Narendra Modi is walking a tightrope with his fight against black money. The Prime Minister has unleashed a wave of bold, and sometimes brazen, initiatives to root out income that has been illegally obtained or not declared to the taxman. But that has chilled the economy. Managing the short-term fallout is key to smoothing the path to his re-election.
Soon after the BJP took over in 2014, businesses noted it was harder to win special favours from New Delhi. A new bankruptcy law has also started to shift the balance of power from tycoons to lenders. These are significant changes, given a series of crony capitalism scandals turned voters against the previous government.
Over the past year, New Delhi’s focus has shifted from elite corruption to dealing with the next layer down: ordinary taxpayers. The country has more citizens who go overseas on holiday than taxpayers who declare income of more than ₹1 million Modi grumbled in a recent address to accountants, urging them to take less pride in helping clients dodge their dues.
Tax avoidance is deeply entrenched: middle-class Indians and small businesses are reluctant to hand over money to a corrupt system. Public services received in return are also dismal. Many rely on private schools and healthcare. In Mumbai, a few hours of rain can result in deadly flooding. Wading through waterlogged streets last month, one of the city’s top doctors disappeared down an open manhole. Such stories feed the perception that taxes will be wasted.
Hoarding cash Modi has done a number of things to try force a change in collections. A controversial ban on big banknotes last year made people less comfortable hoarding undeclared cash. The goods and services tax (GST) is based on electronic invoices, forcing small traders to enter the formal economy to claim back tax credits. New real-estate regulations mean it is harder to park illicit cash in property.
Individuals, meanwhile, are banned from making cash purchases over ₹200,000, and must link biometric identity numbers to income-tax filings. All of this will make it easier for New Delhi to track who is spending what and where. That’s already yielding ground-level results. For example, it is no longer quite as easy or socially acceptable to brag about cheating. And even corporate lawyers say clients are no longer interested in using funky structures to minimise tax bills, preferring to play by the book.
But Modi may be trying to do too much at once. India’s economy was already suffering from low private investment and high bad debts, before demonetisation sparked a sharp contraction in the amount of money in circulation. There was no time to recover before the July rollout of the complex GST, with minimal preparation. Serious glitches mean claims for rebates are already much higher than expected.
As a result, GDP growth has declined for six consecutive quarters to 5.7 per cent in the three months through June. The pain will have been more pronounced in the part of the economy that is not taxed. Saurabh Mukherjea of Ambit Capital reckons that tax-evading companies have driven growth in employment and might account for 80 per cent of jobs. That’s potentially dangerous for Modi since he promised to create work opportunities, not destroy them.
Ballot-box test To support the economy and square the funding circle, New Delhi is now considering relaxing the fiscal deficit target from 3.2 per cent. Low inflation, a narrow current-account deficit, and large foreign-exchange reserves would make a limited adjustment manageable. As long as the pain can be contained, the black money crackdown will continue apace.
An official report last year noted India’s tax-to-GDP ratio hovers at around 17 per cent, just half the 34 per cent average of the mostly prosperous countries that make up the OECD. Even Vietnam, which is roughly as rich as India on a per-capita basis, collects 22 per cent.
Moving the needle isn’t easy: India’s tax-to-GDP ratio increased only 10 percentage points over the past six decades. It will take time to bed down recent changes, but if India can in time match Vietnam’s ratio , that would give the Government an extra $120 billion each year to spend. The absolute size of the economy would also grow if more people are inside the tax net.
If Modi can put growth back on track, he can claim to have delivered on at least one key promise. While the Opposition remains in disarray, he knows that a weak economy and its negative impact on jobs is no small threat to his position.