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Going ahead

Challenge for government: To earn back trust, not brush warnings under black carpet.

Former Prime Minister Manmohan Singh reckons that India’s GDP would take at least a two percentage point hit from the NDA government’s decision to scrap high-value notes. He isn’t the only one to sound a warning. A host of rating agencies, brokerages, economists and analysts have cut their growth forecasts for 2016-17, with the decline ranging anywhere from 100 to 350 basis points. At the end of the day, these are matters of detail. What is not in doubt is that the Indian economy is going to register a dip in growth —at least over the current and next quarters — from the cash crunch and it will take some time for liquidity to be restored in the system. And this comes when two of the economy’s growth engines — private investment and exports — were already sputtering. Demonetisation could take the shine off private consumption, the sole bright spark until now. The fact that there are fiscal constraints in the way of revving up the fourth engine — government spending — further increases the challenge for growth returning in the immediate term.

Yet, if handled well, the strain may be short-lived. In the last few years, activity in the informal sector or the “shadow economy” — which is estimated to be as high as one-third of India’s formal economy — has helped keep the growth engine humming. It is this sector that is going to be hit the maximum by demonetisation, as the firms in this case deal largely in cash which also helps keep their transactions outside the tax net. With demonetisation and implementation of the goods and services tax, many of them may go out of business. That opens up two possibilities. The first is that firms in the informal sector will choose to function by going increasingly cashless and bringing most of their transactions on board. The potential benefits of such sweeping financial inclusion far outweigh the short-term pain. Alternatively, and this is where the government needs to do a lot more, there will be those who will wind up and cede market share to organised players. Either way, the economy gains as the tax base expands. Right now, we have a very perverse system of a limited number of people and firms shouldering most of the burden of taxes. It results in high tax rates, which, in turn, further encourages evasion and parallel economic activity.

Manmohan Singh is right when he points out that the restrictions placed on withdrawal of cash by people from their own bank accounts are unprecedented in any country. Indeed, the way the present demonetisation exercise has been implemented, the way there are announcements and amendments day by day, is a textbook example of a government not having done its homework. As the next phase begins, the government needs to earn that trust. The onus for proving that this was a sacrifice worth it — in terms of giving a decisive push towards a formalised, less cash-oriented and more tax-compliant economy — lies with it. It has its task cut out.

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First published on: 28-11-2016 at 00:02 IST
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