Home / Opinion / Columns /  A neglected X-factor that lies at the core of our economic stasis

Many theories have been floated on why the Indian economy is struggling to get back on its feet, especially since its slowdown showed little signs of easing even before covid-19 lockdowns happened. It is easy to blame demonetization for the problem—it is an obvious scapegoat—but we have forgotten that the economy was decelerating in the quarters before 8 November 2016 too.

The real questions are: why was our economy decelerating before demonetization, and why did it not get its mojo back even after the re-monetization exercise was complete?

We are missing the elephant in the room: the Narendra Modi government’s excessive aggression in its effort to reduce black money and enforce tax compliance, of which demonetization was only a political gambit. We had two high-penalty tax amnesty schemes in 2015 and 2016 (one each for foreign and domestic incomes and assets), an attack on shell companies, a tapering down of participation certificates for stock market investors from abroad, renegotiations of our tax treaties with Cyprus, Mauritius and Singapore, the use of Aadhaar authentication for direct benefit transfers, the implementation of a goods and services tax (GST), a bankruptcy code, and a notification on benami (false name) transactions, among other things.

This points us in one direction: the Centre’s squeeze on the black economy came too quickly and too abruptly for India’s corporate sector to adjust. Hence the weak revival.

Those measures were accompanied by equally aggressive Reserve Bank of India moves under governor Urjit Patel to force banks to recognize their bad loans and start providing for them. The double-balance sheet problem essentially morphed into a credit-cum-capital squeeze for most companies. Why are we surprised that private investment never recovered after 2012?

Consider also how many big businesses went bankrupt and were forced to sell their best assets (and not their worst ones). From the Ruias to the Jaiprakash, GMR, GVK, Tata and Ambani groups, companies were either stuck in bankruptcy courts or pursued by creditors to sell their best assets. This was in contrast with the old crony-era reality in which India Inc expected profits to remain private and losses to be written off or nationalized.

It is difficult to cite numbers to link the economy’s prolonged weakness with the Modi government’s attitudes towards cronyism and tax-evaded income and wealth, but it would be foolhardy to assume that its actions had no impact on the animal spirits of India Inc. If we accept that cronyism is less today than before 2014, and if we also assume that businesses had their own back-channel ways of getting illegal money when they really had no other option (like milking banks and bargaining for repeated debt recasts, also called evergreening), why, again, are we surprised that a recovery is so uncertain?

The government needs to internalize a simple truth: when it comes to the real economy, growth in the medium-term can be as heavily impacted by crimping the supply of tax-evaded and concealed incomes as by other better-recognized deflationary moves. If an entire illegal ecosystem of cash incomes is squeezed dry, it can also damage the jobs of those who live off this source. Consumption also suffers, for cash from an illegal source is more likely to be spent than cash on which taxes have been paid. Taxes paid boost incomes and consumption only after a lag.

The larger point is this: the aggression on black money has probably driven it deeper underground to zones that don’t benefit the economy. Some of it is perhaps abroad, which might explain the rush among high-net worth individuals to emigrate from India; much of what remains in the country has probably moved into real estate, which makes this under-reformed sector dependent on a narrow base of customers for over-priced property.

Now that covid-19 has set government revenues back substantially, the sensible way out of the mess is to put black money to work for a domestic revival by offering tax amnesties that are enticing. This is entirely possible under the current lower tax regime. Corporate taxes have been cut and income taxes (especially the part deducted at source) have already been trimmed to boost cash flows in the hands of citizens and smaller firms.

If a new amnesty scheme focuses on allowing firms to receive unaccounted money with, say, a tax rate of just 30%, and if companies in liquidation are allowed to be bought with unexplained money sources, it should be possible to kill two birds with one stone. We could increase government revenues and improve corporate balance-sheets. The only thing that will be tested here is the assumption that large hoards of illegal money exist, both abroad and in India.

The pursuit of black money has to some extent hurt the economy. Isn’t it common sense to harness it now for the benefit of a revival? Deng Xiaoping famously said that the colour of the cat doesn’t matter as long as it catches mice. The colour of the money needed to revive the Indian economy should not matter at a time we’re all trying to pull ourselves out of a ditch.

R. Jagannathan is editorial director, ‘Swarajya’ magazine

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