Impact of Demonetization & GST

“What is our country today?” started PP Rtn Shailesh Haribhakti, a renowned chartered accountant, who lends his expertise to several professional and governmental regulatory bodies, and is currently the chairman of the National Pension Scheme Trust as well as a Member of the Advisory Committee of Pension Fund Regulatory and Development Authority. “We are a nation of a 125 crore people. Our expected GDP is said to be 2.3 trillion USD. We have only 3.5 crore-tax filers, in addition to the 1 crore people whose taxes are deducted at source because they are employees of some organization. Therefore, out of the 125, only 4.5 crore Indians have had anything to do whatsoever with the tax department.” “The great thing is that we have issued 26 crore PAN cards and this is a first in the world, as no

“The great thing is that we have issued 26 crore PAN cards and this is a first in the world, as no other country has this kind of a population. Aadhar Cards are issued to a 107 crore Indians, which in itself has been an incredible achievement. In addition, we were the fastest nation to dematerialize all our securities, and today, no trading of any security in India can happen except in dematerialized form.”

“Sadly however, our tax to GDP ratio is amongst the lowest when compared to larger economies at close to 10%.”

“So what has the government done so far to make us ready for demonetization?” questions Shailesh, as he believes that this set the context. “In the earlier demonetizations, there was no preparedness at all. It was impossible for people to find an alternate way to transact. Whereas today, because of the very sound implementation of the Jan trinity, i.e. the Jan, Dhan, Aadhar, and the mobility, we have seen India digitize more rapidly than ever before. I have multiple choices on payments, multiple credit cards, I have absolute information at my beck and call information, and I really don’t need cash. And that is a realization that many of us had when our notes became useless.”

“Also, it was in 2006 that India first got exposed to what can happen if a tax information network is put in place. This was done by a company called NSDL e-Governance, which transformed the tax collection framework of the country, and our tax collection growth has always been after that – a multiple of growth in GDP. Largely because this tax information network captured, information which the tax dept. could follow through, and get to who had not paid what they were supposed to pay.”

Clarifying the context further, he said, “We had a Voluntary Disclosure Scheme, wherein `65,000 crores of voluntary disclosure was made. We had every chance to come clean, and it seemed like it was just not happening! This is because; the currency in circulation at about 16.5-17 lakh crores is more than the total value of equity investment at original cost of all Indians. Of this currency in circulation, the high denomination notes were close to 85% and growing. And to add to it was the menace of 40,000 crores worth of fake currency.” “With this context, on 8th November, we heard the all-familiar ‘Bhaiyon

“With this context, on 8th November, we heard the all-familiar ‘Bhaiyon aur behno, aaj ratri se 1000 aur 500 rupiye ki note kharij’. And it was completely dramatic! It came without warning, it came as a surgical strike, and this was the reaction that I spontaneously gave as the TV channels started accosting all of us. It was incredible that nobody knew about it. Had people known, these ATM shoots, may have been calibrated earlier.”

“Let me share with you the maths. Currency notes in circulation in India is approximately 280 billion USD. Of this, 62 billion USD are in small currency, which we can use even today. The currency chest of banks, a kind of a valve through which the movement of currency in the bank branches is modulated, is about 18 billion USD. So that leaves 200 billion USD of currency in circulation of high denomination notes that have been demonetized. Hundred billion of this is expected to be re-monetized, wherein you have full documented evidence as to why you had to withdraw that money – the actual numbers may wary by 10-20%. That leaves about 100 billion USD. Of this, 60 billion will consist of people who are confused as to whether Section 272 will apply or not, which says that you need to suffer penalty only if there is a difference between your assessed income and your returned income. Now, if your income has not been assessed at all, the question of Section 272 does not arise. So this year you make an undisclosed income disclosure of let us say 10 crores, you will pay tax at the highest maximum marginal rate. Which is less than the rate, which was due to be paid in the Voluntary Disclosure Scheme. However, the income tax department has the right to go back 16 years, to ask and determine, whether you had concealed your income in any of your past years based on your existing business model. And if you’re not able to answer that, you might end up paying those excess penalties. Therefore it is expected that out of the 60 billion USD, between 15-30% tax on an average basis will be collected by the Government of India, i.e. between 9 to 18 billion USD, which is a significant contribution to the Fiscal effort, while the 40 billion can remain demonetized.” Where does this money go? “This is a 40 billion USD of credit sitting

Where does this money go? “This is a 40 billion USD of credit sitting in the balance sheets of Reserve Bank of India. It is a liability, which will never have to be repaid! Therefore, if 40 billion out of the 280 billion USD is not remonetized, then we can have the largest-ever- conceptualized dividend being paid to the Government by the Reserve Bank of India” explains Shailesh. And what can this dividend be used for? “One of the potential uses of this windfall bonanza that the Government gets is of re-capitalizing banks. Today the only antidote to collapse of prices and

And what can this dividend be used for? “One of the potential uses of this windfall bonanza that the Government gets is of re-capitalizing banks. Today the only antidote to collapse of prices and collapse of all value in our economy is the ability and willingness of the banks to lend to the right purpose.” “Also the reason why after the international financial crises, India did not suffer a collapse in real estate prices is because, banks lent unprecedented sums of money to this sector. It is the only reason why India did not have a collapse in property prices. And that may yet be another reason why despite the demonetized, real estate prices will not crash, but instead could spark a genuine revival of actual investors buying right sized homes for living in them, which can be another game changer”, he adds emphatically.

“GST, on the other hand, is the most modern implementation of indirect tax law, and going forward, the whole world will copy India on the way it has structured its GST.”

“The biggest difference is that the GST Network determines the tax payable based on your credit from purchases. And if the person before you in the value chain does not pay tax, then in six months, your credit will get reversed and you’ll have to pay tax on his behalf. This way, you’ll never deal with anyone who has not paid taxes. And thus every person will become a natural tax gatherer, as the entire system is automated and fully digitized.”

What could be the challenges? “In addition to the PAN cards holders; 80 crore small & big dealers, will have to be issued GSTN. Also, since the entire incentive to pay tax has been completely changed, anybody who does not pay due taxes is liable to be found out. So don’t assume that this system will be easy to game, as there are checks, balances, and traceability at every step.”

So what can it lead to?
Downsides:
1. Long queues – It is absolutely disheartening to see the long queues and all the human-interest stories that are covered in the press.
2. Temporary drop in consumption, as people will hold back and not want to spend.
3. Getting 125 crore people to switch from cash to e-money or to plastic money, which can almost take a decade.
4. Test of this whole experiment will depend on actually how much black money is removed from the system. If it is anything less than 5-10 billion USD, it will prove to be too costly an affair. And people will start complaining if the intended fiscal mathematics equations don’t come through.Upsides:

Upsides:
1. Bank CASA, i.e. lendable resources will go up by close to 50 billion USD – This when combined with other liabilities, will allow larger risk to lend.
2. Dogeka, i.e. lowering of lending price – With the money flowing in and the compression of purchasing power, inflation will collapse and therefore interest rates will collapse. So while we will feel impoverished because our fixed deposits will not earn enough interest, but at the same time, business will get loans at lower interest rates. Hence what was happening hesitantly at 0.25% each time, will see a big shot in the arm, as you need to bump up the purchasing power in the economy, and the only engine is banks.
3. GDP will rise by at least 1.5%, because of the twin effect of demonetization and GST. The tax to GDP ratio too will go up, along with the credit ratio of our country. Fiscal deficit will be seen to be in control, inflation will be low, interest rates will be low, and so there is no reason why we cant get to investment grade!
4. As things become normal, people will start seeing `2000 and `500 notes, gross national happiness, which had a huge dip, will have a ‘V’ curve flying out of this psychological depression we’re feeling.
5. Most importantly, bad intent will stop. That to me is going to be the biggest outcome of this demonetization. So while we have short-term pains, we can look forward to an exceptional year particularly when the demonetization and the effects of which are fused with the positive effects of GST.