A 14-page report from the Indian financial services firm Ambit Capital titled M+R+T resets to the fore and released on November 18, offers the gloomiest prognoses for the Indian economy post-demonetisation.

Ambit predicted that, paralysed by invalidation of high-currency notes starting November 8, the GDP growth in the second half of the financial year 2016-’17 would peter out to 0.5%, compared to 6.4% in the first half. It also virtually halved its growth projections for 2016-’17 to 3.5% from an earlier estimate of 6.8%.

Several other brokerage firms and rating agencies have also revised the GDP numbers downwards, but none as dramatically as Ambit. Researchers from Ambit explained that given the extraordinary nature of the demonetisation, they used a different GDP forecast model. The model, called the quantity theory of money, posits that the nominal GDP of a country is a product of total amount of cash in the system, or base money, and the pace at which it moves in the economy. Ambit analysts deemed the earlier model – a composite of agriculture, investment, industrial and services sector growth – insufficient to determine the growth implications in the post-demonetisation reality.

Questioning the models

Predictably, the Ambit analysis elicited despair and derision on social media. In an excoriating blog post on November 19, Vivek Dehejia a professor of economics at Carleton University in Ottawa, wrote:

“Ambit’s ‘model’ from which their extreme prediction is derived is non-serious and would be laughed out of court by anyone serious about macroeconometric modelling of economic dynamics. It is frankly surprising that is has received so much play. Were it submitted to my upper division or graduate seminar, it would rate a B+ or so for effort.”  

Prominent economist, Surjit Bhalla, who runs an the firm Oxus Investments, was equally scathing. In a series of tweets, he labelled the Ambit report biased, prejudiced and manipulated, and an insult on economic modellers.

Track record

But this animadversions aside, let us consider Ambit Capital’s track record for clues to its alleged political prejudices.

Ambit Capital, founded in 1997 by Ashok Wadhwa is a fairly well-regarded investment banking firm. Its research reports are generated by the institutional equities division, headed by Saurabh Mukherjea. A research head at a large rival brokerage firm describes Mukherjea as a conservative analyst with a slightly bearish bent most of the time. “But with the estimate of 0.5% growth for the second half of this year, Ambit is being a bit optimistic, given the incredible short term devastation caused by demonetisation,” he said.

Contrary to accusations of Ambit’s negative bias, it is noticeable that ever since Narendra Modi rode to power, its research team focussed extensively on the prime minister’s purported fight against corruption and cronyism and the reports have been more laudatory than most others’ in the fraternity. In a recent interview to the Economic Times, Mukherjea praised Modi for attacking the black money economy through demonetisation and said that benefits of it would come through in 2017-’18 or the financial year after that.

On the very day of Modi’s victory on May 14, 2014, in his economy and strategy report Can India Turn Back The Clock, Mukherjea wrote, “Over the past decade, powerful cliques of politicians and promoters have suppressed competition in a range of sectors and driven India’s inflation rate up from 4% to 11%. With the changes taking place in New Delhi and in the RBI, this vicious spiral could be on the retreat.”

Six months later, in November 2014, Ambit argued that Modi’s “Strongman Economics” (ad-hoc economic policies driven by an aggressive leader with a focus on nationalism, witnessed in several emerging markets and East Asia) would contain inflation and spur growth, but was unlikely to effect structural economic changes.

The oddest of the Ambit reports on the Modi came in March 2015. It contended that the prime minister had hit the reset button by shifting India’s savings landscape away from physical assets towards the formal financial system, disrupting the model of crony capitalism, and redefining India’s subsidy mechanism – all of which would combine to slightly pull down economic growth in the short run, but provide bumper dividends later. So far so good. However, when discussing Modi’s attack on cronyism, Mukherjea and team ventured that many of the miffed beneficiaries of the previous United Progressive Alliance government’s cronyism were consciously [emphasis mine] holding back investments to create an economic slowdown which they hoped would force the government to go easy on graft. The report said:

“As the Government goes after corrupt officials and businessmen, it seems increasingly unlikely that the big crony capitalist conglomerates will kick-start the investment cycle; in the absence of supernormal profits (which they earned under the UPA regime thanks to the ‘corruption, competition, inflation’ triangle), these conglomerates seem disinterested in pushing through capex [capital expenditure] in India.”

As evidence, the authors offered the experience of Indonesia. The country witnessed a five-year period of poor growth (0.1%) and stock market returns right after the military dictator Suharto’s three-decade-long “new order” till 1998, in which cronies prospered. All of this is hardly the kind of stuff that fans conspiratorial anti-Modi flames.

Outside the ambit of trust

The National Institute of Public Finance and Policy estimates that the informal sector contributes as much as 40% to India’s $2 trillion economy. It employs 80% of the country’s workforce. Big businesses in the formal sector negotiate the demonetisation-induced cash crunch far better than the small and medium enterprises. The informal sector, and even small enterprises in the formal sector, depend heavily on lenders other than banks for capital. Even when banks do regain the liquidity and latitude to lend, the big businesses will get priority access to debt. The micro-finance sector could be crippled for a very long time to come.

Whether intended or otherwise, demonetisation reinforces the simplistic view that cash transaction-dependent informal economy is an unscrupulous economy. Most equity analysts are recommending people to invest in sector-dominating companies that are best placed to grow at the expense of the millions of tiny businesses that constitute economic informality.

So if the Congress-led United Progressive Alliance government was accused of favouring a clutch of coprorate houses, Modi’s demonetisation could work out to be a multi-billion dollar boon for big businesses in general.

Little wonder then that so-called captains of the Indian industry, from Ratan Tata to Anand Mahindra to Chanda Kochhar have praised the move. However, to be fair, India Inc’s is hardly the voice that utters anything that the government of the day might not like to hear. This not in its ambit or remit.

Narendra Modi, as the prime ministerial candidate and the holder of the executive office has emphasised the need for trusting citizens, including corporate ones, as the essence of reforms.

Is demonetisation evidence that he means only half of what he says, or rather, that he only trusts about half the economy?