The demonetisation exercise is probably the largest venture undertaken by any government to remove high denomination currency and replace it over a period of time, depending on the requirement. It has evoked a lot of emotion on both sides.
While the stated objective was attacking black money, this has gotten fine-tuned along the way, and has become changing the way we transact business. This, it is hoped, will check the growth of the black economy in the future. There are however no clear conclusions that can be drawn; at best, there are conjectures based on logical reasoning. Let us look at some of the questions for which answers may be sought.
Will the economy be affected? The answer is “yes”, though one is not sure of the extent with estimates ranging from 0.5-3% of the GDP. That there will be lower growth is certain as the services sector has countered some irrecoverable loss of output in Q3. For manufacturing, in case of durable goods and automobiles there could be some recovery in demand when conditions stabilise, though for FMCG products, the loss would be permanent. A slowdown in the real estate and construction business has negative backward linkages, too.
Similarly, farmers have had to resort to distress sale for horticulture products due to the currency crunch that has affected their income though output per se has been higher. Overall, the fact that we are a cash-based economy does indicate that there will be a deep gash in the consumption balloon and it would take time—maybe even one or two quarters—to get back to normal.
How about black money? To begin with, there were discussions on how much money would stay out of the system and hence get impounded. However, with various amnesty schemes at different levels of taxation, almost all the currency should come back and one may never know how much black-cash was in the system. The guess now is as to how much will actually get taxed at 50% and 85% which will accrue as tax revenue for the government. But one thing is certain. All black money in these denominations will get out of circulation and enter the white stream. Therefore, the ‘most negative effect’ will still be ‘positive’ as all money enters the taxable stream in future, which is also a major achievement.
Will a new black economy develop? One cannot be sure about it, because a black economy develops basically when two parties in a transaction agree to game the system. As long as there is cash, transactions can always take place outside the system, and markets involving property, forex and gold are those which engender such money. There is no guarantee that future transactions will all be through the regular channels as the problem is not addressed by demonetisation which does away with old notes and replaces with new.
Hence, while demonetisation can thwart the existing stock of black money residing in cash, future flows can be controlled only by having strong systems in place. Human intervention in any transaction which involves regulation and permissions—like real estate—will always be prone to the creation of such money.
How will the so-called transformational objective of changing the payments systems pan out? At present, an increase in use of cards and e-wallets has been seen. But this is more out of compulsion, and curiously, the value of transactions is low. Hence, it is not really indicative of people switching over. Also, the argument that there is less cash being used in the system is more because there are limited supplies and not that people are demanding less money.
Cash is held for three reasons: transactions, precautionary and speculative. If people have to go digital for transactions, they need to be incentivised and not penalised. Further, we need to address the question as to why do people hold money for precautionary purposes. It is always for emergencies, and when there are no alternatives offered, which is the case when one has to get admitted to non-government hospitals, the transformation will never really take place.
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The government has addressed, to a large extent, the speculative aspect of holding money by taking such businesses online. Hence, the stock market, which up to the1990s was cash-based, had been made clean by introduction of dematerialisation and online trading. But the same does not hold for dabba trading or real estate transactions which are difficult to monitor. The clue is to rationalise duties and taxes and ensure that bribes do not have to be paid for the system to work.
How will the banks look back at this ordeal? Banks have been proactive in meeting the 60-odd amendments made in the last 50 days or so. They would be wary of the Jan-Dhan accounts—opening more of these was a target earlier—which have become a reason they could be questuioned by the taxman. While going digital is pragmatic, the cost for the same has to be borne by someone. This is a typical catch-22 situation, one where we have to incentive people to go digital but by doing so have someone else bear the cost. Ideally, it should come from budgetary allocation. Otherwise, it will be onerous for banks.
Hence, the three-months period following the end of the exchange scheme will gradually provide clues about what all has been achieved. Gains from taxing the revealed black money will be a one-shot flow, but to ensure that tax collections increase over a larger base, systems have to be changed and rates rationalised. For example, even today, for registration of property, one has to go through agents and pay one’s way through the office as alternatives do not exist. The same holds true for any dealing with government departments with tiers of bureaucracy.
Transaction behaviour is more complex and will evolve over a longer period of time given the expanse of the nation and the limited access for all to technology. The advantages have to be driven home convincingly to bring about such change. Hence, while demonetisation could be the right move, its efficacy would depend on how we follow up on the basic objectives and not just move on to another agenda. While this is the Indian habit, given the performance of this government, it looks likely to be different this time.
The author is chief economist,
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