Demonetisation – Some after thoughts
By Radhika Vijayalakshmi The year 2008 is important in history especially in the domain of ...
By Radhika Vijayalakshmi
The year 2008 is important in history especially in the domain of finance – the financial crisis that originated in the United States engulfed the globe as such, including the fiscally fit nations .The economic crisis slowly developed into a severe fiscal meltdown and even the healthiest nations were still struggling to wriggle out of the crisis.
India, to the surprise of many, survived well! One of the contributing factors for our resilience was the informal/shadow economy which even today accounts for almost 50% of the Gross Domestic Product (GDP). Ironically, what protected us then, unless controlled, has the potential to be the very reason for weakening of our economy in the coming years - the signs of which were already visible when the Indian Government took the historic and bold decision of Demonetisation. The signs were in the form of inflated asset prices that gave the false perception of a strengthening economy, but with limited real growth on ground and miniscule job creation. The bubble would have eventually busted bringing the whole economy down in the near future itself. If, the subprime mortgage crisis,i.e.the banks lending more money than they can afford to, is what caused 2008 recession, limited money in banks and higher denomination notes never reaching back to the banks – increasing every year, was the problem India was facing. The unaccounted money and a low digital adoption have many adverse consequences - a reduced tax base, degradation of social and economic institutions and distortions in market competition are a few of the issues resulting in slow economic growth. India, in addition to these, was facing the issue of counterfeit currencies, believed to be originating from our neighbouring countries and was amply supporting the terrorist and anti-social activities. All this was expected to end with the withdrawal of 500 and 1000 rupee notes from circulation for a short period of time and reintroducing new notes.
Like the change or not, it happened - dividing the population to two groups- those who supported it and those who were vehemently opposed to it, and an year later the debate still continues, each group arguing with the selective set of data and indices that best suits their position.
The against arguments are mainly on the inconvenience caused to people, the 99% money that's returned as per RBI,which in view of many, has turned the whole exercise futile and the low GDP growth compared to past few quarters. As for inconvenience, nothing can be done now - though who suffered (a bit in my view) suffered, the carrot of a promised landwon't be well taken any more. The return of 99% of the higher denomination notes is in fact a blessing ashaving the currency trail, we now have it all under formal economy, available for lending for the banks that were suffering from liquidity crunch in addition to other gains like increased tax base, complete traceability which are already proved with Government taking stringent action on shell companies and benami accounts. The low GDP growth is not something new,we have had much lower rates of growth in the past and we are not alone in this as economic progress is cyclic.
The Finance Minister succumbed to the immense pressure the media has exerted sighting decline in GDP growth, when he mentioned that the govt. might announce a booster package. But, with all leading indicators like auto sales and exports growing despite the uncertainties and uneven rains, it is clear that the economy will recoup on its own, possibly at rates faster than even what the FM expected and any such package is unnecessary at this stage as it will help only to increase the already stressed fiscal gap, weakening rupee and increase in inflation. But, are there any catalysts that can help?Definitelyyes, after all our economy is not that matured orstagnant that nointervention is required. One would have hoped for an interest rate cut by RBI to increase private investment, but given that Fed is about to increase rates and amidst fear of rising inflation, the best option for RBI was to keep the rates same, and that'sexactly what it did.
Some measures that could be taken include
Look at ways to Increase lending by banks - The expectation was that the added savings will be givenout as loans with low interest rates and that will encourage economic activity. But surprisingly lending has reduced. We see some traction in public spending, but localised. Unless supported by soft loans like what we got from Japan recently, that may not be a good idea as Govt.is rightly determined to keep fiscal deficit at 3.2% of GDP. Some kind of nudge and encouragement from Govt. is needed to increase the private spending which is showing a decline. Another sector to look at is the Micro finance banks. Micro financing which caters to nearly four crore households is struggling and many are changing to small finance banks and are struggling. How much of attention larger banks will attach to their newly starting micro banking divisions, need to be seen. As pointed out by many, MUDRA also needs a relook.
GST revamps - both for traders - increase the threshold limits and also reduce the compliance burden. Reducing the tax rate for a few essentials should be looked into. Grievance redressal to be made more effective, technical hitches in the system to be fixed on a war footing basis making people feel the benefits asap.
Going Digital was expected to be another advantage of Demo. Unsure on whether it has met the expectations. Innovative schemes to incentivise digital adoption and other schemes should be thought of.
Tax – Reduce taxes for the low income group in a sizable manner. After all, the public cooperated with the move that it will bring in improvements in their standard of living.
GINI coefficient – the indictor for measuring inequality needs to be closely watched. Special attention must be paid to bridge the gap.
Demo has done one more good, people have suddenly started taking interest in financial matters affecting the country and have started raising their opinion on how the policy should be - right or wrong, biased or not -and in most cases clearly exhibiting a lack of knowledge on macro-economic fundamentals. And those points out to the next area where a massive restructuring is needed - the education system, which is still based on what the invaders left behind, making its citizens good enough only to take advantage of the labour arbitrage.
(The author is an economist from London Business School and the views expressed above are the author's own)
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