For the Narendra Modi government, which stormed into power in May, 2014, coming out of the demonetisation mess unhurt isn’t an easy task, despite what it promises to achieve in the future (an economy, free of black money, corruption and fake notes) and no matter how good the later-stated objectives are (including a shift to a cashless economy). The move to scrap 86 percent of currency in circulation all of a sudden on the night of 8 November has thrown the economy into a crisis situation. Corporate profitability has taken a hit, lakhs of jobs are reportedly lost in the informal sector, consumer ability to spend has been curtailed, farmers are affected as prices have crashed, services and manufacturing sectors are impacted and there is skepticism globally on the rationale behind Modi’s currency ban.
Not surprisingly, both government and private forecasters are competing to show lower India GDP numbers for fiscal year 2017. The estimates range from 7.1 percent (Reserve Bank of India) to an extremely pessimistic 3.5 percent by Ambit Capital, a private brokerage firm. The available data--advance tax payments by corporates, PMI numbers, auto sales and slowdown in service-oriented sectors confirm the fear of a deeper impact to the economy.
Most economists have ruled the third quarter as a miss, but the real danger comes if the cash crunch-woes spill over to the fourth quarter since then there will be a cascading impact in the economy.
According to data from Centre for Monitoring Indian Economy (CMIE), unemployment rates fell to less than 5 percent in the week of 27 November, but has since risen to 6.1 percent in the week of 4 December to 6.6 percent in the week ended 11 December and then to 7 percent in the week ended 18 December. The impact comes with a lag and we need to wait for fresh numbers.
Need of the hour
There are a few critical tasks before the Modi-government that should be done urgently:
First, refrain from populist, non-productive expenditures such as promising the poor that the gains on black money will be distributed to them and that farm loans will be waived. The government should focus on boosting the capital base of banks on an urgent basis so that bank credit flow to productive sectors doesn’t suffer, and sell off the loss-making banks or consolidate a few if there is synergy amongst them. Finance Minister Arun Jaitley has a good opportunity in the 2017 Union Budget slated for 1 February to announce some bold measures to take the reform process ahead in the public banking sector.
Presently, state-run banks are severely undercapitalized and the problem is worsened with their non-performing assets (NPAs) hitting the roof (nearly Rs 6 lakh crore as on September, 2016 or nearly 8 percent of the total bank credit), and total chunk of stressed assets (bad loans and restructured loans together) jumping to 12-13 percent of the total bank credit. Under the government’s Indradhanush plan, of the Rs 1.8 lakh crore capital needed by banks under Basel-III, the government has offered to infuse Rs 70,000 crore over four years till 2018-19 and wants the government banks to fend for themselves for the remaining Rs 1.1 lakh crore from the market. This is not enough. Also, it is almost impossible that weak state-run banks will find takers. This compounds the problem. So far, there is not much progress on the reform front. That is why the government, the majority owner in these banks, will have to think about infusing them with higher chunks of capital and push the reform button.
Two, offer a fiscal boost to the economy by ramping up infrastructure spending. A section of economists agree that the economy is in need of a strong stimulus to get back on track. This is warranted because several layers of economy have taken a hit post-demonetisation. One of the expectations from the demonetisation exercise was to get a ‘windfall’ of Rs 4-5 lakh crore provided that kind of money doesn’t return to the system as black money hoarders run for cover. The government was expecting to garner around Rs 10 lakh crore of the Rs 15.44 lakh crore demonetized on 8 November. But, that hasn't happened yet. This, coupled with the Reserve Bank of India's (RBI) clarification that there is no possibility of a transfer of surplus from the central bank to the government on account of reduced currency liability, has ruled out any immediate tangible gains for the government. Instead, the exercise has resulted in considerable damage to the economy.
Third, Jaitley should also announce reliefs to both individuals and corporations in Budget 2017 by offering substantial direct tax reductions to tide over the difficult phase. This will work in three ways—to make India still an attractive destination for companies when US president-elect Donald Trump's administration rolls out massive tax cuts, reverse the negative mood on account of the artificially imposed cash-crunch and put more money into the household kitty to keep the consumption story going. Corporate tax incentives should be over and above the ongoing plan to bring down corporate tax rates to 25 percent over a period and gradually remove exemptions. But this hasn’t found much appeal in the industry since the effective rate is only about 23 percent after exemptions. This is the reason the marginal tax cut in the last budget hasn't received much response. The government will have to act to regain losing momentum by offering industry a temporary stimulus.
Fourth, it is even more critical now to resolve the cash crunch as fast as possible and bring things back to normalcy. The government can’t expect a miraculous shift to digital payments in a few months replacing a world of cash. Estimates are that 70 percent of the economy still transacts in cash. Pulling out 86 percent cash in one go in a country like India and then facing a cash shortage could be compared to an act of removing blood out of a healthy human body to filling it again with better quality blood, only to realize that there is not enough stock!
Until 19 December, the RBI has infused only Rs 5.92 lakh crore into the banking system as compared with deposits worth Rs 12.44 lakh crore in old Rs 500, Rs 1,000 currencies as on 10 December. Of the total 22.6 billion pieces of notes of various denominations infused, only 2.2 billion belonged to higher denominations of Rs 2,000 and Rs 500. It is not clear how many of the 2.2 billion is in Rs 2,000 notes and how many are Rs 500 notes. Herein lies the problem. The ongoing cash crunch, according to bankers, is mainly due to shortage of the new Rs 500 notes. An end to the current cash crunch is possible only when there is enough Rs 500 notes coming out of the government mints.
But the tricky part for the Modi government will be to find the fiscal space to spend more simultaneously keeping the fiscal roadmap intact. It needs to meet a 3.5 percent fiscal deficit target for the fiscal year 2017. Given that demonetisation itself is unlikely to give any major fiscal boost, the only hope is for the taxmen to dig out substantial chunks of illegal cash from the system from the funds that reach bank accounts either through the black money declaration scheme or raids contributing to the exchequer. Handling a bigger budget, including that of the Railways, is another challenge. “There is a big monster called the Railway budget coming as part of the general budget this year. This can sharply spike numbers on the expenditure. How will the government handle the new situation is worth watching,” said Devendra Pant, chief economist at India Ratings and Research. The expected boost to tax kitty from more number of digital transactions will come, but only at the beginning of the next year.
The short point here is about balancing Union Budget 2017 with the much-required economic stimulus while keeping the fiscal deficit roadmap intact. This will be a trial by fire for the Modi-government.
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Updated Date: Jan 15, 2017 20:55:10 IST