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BW Businessworld

BW Roundtable: The Impact Of Demonetisation On Indian Economy

BW Businessworld brought together four leading economic minds - Surjit S Bhalla, Arvind Virmani, Mohan Guruswamy, and Ajay Chhibber, for a roundtable on the Union government’s demonetisation move

BW Businessworld brought together four leading economic minds - Surjit S Bhalla, senior India analyst, Observatory Group; Arvind Virmani, former chief economic advisor to the Indian government; Mohan Guruswamy, chairman of the Centre for Policy Alternatives; and Ajay Chhibber, distinguished visiting professor at NIPFP - for a roundtable on the Union government’s demonetization move. The roundtable discussion was moderated by BW Businessworld Editor-in-Chief Anurag Batra.

Edited excerpts:

Anurag Batra: Is demonetisation good for the economy?

Surjit Bhalla: This has a potential for being a very big bang reform. (It can be) very good for the economy. How it plays out and what are the additional policies that will come about, hopefully, will determine whether it is a big bang reform. If nothing follows from this and if everything else stays same, then this is a big thud. This is a part of a process, part of a package of reforms and packages of reforms that will become known in a short period of time.

The Budget is going to be presented on Feb 1, so that is going to be the watershed moment. We have had a watershed moment which is November 8 and I think between now and then we will know what this government has in store for the polity and for the politics and for the elections. One has to appreciate the fact that this is a radical step and has never been undertaken by an economy, not suffering from hyperinflation and we are not suffering from hyperinflation. As a matter of fact our inflation rate is 4-4.5 per cent. This step is radical by any definition.

Batra: What will be your advice to the FM when he goes out to present the budget on Feb 1 in light of what happened on Nov 8?

Bhalla: I think the advice has to be strongly that the tree of black money or the black economy has been cut but the roots are all there. Therefore, a prudent FM and a prudent policy would suggest that you get rid of the roots.

So you have to get to the roots, which create black money. What are the incentives for the creation of the black money and you got to try and get to those incentives to change completely. Tax compliance is a big issue and what you will do with the tax rates. The second big issue that the one real sink of black money is the real estate sector and you have got all kinds of duties, stamp duties, capital gains etc. which gives you very little revenue and gives the black money holders lots of revenue and you can easily measure that the 50 per cent is legal and 50 per cent is illegal.

Third one is the electoral reform. You need to really change the way we finance elections. In a much more transparent manner. BJD MP Jai Panda has come out with a proposal on election and election funding. I think the subject has entered the debate and I don’t think it is going to go away very easily. 

Life is not the same. The economy is not the same. The politics is not the same post-Nov 8 and pre-Nov 8 and we think we all will be making a mistake if we think that just a little incident happened and its back to business as usual. I don’t really think so. The probability of that is very low. It will be a big tragedy if it is back to business as usual.

Batra: Mr Chhibber, what are the changes the FM can possibly make? What will be the short-term, mid-term and long-term impact?

Ajay Chhibber: The US had 9-11 and we had our 8-11 or 11-8 as you call it. If not properly conceived not properly consulted, the reforms can be a big disaster for India. India seemed to have everything going for it. Whether you believe in the new GDP or not, but India was touted as the fastest growing economy in the world and Modi-ji was going around the world saying we are the best and then at that time to take a measure without any consultation, to come up with the scheme for India at this stage that even President Trump was saying that India was the one that I have to look at to see how growth is coming. 

I mean the intent is good but such a ham-handed approach to economic policy making could not only end up just as a thud but could also end up being quite a disaster. 

You know one of the well-known economists, my former Prof Raj Krishna, he coined when he described the period of 70s and 80s as the Hindu rate of growth. So forget the short term effect, I hope Modi-ji’s demonetisation doesn’t take as back to the Hindu growth which is associated with 3-4 per cent growth. We were just seeing some signals that the economy was recovering, although banking sector was in a mess. Whatever the little green shoot were we have already killed them.
The history of demonetisation has been terrible. If Modi can pull this off, then he in the history will be known as one of the economic revolutionary.

Batra: How could they have done it better?

Chhibber: How have the countries reduced corruption? They haven’t done by demonetisation. They have done it by tax reforms, by going after real estate transactions, by going into this hawala business, by better monitoring of lavish expenditure. That is a systematic way to go, not by banning 86 % of the currency overnight and expecting it will create a miracle. I must say, people are so patient. If it had happened anywhere else in the world, there would have been an insurrection by now. 

Arvind Virmani: To say that this is an isolated decision and nothing has been done is totally wrong. But, very frankly if I would have been chief economic advisor, I would have not recommended it, but when I first heard it, I had two initial reactions. First, the retail trade and activity will collapse for a couple of weeks. Second, about the political babu, police and the mafia nexus I call it, those are going to be the biggest sufferers and that is the perception among the people. People are happy. It is a matter of happiness.

There is a perception that the fat cats, people who are fattening on us are suffering. Now, let’s come back to economic aspect.

What is the economic problem and what is the pain. Think of it currency has two parts. One is what transaction demand and the other is stock demand. The moment the currency transaction demand is replaced all this negative effect will disappear. The problem is that two week is over and if they can do it in a month that affect will be quite small. For the year as the whole my estimate would be about 0.2 per cent in the fall of the growth from whatever week is thought. If they can’t do it in a month then there will be a bigger effect. So it all depends on that. It critically depends on the replacement of the transaction demand for currency because you have a forced demonetisation. If there is no transaction money, things collapse. When there is zero currency, everything ceases. In a month or so we will know. We really cannot, how competent and in component they will be in bringing the currency. Everything else is now irrelevant. If you don’t do it, it will be disaster. The quicker you do it the less is the impact.

The other part which hasn’t been talked of is the real estate factor.

So the big effect will be on real estate, what my estimates are that up to that entire black part that could possible disappear for a certain number of years, my guess is 3 years. So you could expect a price fall of up to 50%. Remember people are assuming that won’t change at all. They are terming that the move has been taken just for that 5%. But we don’t know that number could be 50-60%. This seems like a possibility. 

However, to make this happen you need to have complementary policies. One of them is Circle rates. The circle rates need to be low otherwise the prices cannot fall. Secondly, the stamp duty has to be reduced because this is an outdated tax since British Raj. They had to give something to the local guys so they introduced this stupid tax, which they themselves don’t use anymore.

Batra: Yes, it’s a bad tax and its abolition would benefit the whole ecosystem…

Virmani: First thing is to make this an issue of black money. We all have seen that the PM is an expert on that. It is very closely related to the black money. 

After real estate, there is jewellery and hawala. These will be less affected. There are 2 differences, in real estate the prices are arbitrary, in short, and whatever people are willing to pay. In contrast, gold is related to international prices which cannot fall below a certain limit. Similarly hawala, you are dealing in dollars which is again linked with international prices. These things have a price, unlike real estate which is arbitrary.

Batra: In terms of real estate, there is a contrary view that because the cash component was there, it added to the final price. Now that it won’t be there, the tax component would have to be borne by the buyer and the prices will go up. Hence that 50% drop won’t happen.

Virmani: That is the circle rate and the taxation is all based on that rate. So they have to reduce that.

Bhalla: Like Mrs Indira Gandhi said that I need more revenue, so I will make the tax rate 97%. The point is to do away with the capital gains tax and others. It should be that we will maximize the revenue to that number and then determine the tax. That is where we have gone wrong.

Batra: Mr Guruswamy, your take on this?

Guruswamy: I think this is like chikungunya.

It is symptomatic of this government’s/governance failure in the country. You don’t keep the drains clean or keep the sewage dirty. So the mosquitoes breeding there become problematic.

Now demonetisation might have the step you had to take but is the symptom of what went wrong or what has been going wrong in this country. So I don’t blame the Modi government. Both the Modi and Vajpayee governments have been a part of this. We have allowed the system to grow that way. So it’s coming back to us.

If the PM’s wisdom or the RBI says this was necessary, then good. But the way they have implemented and enacted upon it, is absolutely stupid. They have been out of touch with the reality, people, what is happening in the world, how the system function, they are totally out of it. The kind of pain this incidence has inflicted, they are I think out of touch with that as well.

They have made this is a war between the rich and the poor. It’s the most absurd this I have come across. Right now the PM is going around the country selling this as war against on the rich. This is now the right way of action. You might be able to sell that idea to some people for some time, till the reality bites you. The reality is that 74-75% of the daily wage earners are in the unorganised sector. They are the farm workers, the construction labour, small retails etc. they have been hit today and for weeks they have been unemployed or on daily wages.

Now the black money has been estimated between 26-72%. Let’s say its 50%. On 50% of the GDP we have lost tax, revenues and if you want to capture that revenue, where the compliances and the non-compliances are punished, first you have not enacted any law on that, carrying the business as usual. The question is what are you going after, you are going after the tailend, i.e the unaccounted or unpaid tax wealth which is 5% of it. Out of that 5%, almost half of this is on rotational business of everyday.

If today, you want to buy say sand for construction, you never get it against the bill, there is always a ‘parchi’. How will you get sand to be taxed or a tailor to charge you sales tax? This is all because there is no fear of compliance. The person, who is feeding off you, will not charge you. So you have to set up a compliance mechanism and address that.
Now, what the government has done is they have slowed down the economy.

Batra: Maybe in the short term.

Guruswamy: Not really.

You go to the market, you buy good and don’t pay sales tax because that is offered as an option. I myself bought some wood work; the contracting company asked me if I need a bill and was willing to make the transaction with old notes as well. So there is no fear.

Now, we are also talking about the property tax. It’s a state subject, for instance registration. Nobody is going to listen, because they have become used to it. Circle rates are fixed by the IT. If you want more tax, you raise the circle rates. There is difference between circle rates and the registration costs. And it is where the builders make money.

Bhalla: But why do we need circle rates?

Guruswamy: Precisely. We just want a stamp of approval. We need a stamp of approval because our litigation system requires us to do so.

Bhalla: Everywhere in the world, people register without having a circle rate. So why not abolish the circle rates…

Batra: Maybe it’s a start to that change. Why are we being cynical about it?

Guruswamy: There is nothing in Modi’s or Jaitley’s track record that inspires me to believe that they are going to change something. I know Modi personally and have worked quite a bit with him when he was the general secretary of BJP and let me be frank here, he doesn’t have the full vision which is needed. He is a doer and a great events manager, he can paint a good picture. But that’s about it.

They have invested in the system and they will not change. The whole political system is geared at winning the next elections.

Chhibber: Actually, the rupee holding, my guess would be that, actually you look at Nigeria, 3% of the GDP is cash, most corrupt country in the world because nobody trusts the Naira anymore.

We were heading towards rupee convertibility. Look at the hit on the perception of the rupee that is going to have. People say your cash GDP ratio is so high; actually it is not that high. China is about 8-9%. Where are we - 50% of the economy is working in cash, 80% of employ is in cash and we have the highest contract labour in the world. 40-50% of our workforce is casual labour.

Guruswamy: I have one more comment. Someone spoke about the electoral reforms and funding of the parties. Where are the parties? The only parties which have the constitution are BJP to some extent and the Communists. Rest are clans. Parties like the Shiv Sena, the Akalis, Congress are clans. Are you going to give money to these clans which are not even constitutional? These are just grouping of individuals. On what basis are you going to give them money? Legally they don’t exist. You ask Shiv Sena, you want to see their constitution and how you function. They won’t answer. None of them qualify.

Batra: Focussing on the GDP, in the next few years do you think it will be more than 8% or less than that, if you had to make a prediction?

I don’t want to make that prediction. Firstly, I don’t feel that the GDP is growing at that rate. We have picked up the Chinese habit of fudging figures. 

If you want to compare it with the past you go back to those bases and there is thing of irreconcilables that piling up. So I would not subscribe to the GDP numbers.

Bhalla: I think to answer your question, it shouldn’t be a number but from whatever estimates one has of what the GDP growth would be, to decide, whether it will accelerate the growth rate.

Guruswamy: I would say that it would decelerate. There will be a definite impact on that. But on the other hand, reforms are needed and they need to be holistically conceived, not for immediate or other gains and not to divide the country further between the haves and the haves not. This kind of populism is not going to get us anywhere.

Virmani: I have already given my estimate which was 0.2% affect for the whole year below my estimate. Of course, everyone has their own estimate. I am not talking about the quarter, but for the whole year. Just very briefly on things which need to be done. I must mention 2 factors - people are assuming that tax collection can go up if the GDP goes up. My point is that declaration will go up because of the nature of demonetisation. Again the people who are theoretical, sitting in Cambridge or US don’t understand how our economy operates. Despite what happens to the GDP, the declaration for this year 2016 will be higher and the revenue collected from income tax will be higher.

If you want to sustain it, you must reduce the rates from this budget and reform the income tax, the personal tax as that has not received attention. I have earlier mentioned GST and the CIT that is already in the agenda. What is not on the agenda is the income tax. So I would bet along with Surjit, who has already mentioned that the personal income tax will be reformed in the next budget. Will be, I am giving you a prediction and the effective rates will be reduced.

Batra: What will be the short term, medium term and long term effect of demonetisation on GDP?

Chhibber: Short term - one per cent GDP loss. Medium-term - Can go worse in terms of growth rate.

Virmani: Short term - 0.2 per cent loss.

Batra: Three years from now, what will be the GDP Numbers?

Bhalla: If they do the other reforms and in the short terms, my interpretation in the view this will be the biggest reform in India and it will make 1991 reform seem like very mild. In the long-term, it will accelerate the growth rate by 1-2 per cent from whatever the base you take.

Guruswamy: First of all, I don’t take it as a reform. PM has taken serious measure but now you will have to follow through. Most of subsides are not deserved. Subsidies in health, education are fine but subsidies in milk and gas are not deserved. I think a lot of thing has to be done. I think there should be other steps. Some kind of things so that consumer expenditure can go up again. Then your tax compliance gets better. They never thought of this.

Virmani: In addition to all this, 2 critical aspects need to be discussed. One is the election funding reforms. There are a lot of papers who have written about it and every reform they mention cannot be implemented.

The second is the reforms of the police legal system. Again the template is already there, there is that court case of the ex-IPS Officer Prakash Singh.

The point is that I keep criticising the media we take up all kind of silly issues but nobody takes up the issue of the police reforms. The template is already there. Why doesn’t anybody talk about it? Surjit and I differ a little bit here. He focuses only on the tax evasion and I have been repeatedly saying that the more deadly stuff is the political, babu, police mafia.

(Transcript prepared by Naina Sood, Arshad Khan)