Squaring The Nation’s Books In Times Of Less Cash

At the end of the 50-day wind-up of the demonetisation exercise, Prime Minister Narendra Modi doled out many “sops”, particularly for farmers and small enterprises, to mitigate some of the cash crunch pains. It was also an exercise to improve voter sentiment in five states going to polls in February, before the constraints of the election code kicked in.

Up ahead, the NDA government faces a major challenge when presenting its fourth budget on February 1, which will indicate the policy direction for its ­remaining tenure in the run-up to the 2019 general elections. The challenge is not just to boost investor sentiment, but also to revive demand growth that has been severely hit, making many national and global bodies such as the IMF to scale down India’s growth projection to below 7 per cent.

“My government is strongly committed to continue the reform of the Indian economy,” Modi told potential investors at the biannual Vibrant Gujarat Global Summit last week. Among the over 25,000 MoUs signed during the three-day gala, it was mostly small and medium enterprises that commited to invest.

It is not just in Gujarat that investment sentiment has seen a dip. Data compiled by the Centre for Monitoring Indian Economy Pvt Ltd (CMIE) suggests that demonetisation has hit the pace of new investment proposals during the quarter ended December 2016 with only 404 new investment proposals. In over a decade, this is the lowest number of new projects announced in a quarter. Post-demonetisation, CMIE forecast that growth trajectory could “shift down to about 6 per cent per annum for the next five years”, which contradicts many other projections that the negative ­impact may wear off in one or two quarters after the money supply improves.

“It normally takes six to eight months for liquidity to get normalised and even longer for confidence to be restored,” exp­lains Mahesh Vyas, managing director of CMIE. “In six months, consumers would have found equilibrium at a lower level, so coming back to old levels of consumption will take time, leading to delay in investments, which, in turn, will hurt employment growth as well as demand growth. Clearly, any hope of growth returning to higher levels in the near future runs on thin arguments. We are being more cautious and realistic, and not pessimistic.”

Moreover, with the government having failed to scotch rumours of the new Rs 2,000 bank notes being demonetised, there is lingering fear among ­consumers. Adding to the woes are the weekly limits to withdrawals by individuals still at Rs 24,000. So the liquidity needed for higher levels of consumption demand are just not there yet. Investors, on their part, would obviously wait for demand to be restored, supply chains to be repaired, the spectre of raids to go away and banks to return to normalcy before they display any enthusiasm for creating new capacities.

While the government seems gung-ho about the switch to the digital mode of transaction, everyday experience of ­consumers tells a different story, with most traders unwilling to ­accept ­anything but cash. From 98 per cent cash transactions to a less-cash economy is going to take alm­ost a behavioural and attitudinal change, feels Rajat Kathuria, chief ­executive of think-tank ICRIER (Indian Council for Research on International Economic Relations). “Enforcement of digital transactions will have to become part of the system. It will take longer to gain traction and become entrenched,” he says. “Meanwhile, ­investment is not happening as there is uncertainty in the economic environment, which is never good. Demonetisation, for example, was never ­anticipated. One of its imp­acts is that it has made people a little more risk-averse.”

Kathuria is nonetheless ­optimistic that investment will return as India is still the most promising of markets. Despite the lowering of growth expectations, India, along with China, is expected to record relatively higher growth among the developing countries. While it is still early to predict the impact of demonetisation, how soon the cash would come back into the ­system and by when digital transactions would have gained adequate ­acceptance, Kathuria is concerned about the disruption in the labour market, “as it will take a lot more time to be resolved than getting the monetary system back in place”.

D.K. Srivastava, chief policy advisor at Ernst and Young India, points out that the economy had started showing signs of slowdown due to investment contraction even prior to demonetisation. In turn, the inventories were getting accumulated. As a result, the Central Statistical Org­anisation (CSO) had revised the ­adv­ance estimate of GDP growth from 7.6 per cent last year to 7.1 per cent this year, without taking into account the impact of demonetisation. “Impact of demonetisation led to consumption contraction, ­sup­­erimposed on investment contraction,” says Srivastava, who was formerly director of Madras School of Economics. “The IMF has revised India’s growth outlook to 6.6 per cent, which is a fall of one per cent compared to its earlier forecast and around 1.4 to 1.5 per cent below the potential of 8 per cent growth.”

Vineet Rai, founder of the Aavishkaar-Intellecap Group and a member of the Business and Sustainable Development Commission launched in Davos in January 2016, is more upbeat. “Most people I have met, both in senior leadership positions at the commission and outside here at Davos, believe that the India story is intact and, if anything, the move to demonetise signals the current government’s intent to rise above political considerations and act,” says Rai. “The impact of demonetisation over the next two quarters would be a drain. Whether it was necessary, given that we are already on the path to delivering GST, is a debatable position and most people believe we could have waited. Having said that, the general belief is that India would be back to growth and high growth over the next three quarters.” Describing demonetisation as “shock therapy”, Rai says it would depress spending as “it removes black money, which was equivalent to the purchasing power capacity that got wiped out”.

The upcoming budget is seen as the first major opportunity for the Modi government to lift the economy back to the potential for 8 per cent growth. For that, both fiscal and monetary stimuli are necessary, Srivastava points out, with fiscal preceding the monetary as even a fall in interest rates is not expec­ted to revive demand until inventories are brought down. There are several means by which fiscal stimulus can be provided. “I think the economy can be boosted by fiscal means to an extent of 2.5 per cent of the GDP and all of that should be spent on infrastructure. Once this gets going over two or three months, monetary stimulus can then be thought of by reducing the ­interest rate,” says Srivastava.

Elaborating on the room for fiscal stimulus, Srivastava says that despite the much lower expectations now, there will be some fiscal windfall gain from the extinguishing of the demonetised currency and some additional one-time tax revenue gain ­because of the income-tax amnesty schemes, while the surge in bank deposits should result in some additional tax revenue. The government can also relax the FRBM (Fiscal Responsibility and Budget Management) norm, which is targeted to be 3 per cent next year, and let it grow an additional 0.5 per cent of the GDP. Thirdly, the state governments can also be brought on board and allowed relaxation of 0.5 per cent of the GDP. There is also the possibility of letting public sector enterprises and dep­artmental enterprises such as the railways and posts to take up their investment plans this year, particularly as the prices of investment goods are currently low.

“We cannot depend on any global support to Indian growth. It will have to come from within,” says Kathuria. “If the preconditions are in place, such as getting the GST off the ground (it will take at least two years to completely fall into place), improving and easing the cost of doing business, which we have started doing to woo more investments, digitisation of transactions and transparency in funding of political parties, and making our tax regime more tax-payer friendly, then we would well be on our way to 8 per cent or even higher growth rate.”  

After five to six quarters of negative to zero growth, India’s exports have started looking up, with the pickup in demand from the US and Europe. The challenge before the government is to attract FDI and other investments as the incentives being offered have had little uplifting impact. Most worrying is that both domestic savings and investment rates have fallen over the past few years, which are fundamental weaknesses in the system.  

At the macro level, experts point out, both the industry and investors want policy certainty even as they clamour for ­incentives. The industry has also been demanding greater public sector investment in infrastructure, while urging the government to address market failures. There is also the government promise to reduce the corporate income-tax rate in four years to a nominal 25 per cent and simultaneously reduce some of the deductions and exemptions so that it is not a revenue-losing proposition.

“If the government focuses on investment and tries to leave a little more disposable income in the hands of consumers, then it will give a big boost to growth in 2017,” says Ranen Banerjee, leader (public finance and economics) at Price­waterhouseCoopers, who believes one of the biggest impediments to the Make-In-India programme “are the constant issues around taxation. International companies and investors want certainty on taxes to be paid, so coming out with regular clarifications unnerves investors.”

The fundamentals to boost growth are on our side—the demography is just right and there is lot of scope for building infrastructure and creating jobs. Moreover, there is greater clarity today about the rural-urban link, which is becoming stronger and stronger. “Today rural economy is not just agriculture, which constitutes just 45 per cent of it,” states Rajesh Shukla, managing director of think-tank People Research on India’s Consumer Economy. “With rural areas becoming dynamic for growth, it has become a focus of interest to everyone, including industries, which are trying to push sales of consumer ­durables and two-wheelers.”

The biggest challenge in rural areas is the poor implementation and administration of socio-economic development schemes by both the states and the Centre.  This is forcing the government to pay ­greater attention to rural demands, whether for votes or for demand growth.

The 2017 budget could well be the last budget for the Modi government to ann­ounce major policy decisions with the larger national interest in mind. The next budget will be closer to the 2019 polls, when there will be certain obvious constraints in taking any bold policy actions and even lesser scope to roll out any grand scheme. The expected boost in government revenues due to the impending GST rollout in July and the expansion of the tax base in the wake of demonetisation with more people moving into the tax net, at least in the service sector, should provide more resources to enhance public investments. It could also make room for giving some tax breaks to those at the lower end of the income bracket. Given Modi’s penchant for devising new ways to engage with the public, one can surely look forward to some move to recover the lost sentiments.