Of Carrots after the Stick?!

The Indian economy's growth rate in the current financial year could be around 6.5% to 6.75% after accounting for an adverse impact of about 0.25 to 0.5 percentage points due to demonetisation, the official Economic Survey has said.

This impact is likely to be temporary and the economy should rebound to grow by 6.75% to 7.5% in 2017-18. This, however, will depend on expeditious remonetisation, estimating this should largely be achieved by end-March. Interestingly, the Survey also seemed to strike a cautionary note on any aggressive push for digitalisation--the new buzz word in government.

Suggesting that the demonetisation drive was a potentially powerful stick, the Survey said that it now “needs carrots as complements“. These would include lowering income taxes and stamp duties and accelerating the reduction in corporate tax rates. It would also be important to ensure the tax administration does not get overzealous and harass taxpayers, it cautioned.

The Survey admitted that demonetisation has had the effect of creating uncertainty and pushed for an “early elimination of withdrawal limits“ to help build confidence. It said there should be no penalties on cash withdrawals, since these would only encourage cash hoarding. Unless people have confidence that money deposited in bank accounts is freely convertible into cash, and vice versa...they will hoard it,“ the Survey warned, adding that the poor would be worst hit in such a situation since the affluent would corner the limited currency available.

About the immediate adverse impact of demonetisation, the Survey noted that there have been reports of job losses, declines in farm incomes, and social disruption, especially in the informal, cash-intensive parts of the economy.

It acknowledged that the cash crunch must have affected the informal economy , which could account for 50% or more of the overall economy . The formal economy too would have suffered because workers laid off in the informal economy have bought fewer products from the formal economy .

Among the sectors the Survey specifically looked at, it conceded that real estate had been badly hit but expressed the view that this was not entirely a bad thing.

In the short run, demonetisation could also affect supplies of agricultural products like milk, sugar, potatoes and onions.

Defending the long-term virtues of demonetisation, the Survey said it could be interpreted as a demonstration of the state's resolve to crack down on black money , showing that tax evasion would no longer be tolerated.

It said the combined effects of the financial penalty cash hoarders have had to pay ­ either by declaring incomes they had concealed so far or by having to shell out a “conversion“ cost for turning black money white through intermediaries ­ and of “social condemnation“ could have a powerful and long-lasting effect on corruption and tax compliance.

The tax-GDP ratio, as well as the size of the formal economy , could be permanently higher, the Survey said, adding that if it was successful it would in the long run reduce the cash-GDP and cash-deposits ratios, thereby increasing financial savings and boosting long-term growth.