DeMon, at what cost?

Any assessment of demonetisation is clouded by ongoing reforms such as imposition of a Goods and Services tax (GST) in July 2017 and the Real Estate (Regulation and Development) Act (RERA) in March 2016. All these hurt the informal, cash, and black economy, and have had spillovers in the formal economy.

The impact of the other two is more persistent, and definitely positive in the long term. Demonetisation was a short-term measure that has been now reversed. While it makes sense as part of a package to reduce informality, increase the tax base, leverage new technology and shift the economy to more transparent digital payment modes, in itself it is not worth the high costs it imposed. Alternative means could have achieved these objectives.

The aim to confiscate black money may have necessitated the secrecy, which was partly responsible for poor implementation, immense inconvenience, and even loss of life. Despite this almost all the money came back to the banking system.

Large cash deposits, however, generated many leads to potential tax evaders. A strong signal went out that tax evasion would be costly. Follow-up of additional information is ongoing. There are conflicting claims and definitions. Official figures show a 25 per cent increase in income tax e-returns filed up to August 5, 2017; 40 per cent increase in advance personal income tax; and 1.26 crore new tax payers.

Final figures await a comprehensive CAG audit. Meanwhile, the first criminal cases based on excess deposits were initiated against shell companies, set up to avoid taxes. Global data exchange against tax evasion will help the clean-up. Increasing the direct tax base is essential to improving public services. At present only the salaried classes regularly pay income tax.

According to RBI data on all the electronic payment systems, volume which was at 671.5 million in November 2016 peaked at 975.5 million in December 2016. After that it came down, but was still a much larger 883.4 million in August 2017. Thus demonetisation did give a persistent fillip to the digital economy.

It also gave a fillip to financial savings. Indian household savings comprise formal financial sector savings and largely informal savings in physical assets. Household financial savings that used to be about 7 per cent of GDP rose above 8 per cent. Demonetisation followed by RERA made the use of cash difficult in the real estate sector, once a haven for black money. Some of the money that used to be invested in real estate now switched to mutual funds. Household acquisition of shares and debentures rose from ₹413 billion in 2015-16 to ₹1,826 billion in 2016-17. These savings can be better intermediated to firms and government. The switch from unproductive cash to earning assets may reduce wasteful consumption by the poor. Currency supply had stabilised by mid-2017, alleviating cash shortages. A sharp rise in currency held over 2014-16, regarded as an attempt to escape a rise in service taxes, may have triggered the decision to demonetise. The currency deposit ratio fell to 8 in December and then stabilised at 13.5 below its prior value of 16.9, suggesting a permanent reduction in cash use. Currency ratios are much lower in most economies.

There was a temporary reduction in high-powered money, and rise in bank deposits.

If more savings stay with banks, the money multiplier, or broad money compared to cash, should rise over time. This peaked at 8.7 as currency was withdrawn, but stabilised at 6.4 by June, higher than 5.5 before demonetisation.

Since the informal sector is heavily cash-dependent, it bore the brunt of cash withdrawal. One survey-based estimate is that 2 million jobs were lost between January and August 2017. The crucial question is: Was this temporary or permanent? The labour participation rate suggests a temporary loss that lasted about 8 months. This ratio of all employed or unemployed adults willing to work to the total population, fell from 48 per cent in January 2016 to below 45 per cent in November 2016, and further to 43 per cent in July 2017, before recovering. The drying up of informal work may have discouraged job search activity. Badly hit construction and real estate has also bottomed out by mid-2017.

The problem is that GST also hurts the informal sector. Whether the costs of forced formalisation will be larger than the benefits will become clear only over the longer term.

The society itself largely supports the policy shows a willingness to undertake costs to increase the tax base and reduce corruption. The political motivation also seems to have been the latter, and fits in with actions taken against industrialists who had received large loans.

Reforms always hurt some groups — that is why they are hard to do. The set implemented do have the advantage of leveraging new technologies and global trends to create potential long-term benefits. For example, better data is allowing NBFCs and new fintech companies to assess risks and lend to the informal sector with low lags based on cash flows rather than collateral. Better records will facilitate bank lending to small firms.

Society seems to be ready to switch from a norm where few paid taxes, to one where the majority is willing to pay. Incentives are also working in that direction. GST puts the onus on the firm to ensure that its supplier pays taxes since only then can it claim credit. Industry becomes a giant tax collector.

As the tax base and compliance increases rates can come down, and the excessive inputting and matching of invoices imposed to catch all transactions be removed. Simplicity aids compliance, and the latter breeds trust.

The writer is a part-time member EAC-PM. The views are personal