Currency moves

After one-nation, one-tax, get set for higher tax-base, lower-tax regime and easing of doing business

By Mohan Sule

Replacing notes making up nearly 86% by value of the currency in circulation is a huge decision, particularly so when more than two-thirds of the economy is run on cash. Add to it the reluctance to use plastic money, inadequate penetration of the banking system and illiteracy. The resultant concoction is indeed combustible. Yet to go ahead with the risk of demonetization means even modest gains outweigh the repercussions of not doing anything to dismantle the parallel economy. The bold move that will add to the GDP growth by transiting to cashless transactions succeeding is more than it failing. For one, the infrastructure to switch to paperless banking is operational though not fully embraced. The working population even in the remotest corner of the country has been covered by the Jan Dhan Yojna’s zero-balance bank accounts to deposit subsidies as well as wages for government work.Online payments and credit and debit card usage are increasingly gaining acceptance in urban areas. The share of credit card-based lending in the overall bank loans has gone up up over the last five years, though it constitutes less than 1% of the value right now. Second, a system is in place to monitor high-value exchanges. Though the correct size might not be visible from invoices, bills or agreements, the revenue department at least has an idea who is entering such deals. Third is the spread of mobile telecom services, a medium through which the government is seeking to disseminate information about its schemes and can also be used to receive and dispatch money.  For all-pervasive use, smart phones and data tariffs have to become affordable. 

Prime Minister Narendra Modi seems to have two goals. The first is to burnish his pro-poor credentials by targeting tax evaders. Second, reducing the scope and size of the cash-based economy along with the incoming one-nation, one-tax regime will give him room to ease business regulations. The subsequent widening of the tax base will provide leeway to cut peak personal and corporate taxes. As Modi is fond of repeating, India is the only bright spot in the globe. As such the attack on unaccounted wealth could not have been delayed. The NDA government has reached its half-way mark. If the salutary impact of the crippling of the underground economy has to percolate to the grassroots before the Lok Sabha polls mid 2019, there was no time to waste. Besides, buying activity is poised to recover after the partial disbursement of the Seventh Pay Commission recommended payout and a normal monsoon. Some of the arrears might have generated cash payments but now will be absorbed into the real economy, translating into more tax revenues for the government. The unorganized sector, populated by unskilled workers and migrants, might see temporary drying up of business due to the cash crunch. The segment, on the flip side, does not get the benefit of the formal lending system such as pass-through of reduction of interest rates. If the discomfort caused in replacing old currency with new prompts even some to shift to the banking system, the temporary dislocation will be worth the effort.

Importantly, the formal sector too stands to gain as the lopsided competition with small units without any book-keeping will reduce. In the meanwhile, the income tax department has obtained a huge database of first-time depositors who had ignored the voluntary income disclosure scheme that closed end September 2016. Along with GST, the current crackdown on illegal funds has the power to expand the tax basket if accompanied by easy compliance and low rates, thereby shrinking the informal economy. Crucially, some of the links in the vicious chain of conversion of electronic money into physical form to meet the demand of those relying on cash will come loose. There are bound to be political ramifications arising from striking at black money. At the visible level, influencing voting might go down because big withdrawals will act as red flags. Injection of liquidity on the eve of elections, thereby distorting prices of essentials, will cease, allowing the central bank to focus on the underlying strengths and weaknesses of the economy. Defence deals and infrastructure contracts will lose luster. Real estate, a conduit to funnel below-the-counter wealth, will turn into like any other industry. Players will have skill sets rather than political connections and cater to different niches of customers rather than putting up towers of babble to recoup their rent money. There might be consolidation among political parties and fading of regional power centers. Do not be surprise if there are coups against entrenched leadership so far perched comfortably due to control of the purse strings.