan is boiling over before winter sets in while the China-Bhutan border has flared up. A series of statistics on the India-Pakistan “Kashmir problem” shows no signs of letting up.

4) The Doklam border issue between Bhutan-China came to a boil when India – which has a strategic defense partnership with Bhutan – faced the troops from China head-on. For now India and China have stepped back – China is hosting a BRIC summit in early September and an Indian presence is necessary.

5) The global geopolitical and economic situation remains tense with multiple economic variables that can be impacted including interest rates, portfolio flows, North Korea, and oil prices; a dislocation of any factor could hurt India.

Wedded to India – but balanced.

India is a dedicated investment destination for us, not a flavour of the month that we dish out when “hot”.

As value investors, we are being tested for our discipline and the conviction of relying on our assessment of facts v/s the basic instinct of a larger pool of money that is, in some sense, willing to roll-the-dice and pledge its faith on Alternative Facts.

We are not India bears: with rising stock prices, our cash levels have predictably inched up because the Upside Potential Indicator has slipped from very attractive levels of 60% at the start of the calendar year 2016 to current levels of 25% over 2 years in our forward-looking proprietary chart.

That is a very respectable number, no doubt, in a world where returns are hard to find. But someone needs to assess the risks, too – and wait for an opportune time to go overweight on India.

Ajit Dayal
For The Daily Reckoning UK


Ajit Dayal is a longtime friend and business associate of Agora founder Bill Bonner. Ajit’s publishing house in India, Equitymaster, agreed to partner with Agora back in 2005. Ajit and Bill hold several joint investment interests to date.

Before Equitymaster, Ajit was acknowledged as #1 India Equity Analyst, “AsiaMoney” in 1993 & 1994. He was formerly Deputy Chief Investment Officer of Hansberger Global Investors, Inc with USD 5 billion of assets; lead manager on the USD 2 billion Vanguard International Value Fund and lead manager on a USD 300 million pension account. He was named to the All-Star Asian Team by “Institutional Investor” 1994, and was CEO & CIO of QIEF Management, LLC from January 2007 to March 2015.

Ajit is the founder of Quantum Advisors Pvt. Ltd., an asset manager based in India. You can track the Q-ACPI India Equity UCITS Fund he co-manages here.

Ajit has over 28 years of experience in the Indian capital markets, including 7 years of experience in the international stock market as an analyst and a portfolio manager. He brings a wealth of Indian investment knowledge and experience that is unique for the UK and world markets. He gives Agora Financial UK kind permission to publish his writing here in England.

Ajit receives no fee for writing for Agora, and Agora receive no fee for the mention of his fund above.