A key theme of the Economic Survey presented to Parliament last week was demonetisation. The survey sought to discuss “complexities of the analytics, empirics and potential impacts of demonetisation”. It has focused on the three sets of issues in this regard: (a) broader aspects of management of demonetisation, as reflected in the design and implementation of the initiative, (b) economic impact of demonetisation in the short and medium run and (c) implications of demonetisation for the broader vision underlying the future conduct of economic policy.
The Survey refrains from discussing the broader aspects, steering away from the most critical aspects of the entire exercise of demonetisation. It is the ill-conceived and poorly-timed design and implementation of demonetisation that is at the crux of the many adverse consequences that have impacted the common citizen, besides hurting the economy.
The exercise was based on a false perception that cash transactions breed corruption and less cash means that the level of corruption is reduced. The poor and inefficient technological readiness made such a massive operation ineffective. It is a pity that money supply figures are not recorded properly and the Reserve Bank of India’s (RBI) hesitancy to report the remonetisation figure is a clear evidence of this.
The survey maintains that there have been short-term costs but potentially long-term benefits. To prove this point it has carried out an impact analysis using 10 variables which include: (1) Money/interest rates, (2) Financial system Savings, (3) Corruption (underlying illicit activities), (4)Private wealth, (5)Public Sector Wealth, (6) Formalisation/Digitisation, (6)Real estate, (7)Broader economy, (8)GDP, (9) Tax collection, (10) Uncertainty/ credibility.
A perusal of the long-term impact on the above heads leads one to conclude that there is no definiteness and that the so-called impact analysis is highly conditional. For an example, the survey comments that loan rates could fall further, if much of the deposit increases prove durable; that the financial sector system savings will increase to the extent that the cash-deposit ratio falls permanently; that corruption could decline, if incentives for compliance improve.
It goes on to argue, without providing any basis for such assumptions, that private wealth could fall further, if real estate prices continue to decline and that government/RBI’s wealth will increase when unreturned cash is extinguished, reducing liabilities. Further, it claims that real estate prices could fall as investing undeclared income in real estate becomes more difficult and that the tax component could rise, especially if the GST is imposed on real estate.
This is more of a wish list rather than any analysis. The long-term impact of demonetisation has been sugarcoated with many `ifs’ here. Such an analysis, claims and statements are neither expected nor appropriate in an important document like the Economic Survey.
More importantly, the impact of GDP analysis lacks analytical rigour and is misleading. The Survey, to defend demonetisation, takes the shelter of nominal growth. It mentioned that “an even better counterfactual for comparison would be the level of nominal rather than real GDP growth. After all, demonetisation is mostly a nominal demand shock, so its effect in the first instance will be on nominal magnitudes.”
This is not only an analytical blunder and but also a classic case of creative accounting to defend and justify a wrong. For all analytical purposes, the real GDP represents truly the performance of the economy and certainly not the nominal GDP.
Furthermore, the survey to prove the point of minimum adverse impact of GDP has gone into the technicalities and concluded that when one is comparing the GDP growth estimates by the IMF, the Central Statistics Office and others, it would be more appropriate to make a comparison based on the changes in the forecasts rather than their levels. This suggestion has the potential of inconsistent approach to make any comparison.
Tax collection
Another important issue is tax collection. The survey claims that indirect and corporate taxes could decline, to the extent growth slows. Over the long-run, taxes should increase as formalisation expands and compliance improves. This is again a very simplistic and an erroneous view. It is important to recognise that less cash in the economy does not mean formalisation in the economy is automatic. There are structural rigidities in the form of bankable habits and stricter KYC norms. Even in the much- discussed ‘Jan-Dhan’ accounts, as the demonetisation experience suggested, there are ample cases of misuse.
The increase in tax–GDP ratio is a sustainable answer to prudent fiscal management. But moving to a formal economy has no direct relation with the increase in tax compliance. Tax compliance is one issue but more important is enhancement of tax base along with rationalisation in tax rates and withdrawal of many tax exemptions.
With regard to credibility, the survey has mentioned credibility will be strengthened if demonetisation is accompanied by “complementary” measures. However, these complementary measures have not been defined in the survey. There seems to be some inconsistency in the Survey: on the one hand, there is an argument that full remonetisation will not happen but while discussing the credibility, there is a mention that early and full remonetisation is essential.
It is difficult to resist the conclusion that the Economic Survey has been used to justify the erroneous decision on demonetisation and related issues. Counterfeit notes and black money are the result of deficiencies in the currency management architecture of the RBI the tax administration of the government. At the end of the day, it is important for the RBI to improve the currency management architecture. In a longer-term perspective, it is important to strengthen the currency management architecture and tax administration without harassment.
(Pattnaik is Professor, SPJIMR; Rattanani is Editor, The Billion Press, SPJIMR)
The Survey refrains from discussing the broader aspects, steering away from the most critical aspects of the entire exercise of demonetisation. It is the ill-conceived and poorly-timed design and implementation of demonetisation that is at the crux of the many adverse consequences that have impacted the common citizen, besides hurting the economy.
The exercise was based on a false perception that cash transactions breed corruption and less cash means that the level of corruption is reduced. The poor and inefficient technological readiness made such a massive operation ineffective. It is a pity that money supply figures are not recorded properly and the Reserve Bank of India’s (RBI) hesitancy to report the remonetisation figure is a clear evidence of this.
The survey maintains that there have been short-term costs but potentially long-term benefits. To prove this point it has carried out an impact analysis using 10 variables which include: (1) Money/interest rates, (2) Financial system Savings, (3) Corruption (underlying illicit activities), (4)Private wealth, (5)Public Sector Wealth, (6) Formalisation/Digitisation, (6)Real estate, (7)Broader economy, (8)GDP, (9) Tax collection, (10) Uncertainty/ credibility.
A perusal of the long-term impact on the above heads leads one to conclude that there is no definiteness and that the so-called impact analysis is highly conditional. For an example, the survey comments that loan rates could fall further, if much of the deposit increases prove durable; that the financial sector system savings will increase to the extent that the cash-deposit ratio falls permanently; that corruption could decline, if incentives for compliance improve.
It goes on to argue, without providing any basis for such assumptions, that private wealth could fall further, if real estate prices continue to decline and that government/RBI’s wealth will increase when unreturned cash is extinguished, reducing liabilities. Further, it claims that real estate prices could fall as investing undeclared income in real estate becomes more difficult and that the tax component could rise, especially if the GST is imposed on real estate.
This is more of a wish list rather than any analysis. The long-term impact of demonetisation has been sugarcoated with many `ifs’ here. Such an analysis, claims and statements are neither expected nor appropriate in an important document like the Economic Survey.
More importantly, the impact of GDP analysis lacks analytical rigour and is misleading. The Survey, to defend demonetisation, takes the shelter of nominal growth. It mentioned that “an even better counterfactual for comparison would be the level of nominal rather than real GDP growth. After all, demonetisation is mostly a nominal demand shock, so its effect in the first instance will be on nominal magnitudes.”
This is not only an analytical blunder and but also a classic case of creative accounting to defend and justify a wrong. For all analytical purposes, the real GDP represents truly the performance of the economy and certainly not the nominal GDP.
Furthermore, the survey to prove the point of minimum adverse impact of GDP has gone into the technicalities and concluded that when one is comparing the GDP growth estimates by the IMF, the Central Statistics Office and others, it would be more appropriate to make a comparison based on the changes in the forecasts rather than their levels. This suggestion has the potential of inconsistent approach to make any comparison.
Tax collection
Another important issue is tax collection. The survey claims that indirect and corporate taxes could decline, to the extent growth slows. Over the long-run, taxes should increase as formalisation expands and compliance improves. This is again a very simplistic and an erroneous view. It is important to recognise that less cash in the economy does not mean formalisation in the economy is automatic. There are structural rigidities in the form of bankable habits and stricter KYC norms. Even in the much- discussed ‘Jan-Dhan’ accounts, as the demonetisation experience suggested, there are ample cases of misuse.
The increase in tax–GDP ratio is a sustainable answer to prudent fiscal management. But moving to a formal economy has no direct relation with the increase in tax compliance. Tax compliance is one issue but more important is enhancement of tax base along with rationalisation in tax rates and withdrawal of many tax exemptions.
With regard to credibility, the survey has mentioned credibility will be strengthened if demonetisation is accompanied by “complementary” measures. However, these complementary measures have not been defined in the survey. There seems to be some inconsistency in the Survey: on the one hand, there is an argument that full remonetisation will not happen but while discussing the credibility, there is a mention that early and full remonetisation is essential.
It is difficult to resist the conclusion that the Economic Survey has been used to justify the erroneous decision on demonetisation and related issues. Counterfeit notes and black money are the result of deficiencies in the currency management architecture of the RBI the tax administration of the government. At the end of the day, it is important for the RBI to improve the currency management architecture. In a longer-term perspective, it is important to strengthen the currency management architecture and tax administration without harassment.
(Pattnaik is Professor, SPJIMR; Rattanani is Editor, The Billion Press, SPJIMR)
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