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Wednesday, November 25, 2020

The train of structural reforms set in motion on Nov 8, 2016, has led to formalisation of economy

Demonetisation played an important role in stirring a debate about the entrenched informality in the economy — what to do about it and how.

Written by V Anantha Nageswaran | Updated: November 9, 2020 9:40:09 am
demonetisation, demonetisation anniversary, india economic slowdown, India note ban, demonetisation news, noteban anniversary, indian economy, india gdpFormalisation is not a force-fitted solution to the problem of the pervasive informal nature of production in the Indian economy. Informality is not a curse.

The demonetisation of high-denomination notes in India took place on the same day as the election in the United States — November 8, 2016. Therefore, the fourth anniversary of demonetisation happens to coincide with the US’s election cycle. Even as the US is coming to terms with the outcome of the elections that nominally concluded on November 3, India is taking stock of the scorecard concerning demonetisation. Its objectives — stated, unstated and added — were several. Mainly, it was about discouraging the use of high-denomination notes for illegal transactions and thus curbing the widespread use of black money. In the process, it was expected that the ban on high-denomination notes would encourage digitisation of commercial transactions, formalise the economy, and so, boost government tax revenues.

Let us look at a few indicators. In the last three odd years, cash deposit data was analysed to identify persons whose cash transactions did not appear to be in line with their taxpayer profile. This analysis resulted in the identification of about 17.92 lakh persons for the online verification process in the first phase. Largely, as a result of this and other formalisation measures that complemented demonetisation efforts, direct tax collections went up by 17.9 per cent and 13.5 per cent respectively in the financial years 2017-18 and 2018-19. In this regard, along with demonetisation, the introduction of the Goods and Services Tax, the Insolvency and Bankruptcy code and new laws regulating real estate and benami transactions encouraged compliance such that the number of income tax returns and the number of income tax filers grew at a healthy rate in 2017 and 2018.

It is impressive that these improvements took place even as economic growth rates peaked in line with trends elsewhere in the developed world and due to the emerging and sustained tightness in financial conditions in India in 2017 and 2018, partly due to the collapse of IL&FS and tight liquidity conditions maintained by the central bank in those years. Doubtless, structural reforms have played their role as they required the public to abandon old methods and practices and adopt a more compliant culture. That is a long-term trend that looks irreversible. Once the current uncertainty over the lingering growth impact of the COVID-19 pandemic abates, the benefits of these reform measures will shine through.

On digitisation, the volume of financial transactions done through the Unified Payment Interface (UPI) jumped from 17.9 million in 2016-17 to 915.2 million in 2017-18, 5,353.4 million in 2018-19 and 12,518.6 million in 2019-20. We can split hairs and expend bandwidth in assigning causality to these numbers. Demonetisation was a catalyst for, if not the cause of, the digitisation of financial transactions that now offers a trail. The trail is beneficial in multiple ways. It raises the volume transacted, delivers payments faster and safely, and helps in tracking consumer behaviour. The pandemic has now come as a force multiplier for digitisation. Sometimes, the law of unintended consequences can work in our favour, too, in meeting certain objectives.

Formalisation is not a force-fitted solution to the problem of the pervasive informal nature of production in the Indian economy. Informality is not a curse. It is a feature of Indian economic policymaking as it evolved since Independence. Unintentionally, it played a role in the fragmentation of the Indian economy. It is a disadvantage in a modern globalising economy, where large sources of capital and large markets require formality. Demonetisation was one piece in the puzzle that not only facilitated but also actively contributed to formalisation. Formalisation is not about taxing productive activity and collecting various other dues. Formalisation is about enhancing the productivity of enterprises and ensuring access to credit.

Demonetisation played an important role in stirring a debate about the entrenched informality in the economy — what to do about it and how. In that sense, it played a big role in focusing minds on the problem and, as one would expect, solutions turned out to be multi-faceted.

The debate on informality spurred action on the discounting and factoring of trade receivables. Micro, small and medium (MSME) suppliers to large businesses and governments are often helpless in securing payments for goods delivered and services rendered. That is slowly changing. It is still work-in-progress, but the government’s unwavering attention on facilitating the factoring and discounting of trade receivables will result in an inflection point in their widespread acceptance. The sooner the government puts its own procurement and payments in the Trade Receivables Exchange, the earlier will be the arrival of this inflection point.

The second is the re-classification of MSME enterprises. The fear of growth and hence the reluctance to grow is being addressed. The third offshoot of demonetisation is the de-criminalisation of violations of many penal provisions of the Companies Act, 2013. Demonetisation focused minds on the compliance burden that businesses carry. In the last week, the compliance stranglehold on information technology enterprises has been eased.

Judgement on epochal policy decisions cannot be rendered instantaneously or in real-time. Bank nationalisation is an example. At the end of the first two decades, its scorecard was positive, on balance. At the end of five decades, it is mixed to negative. Historians will record that the opposite is true of demonetisation.

The writer is member (Part-time), Economic Advisory Council to the Prime Minister of India. Views are personal

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