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October 18, 2017

Indian Economy

The Year Past and the Year Ahead

By Nitin Desai


Today marks the end of Samvat 2073 and the beginning of Samvat 2074 in some parts of India. The turn of the year is a time when one takes stock of the past and assesses what lies ahead. Yesterday on Diwali, many businessmen will have closed their accounts for the previous  year and done a Chopda Pujan to open the books for the new year.  One wonders what went through the minds of those who performed this Diwali ritual and prayed to Laxmi for prosperity.

The year that has passed began with bombshell for the businessmen about nine days after they had celebrated Diwali. This of course was the demonetisation exercise. Some eight months later another jolt came in the form of a radical change in the indirect tax regime with the implementation of the GST. Could the Government have designed these measures differently to reduce the shock and disruption that these businessmen experienced in Samvat 2073?

Take demonetisation for instance. The need to eliminate high denomination notes from circulation has been widely recognised. Peter Sands, who used to head the Standard Chartered Bank, wrote a paper for the Harvard Kennedy School arguing for coordinated action by the G7/G20 countries arguing that this “would make life harder for those pursuing tax evasion, financial crime, terrorist finance and corruption. Without being able to use high denomination notes, those engaged in illicit activities...would face higher costs and greater risks of detection. Eliminating high denomination notes would disrupt their 'business models’ “   

The primary purpose of the November 8 demonetisation was to disrupt the black economy by depriving it of the high value notes required for the cash transactions that oil its wheels. This did not requires an overnight demonetisation of 500 and 1000 rupee notes and certainly not the issuance of an even higher denomination 2000 rupee note. It could have been done by simply withdrawing these notes from circulation whenever they came into the banking system and demonetising them at a later stage when the amount in circulation was way below the 86% of currency in circulation level that prevailed in  November 2016.  The European Central Bank's announcement in May 2016 about their intention to eliminate the 500 Euro note was basically on these lines. Other goals like promoting digital payments and broadening the tax net, that were added later in defence of the move, could have been pursued more efficiently and with much less disruption by other means.

The implementation of the GST in July 2017 was rather different. It had been in the works for a long time and was generally welcomed by businessmen and economic commentators. Unfortunately the Government tried to do too many things too soon. A very sophisticated tax system was imposed on a market system that was far from sophisticated.  Off the record transactions, fudged account books, widespread use of cash payments and receipts is the norm rather than the exception in the informal sector. 

The implementation of the GST in its full splendour could have been staggered over a couple of years. This year the focus could have been on implementing a single tax system and check-post free movement of goods. The registration requirements, filing of returns and assessments could have been like in the old VAT system for most businesses. The electronic system and automatic matching of invoices could have been introduced on a staggered basis and extended gradually to all over two or three years. This would of course leave scope for evasion and false claims. But the threat of exposure when the full system would be deployed would have been a restraint. 

The need for simplifying the rate structure has been recognised; but the GST would have remained stuck in inter–state negotiations if we had waited to secure agreement on a simpler rate structure.  However. the high rates on many items have led to a sticker shock  because the GST rate on the bill now includes both the excise (which earlier were included in the base price) and the sales tax. The bigger problem with the high rates is going to be the greatly increased returns from what is politely called tax arbitrage. In the past the gain from sales without a bill  was just the sales tax amount. Now it will be much higher than that.

It is possible that demonetisation and GST are being blamed for business woes that arise from other reasons like slower demand growth, high real rates of interest, the impact on the real estate sector of the measures to clean up the widespread malpractices there, the souring of success stories like  telecom and infotech, the competition from Chinese imports. But in a difficult business environment, moderating the disruptions of demonetisation and GST would have helped.

What is the mood in business circles now? According to a survey put out recently by the Reserve Bank of India,  the index of  business  expectations  has come down from 105.4 in Q1 to 103.6 in Q2  of 2017-18. Consumer confidence index is also down from 96.8 to 95.5 over these two quarters and inflation expectations have gone up. Order book growth is lower than in the last previous quarter but significantly higher than a year ago. So what lies ahead?

“The only function of economic forecasting is to make astrology look respectable” said Galbraith. Thus in an astrological mood one can say ”Watch out for the end of November when the  CSO's estimate of the GDP growth rate for the June–September 2017 quarter will become available. If this growth remains under 6% then worry and worry hard;  if it is between 6% and 7%, the prospects are uncertain;  and if it is more than 7%, then relax as we are on the road to recovery”

So here's wishing everyone a more predictable Samvat 2074 with no more policy thunderbolts!

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