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  1. Union Budget 2017: Demonetisation has potential to provide long-term benefits

Union Budget 2017: Demonetisation has potential to provide long-term benefits

Demonetisation may exert short-term costs like a potential slowdown in growth and inconveniences to people, but it has long-term benefits, including higher digitisation, greater tax compliance and lower realty prices, the Economic Survey says.

By: | New Delhi | Updated: February 1, 2017 6:07 AM
The Survey suggested that the government windfall arising from unreturned notes be deployed towards capital-type expenditures instead of the current ones. (PTI) The Survey suggested that the government windfall arising from unreturned notes be deployed towards capital-type expenditures instead of the current ones. (PTI)

Demonetisation may exert short-term costs like a potential slowdown in growth and inconveniences to people, but it has long-term benefits, including higher digitisation, greater tax compliance and lower realty prices, the Economic Survey says.

To encash the long-term benefits of demonetisation, the Survey has recommended certain follow-up measures: fast, demand-driven remonetisation, a push to digital payments using incentives, bringing land and real estate (the long-suspected, main parking slot for black money) under the goods and services tax (GST) net, lowering tax rates and stamp duties, and improving the tax system. “These actions would allow growth to return to trend in 2017-18, following a temporary decline in 2016-17,” it said. It has estimated a 0.25-0.5% slowdown in the GDP growth for 2016-17 from its baseline projection of 7%.

The Survey suggested that the government windfall arising from unreturned notes be deployed towards capital-type expenditures instead of the current ones. “And since the windfall will be one-off, its use should be one-off and not lead to entitlements that create permanently higher expenditures,” it said. However, its analysis of the impact of demonetisation, the Survey cautioned, is only tentative.

India’s cash-to-GDP ratio is as high as 12%, roughly three times of even developing countries like Brazil and South Africa, as cash accounts for 98% transaction volumes and 68% of value. According to a study commissioned by MasterCard, which was released early last year, the share of the electronic mode of transactions in the overall payment system has risen to 6.8% from 2.6% in 2007, but still remained far below potential.

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Describing demonetisation as “a potentially powerful stick which now needs carrots as complements”, the Survey said impetus to digitisation must continue in the medium term. However, it added that public policy must balance benefits and costs of both digital and cash forms of payments. Also, the transition to digitisation must be gradual; respect rather than dictate choice; and be inclusive rather than controlled. It further said the incentives for digitisation must be borne by the public sector and not the consumer or financial intermediaries.

To increase trust in digital payments, the Survey stated, cybersecurity systems must be strengthened considerably. One key need is to ensure inter-operability of the payments system, which will be at the heart of increasing digitisation, building upon the newly created UPI.

While advocating faster demonetisation, the Survey also said the supply of currency needs to follow actual demand and not be dictated by official estimates of “desirable demand”. The proportion of low-denomination notes should certainly rise at the expense of higher ones gradually, though no restrictions on aggregate supply should be imposed, it said.

“The RBI should re-establish internal convertibility, guaranteeing to give the public the amount of currency that the latter wants. The early elimination of withdrawal limits will help build confidence. By the same token, there should be no penalties on cash withdrawals, which would only encourage cash hoarding.”

As part of its prescription on tax reforms following the note ban, the Survey said the income tax net could be widened gradually and, consistent with constitutional arrangements, could progressively encompass all high incomes. The timetable for reducing the corporate tax rate could be accelerated; and tax administration could be improved to reduce discretion and improve accountability.

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