Can India recover from demonetisation self-goal?

Can India recover from demonetisation self-goal?

Submitted by alvin on Thu, 2017-01-19 09:59 As Barack Obama said, “Yes, we can!” That is the reaction across the spectrum. From business leaders, politicians, industry, and even the World Bank, everyone says the problem is temporary, short term and India will come out trumps after a small period of disruption. How I would love to believe that!As Indians, we all have a stake in making our country do well. It’s even more so for those who have travelled. Small, unimportant and insignificant nations with economic success in their kitty have raced ahead of us. Many of them have more prestige in the world than we have. We are never ignored. A country with 1.2 billion and our resources will always be in the world’s consciousness. But, whatever our press or NRIs say about our greatness, in the world’s mind India is akin to a computer’s screen saver! The main players on the world’s desktop are USA, Europe, Middle East, and China. And demonetisation, as everyone agrees, has made our situation worse.But what everyone is terrified of saying is that the effects of demonetisation has led us right into the clutches of that nastiest of words – recession.Denial will not help us. What we need to do is understand the actual problems quickly, and solve them even more quickly. But today, we are distracted by the totally useless debate split into 2 camps: The first camp position says: yes, demonetisation has temporary problems, but it will make us great soon. The second camp retorts: No, it was bad and look at the suffering around the country -from liquidity issues to shortage of currencies. Not a single article in the last 3 months has given us solutions. Why? A large majority have not understood the actual problem, so we are parroting what everyone is saying. A minority have understood the issues very well, but also understand that the solution is so disruptive that they don’t even want to talk about it!So, what are the actual problems?Definitely not what is being written in the press. Those are totally superficial ones. The actual problem is the MSMEs (Micro, Small and Medium Enterprises). According to Google, there are 51 million MSMEs in India. But data shows that 48 million of them are micro SMEs with staff strength of less than 10 people. The ‘Economic Times’ estimates that in 2014 micro SMEs contributed 45�f industrial output and 40pc of India’s exports. The critical statistic, however, is that 94pc of the MSME’s are unregistered!Now, for the scary part that no-one wants to really look at. If we do a little math and a little economic extrapolation we get a horrific picture. The math first.Let us be conservative and assume the average an MSME employees 4 people instead of the 7 as per the data. That means 192 million Indians are employed in this sector across every single city, town, small town and big village in India, constituting the most productive Indians in our economy. Now, let us assume that the working capital of an MSME is Rs20 lakh. That is a conservative number. It could be a small ‘kirana’ shop. It could be a small home industry. It could be a small distributor. Any which way, it is a liquidity market that adds up to 96 trillion rupees! And it was all in cash. Demonetisation has ensured that not only has this amount had to be put in the bank, but it has to be explained. Even if the sheer scale makes it difficult get all these people to explain, the fact is that these MSME have seen a massive crash in their liquidity. If there is a danger of 50�ax on the income that was the liquidity running their business, even if it is not enforced, it will still shrink the business drastically. Now, with all the cash running the business in the bank, every time they do transactions there is a danger of another 30pc corporate tax. Then there is an added transaction tax (charge) of Paytm or credit cards that vary from 1.5 to 3�er transaction.This is not a very high profit margin group. They do not have massive infrastructure. They do not have fancy branding. They are totally no-frills group. They survive on cash and quick margins of 15-20�Now, we do the economic extrapolation.If this micro SME with Rs20 lakhs in capital rotated his capital 4 times in a year and earned 20pc, he would have earned a profit of Rs16 lakhs. If you take away his costs (rent, etc), he would have taken away around Rs12 lakhs, a decent living and enough money to back into the business. Today, with all the money in the bank, the same situation would result in a 30�ompany tax and a 2�ransaction tax on every sale. So he pays Rs5.12 lakh in tax and is down to Rs10.8 lakhs. The expenses don’t change, so he now takes home Rs4.8 lakh, a 60pc loss in income for him after demonetisation.When this happens, the instinct is to cut costs. He will fire at least one-third of his staff. Then he will cut down on business and, more importantly, not put money back into the business hoping that things will get better. Extrapolate this for 48 million MSMEs. It translates into around 60 million job losses, a minimum 50pc reduction in revenue for this section, and a looming recession!What can we do to get out of this quickly?The government has to immediately incorporate some daring moves. It has to remove corporate tax for anyone in the Rs1 crore turnover range. One way to regulate this is to make sure they register and get this benefit, like is done for startup companies. This will mean that the MSME will pay only 2pc transaction tax, which may be acceptable to him. Another option is to also remove personal income tax up to Rs50 lakhs, not the Rs5 lakhs being mooted, which will not even make a difference to today’s economic problems.The government has realised the magnitude of the task and has stated that there will be a threshold over which they will look at accounts. This is a good step, but it is not enough. To kick-start the economy again, they have to remove corporate tax to at least Rs1 crore and announce income tax exemption up to Rs50 lakhs. To prevent the siphoning of funds into this sector, they can ensure that source of funds is given, backdated to 5 years. If there is no tax and there are no penalties, most people will bend backwards to show source of funds. It becomes relatively easy to find people who are trying to beat the system and penalise them.