It is now clear that the demonetisation of Rs 500 and Rs 1,000 currency notes by the Modi government will have a deflationary effect in the short-term (meaning, definitely upto 31 December, and probably upto 31 March 2017). We have seen retail trade disrupted, supply chains in disarray, especially in food and grocery, and people are holding back on discretionary spending fearing a severe cash shortage.
This calls for strong counter-measures to defeat the deflationary psychology before it becomes all-pervasive. So what should the Finance Minister being doing now?
First, reflate and make the fiscal deficit target flexible. The only way to counter deflation is to reflate fiscally in the short term. This means government spends must be quickly raised, and cash disbursements speeded up. There could also be indirect and direct tax rebates for some goods and services upto 31 March 2017. Banks must be recapitalised quickly with large dollops of capital for the simple reason that the current happy situation of soaring deposits, falling interest rates and bond yields will not sustain. Remember, it is currency in circulation that is being deposited; when the cash is available, most of it will flow out again.
On the other hand, the disruption in the supply chain will increase the probability of corporate defaults, especially in the small and medium enterprises (SME) sector. The only way to counter this is to recapitalise public sector banks (and some weak private sector banks) quickly to the tune of Rs 40,000-50,000 crore over and above the amounts earmarked in the last budget. This should happen well before the end of the financial year.
While the fiscal deficit limit of 3.5 percent of GDP in 2016-17 looks easy to meet in the context of the higher revenues expected from pulling in unaccounted money into the tax system, if GDP does not expand as earlier anticipated, the targets may look more daunting. And next year’s targets will be a mess. A 0.5 percent relaxation in next year’s fiscal deficit should be budgeted for, though this can be scaled back if the economy rebounds more sharply than expected from April 2017.
A major economic disruption calls for out-of-the-box thinking. This is not the time to play fiscal fundamentalist. Politically, deflation is more worrisome than inflation.
Second, import cash. The long queues at bank counters and ATMs show that the government has been overwhelmed by the sudden upsurge in the demand for new notes. With over Rs 14 lakh crore of currency being withdrawn due to demonetisation, the replacement has to be of the order of at least Rs 10-12 lakh crore to restore normality to a cash-based economy. The entire Rs 14 lakh crore may not be needed for there will be a seminal shift to e-payments in most urban centres. Banks and e-wallet companies are already reporting a huge surge in card and wallet payments. This process will accelerate.
The situation is thus not as bad as it looks from across bank counters, but it is not as simple as it sounds to policy-makers either. The Indian note printing presses, reports Mint, are capable of printing around 24 billion notes a year, and orders for printing 3.5 billion pieces of the new Rs 2,000 note have already been half completed. Assuming all of it is printed by December end, it would effectively replace Rs 7 lakh crore of demonetised money by January.
The challenge is to print the other Rs 3-5 lakh crore in Rs 500 and Rs 100 notes, not over a year, but in just two or three months. Apart from running the printing presses in three shifts instead of two, the only way to up cash supplies quickly is to import it by printing it in Switzerland or elsewhere. The government must check if they have the capacity to deliver quickly and outsource a part of the printing.
If cash is not replenished quickly, it can do long-term damage. The longer it takes to reach the Rs 12 lakh crore cash supply mark, the more prolonged the slowdown will be. This means Modi can kiss goodbye to his electoral chances in 2019, for any recovery would have been very short. This was exactly what scuppered Vajpayee in 2004; the recovery was less than a year old and people hadn’t begun to feel the improvement in their livelihoods.
Three, GST needs to be pushed back. The new integrated indirect tax, which is proposed to be implemented from 1 April 2017, will be another major disruptor. Millions of businesses in goods and services will have to be brought into the electronic invoicing and payment systems that the GST Network demands. The training and investment involved in bringing so many small companies upto to speed will be mind-boggling.
There will be another supply chain disruption when big companies reconfigure their vendors based on optimising GST compliance, production and distribution needs. The supply chain is already reeling under the demonetisation shock, and it makes no sense to put SME businesses through the wringer again in the name of GST implementation.
The GST deadline needs to be postponed, especially since there will be another eruption of centre-state tensions over jurisdiction and oversight of GST assessees. The earliest sensible deadline is 1 October 2017, and even this should be put off if the anticipated rebound in GDP does not happen by early April 2017. A decelerating economy cannot be asked to do push-ups on account of GST by imposing artificial deadlines unrelated to ground reality.
The government is already on the mat for not being fully prepared for the cash rush post demonetisation. The last thing it can afford is another fiasco on GST.
GST should be put on the back-burner for now, and the focus should be on getting the economy back on the rails Asap.
Four, digital payments must be speeded up. Having pushed demonetisation hard, the government cannot sit back and let only private parties push digital payments. It has to do the heavy lifting itself. Digital payments and the unified payments interface (UPI), which allows for peer-to-peer transfers of funds, must be let loose on a war-footing, and all government departments and public sector undertakings urged to abolish cash from their systems. The essential commodities supply chain and distribution networks in cities must be coaxed to accept digital payments, and ordinary citizens urged to move to e-cash. Discounts can be offered on payments to speed the shift. Truckers must become major targets for digital evangelisation.
It should not be difficult to convince most people, as they can see the cash queues and disruption in front of their eyes. Kirana merchants must be ruing the shift in demand to big retailers, who accept credit cards. They will not need too much convincing to shift to e-payments. The government must strike when the issue is hot, and not when the cash crisis abates. Every crisis provides an opportunity, and the government cannot afford to let this crisis go waste.
The simple reality is this: demonetisation will have brought more losses than gains if the government does not do all the other things that are needed to make it work. Demonetisation is not an end in itself; it is the beginning of reforms in many areas.
Jagannathan is Editorial Director, Swarajya. He tweets at @TheJaggi.
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