Silver linings

The huge foreign exchange reserves leave enough room to keep interest rates low and rupee capped

Whether demonetization has resulted in the destruction of the economy or is a much-needed disruption is a polarizing issue. Despite the differences, there is consensus that India needs to widen the tax base. The conflict is how to go about doing it. Opponents such as former governor of the Reserve Bank of India Raghuram Rajan or former economic advisor to the UPA II government Kaushik Basu have no answer other than to point out to the short-term setbacks. The practitioner of coalition dharma, Manmohan Singh, pronounced the exercise as legalized loot, conveniently forgetting the plunder of the national treasury by crony capitalists. A swap of high-value notes mutated to mean their confiscation. How daily wage earners and those with unsteady stream of revenues came to own such a large number of high denomination currency and who was responsible for injecting them into the system remain a mystery. Digital India would have remained a catchy slogan and Jan Dhan accounts with nil balance. Destruction is needed if the edifice is too rotten to be repaired. Disruption results whenever there is change in current status. The sinking of the Titanic in 1912 and the take-off of commercial air travel in 1914 could not have been a coincidence. The outcry system of stock trading got seamlessly converted into online trading without any glitches.  Credit goes to the ease of using the interface as well as the aggressive push by the market regulator. The plunge in telecom data prices should have been the trigger for exodus to cashless transactions. If payment gateways are yet to find widespread usage despite their proliferation, the fault lies with the central bank for not doing enough to push down transaction charges.

The second silver lining is the implementation of the goods and services tax. The entire value chain from the supplier of inputs to the manufacturer to the distributor and the consumer has to become tax-compliant. Not surprisingly, there are complaints about the frequency of filing returns. Much sympathy is being extended to the difficulty faced by micro, small and medium enterprises so soon after DeMo. In a sense, GST is anti-thesis of the socialistic policy of protecting these units with tax exemptions and benefits instead of incentivizing them to grow big. Most of them till recently were reluctant to avail or unable to access capital from financial institutions due to absence of book-keeping. The new regime encourages these units to achieve economies of scale by availing of input tax credit.  Many of them could turn out to be DMart or LalPathlabs by tapping the equity and debt markets. The cascading effect will not only be visible in employment generation but also in boosting consumption. Mutual funds in search of high-quality, low priced offerings will get an opportunity to deploy their subscriptions, encouraging more investors into the market on the prospect of better returns.

A valid point is the number of tax slabs. A uniform tax regime implies a common rate. Enough hints have been given by the finance minister that some of the rates will be merged once the system becomes revenue-neutral. Eventually, there might be just two rates, one for essential and another for non-essential items. No product or service should remain outside the purview. The recent spurt in petrol and diesel prices has provided an impetus to bring them in the GST net, too. The third comforting factor is that interest rates are still high. Recently, the bond market saw turbulence, with yields on government paper rising on talk of an imminent fiscal stimulus. The fear was that increased government borrowing would crowd out private players and strain liquidity, thereby pushing up interest rates.  The concern seems exaggerated. The real rate of interest is near-about 3%. The Reserve Bank of India can adopt a neutral stance for the remaining part of the fiscal even if wholesale and consumer inflation rallies. It can begin the reduction cycle if there are signs of cooling of food inflation as late rains in many parts of the country seem to have nearly wiped out the monsoon deficit. Besides, the high rates have proved to be magnets for foreign funds. Their inflows have bolstered the foreign exchange reserves to a record US$400 billion. The stockpile gives room to the monetary authority to maintain liquidity to keep interest rates soft and to depreciate the rupee to boost exports, thereby ensuring that the withdrawals of the dollars from the treasury are replenished. When the economy begins to recover, inflation will also look up. As long as it does not run away, the development should be welcomed as it will induce risk-taking. Producers will be able to earn better realizations because consumers will be in a position to absorb the prices hikes.

Mohan Sule