A couple of months back when decks were cleared by the law makers for introduction of GST, I thought that the event will go down in the history as one of the biggest reforms in the Indian economy. But the demonetization of 87% of Indian currency at a four hour notice made the historic GST reform look pale.
Successive Indian governments were always faced with the arduous task of dealing with black money. For want of collection of adequate taxes, budgets had to be balanced by invoking deficit financing. The existence of parallel black economy was openly acknowledged by one and all. Corruption was one of the major contributors to the black economy. Governments after governments meekly surrendered to this phenomenon so much so that even some of the past Prime Ministers admitted that only 10 to 20% of the total spend on government welfare schemes, actually reached real beneficiaries and the remaining was making its way to the corrupt system. A large majority of say 95% honest citizens were extremely unhappy with the situation but could not do anything against the might of say 5% corrupt. Situation was hopeless.
To overcome this menace, demonetization of currency was suggested by experts in the past also. UPA Government made a feeble attempt to demonetize one series of Rupees five hundred notes. Enough time was given to public for exchange. Government kept extending the dead line dates but ultimately nothing happened. Even one series of notes could not be demonetized. Taking the cue from past experience, the present government went ahead with demonetization without any notice whatsoever.
Now since the government has bitten the bullet, I feel that this step has the potential to put Indian economy on a very strong growth path. We can expect the budget deficit to go down. The government may net close to Rs. 4 lac crore out of this exercise either in terms of cancellation of currency or recovery of taxes. In addition to this, lacs of crores will be available for investments. To make best use of this opportunity, post 30thDecember, the onus will be on the government to give proper direction to the economy so that the money is gainfully deployed to generate employment, develop infrastructure and bring tax reforms so that the tax base thus created is not lost.
By far there were two major blocks in the progress of Indian economy, one the collection of taxes was very low and the other was that the availability of credit was very limited. With lots of funds flowing into the system, hopefully, India will do better on both counts in future.
Interest rates are bound to come down which is a good news for the enterprises. From my experience as a practicing chartered accountant, I can say that Indian businesses on an average operate on a debt to equity ratio of 2.5 : 1 which means that if an enterprise has an owned capital of Rs. One crore, it is likely to have a debt of Rs. 2.5 crore. Because of this reason, even one percent drop in interest rates will favorably impact the equity by two and a half times. If the business gets an advantage of this kind, they will be willing to expand leading to increased employment. Increased employment will lead to more demand and hence will give further boost to the production. A white economy will also encourage the foreign investment into the country.
All in all theoretically, demonetization at this stage in India especially before the implementation of Good and Services Tax looks like a great move. For its complete success, reaching out to the poorest of the poor will be the key otherwise it may become anti financial inclusion drive of the government.