Don’t get formal, get competitive PDF Print E-mail
Friday, 31 March 2017 05:42
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PMGKY collections will tell us how well demonetisation did, but how much will it raise costs for informal sector?

Informal sector units don’t pay taxes & EPFO/ESIC raises wages 40% ... for DeMo to really deliver, these higher costs have to be reduced



Within a few days from now, the results of demonetisation’s second and major test will be available. It probably failed the first one when, by the end of December, most of the demonetised money came back into the banking system, though the central bank is yet to put out a final number.

Many, including this newspaper, thought that this was certain to happen since, with the new amnesty scheme offering an effective tax rate of 56%, why would anyone choose to lose all the money by not depositing it in a bank? While one newspaper has put the declarations that have come in under the Prime Minister Garib Kalyan Yojana (PMGKY) at a mere `6,000 crore, NITI Aayog member Bibek Debroy has said the number is likely to be around `200,000 crore.

The taxman did a good job of putting out some really chilling numbers, to frighten those who deposited large amounts of cash into using the amnesty scheme. So, according to the finance minister’s budget speech, deposits between `2-80 lakh were made in about 1.1 crore accounts with an average deposit size of `5 lakh; another 1.5 lakh accounts saw an average deposit size of `3.3 crore. As a follow-up, the taxman asked for more information from 18 lakh bank accounts where `4.2 lakh crore was deposited. Since there are not too many individuals who should logically have such large sums of cash, large proportions of this could be black money. The question is whether these individuals/companies can get away by using the cash-in-hand excuse—we had withdrawn cash from the bank and are now merely depositing it back—that most CAs are recommending?

Parallel to this exercise of bringing black money into the formal economy is the issue of digital payments where the government has been extraordinarily proactive, from coming out with BHIM and AadhaarPay to working to lower merchant discount rates (MDR) on credit/debit cards. While March data suggests a 20% fall in debit/credit card usage on a daily basis as compared to December, it is still higher than the pre-demonetisation days and underscores the need to lower MDR further, with the government footing the bill since it gets more taxes with a greater formalisation of the economy. More important, with other forms of digital payment rising, daily transactions are up from `335,660 crore in December to `406,200 crore in the first 26 days of March.

The fact that a Kotak Bank has just launched its 811 virtual account and hopes to double its customer base in 18 months through this or that Visa/Master/RuPay have come together to launch a common IndiaQR code to do away with the need for swipe machines or that a Samsung has just launched a SamsungPay embedded in its latest phones, in fact, suggests formalisation in payments will continue to grow because it’s easy, cheap and convenient.

But as the economy gets more formal—NITI Aayog vice-chairman has said this was the idea behind demonetisation—and GST around the corner will only speed the process, the question to ask is what impact that will have on its competitiveness. If the local carpenter shop is cheaper than an Urban Ladder or a PepperFry, this has a lot to do with the fact that it pays no taxes—including personal/corporate ones—and, to the extent it pays its workers the minimum wage, it certainly does not deduct EPFO/ESIC dues which add another 30-40% to the wage bill. In which case, in a business-as-usual scenario, more formalisation can have disastrous consequences, especially at a time when the economy is not doing well and jobs-creation is crawling. And the fact that governments keep raising the minimum wages can only make it worse.

While the biggest benefit of formalisation is lower credit costs—a vendor selling on an Amazon suddenly has a transaction history to show a bank—reducing the other costs is critical. So, for instance, the Modi government is trying to find a way to carve out EPFO exemptions—this has been done as part of the readymade garments package and new entrants do not have to make these deductions, but the huge delays in implementation has meant the scheme hasn’t really taken off even now. Also, if carve-outs have to be done one industry at a time, and one law at a time, that simply isn’t going to work—a big problem with formalisation, for instance, is that a factory simply cannot shut shop when it becomes unviable but has to follow a long process to be able to do so. Similarly, with tax rates so much lower in competing countries, getting into the formal economy just adds to costs.

Demonetisation, as even its proponents admitted, was about tackling the stock of black money that was held in cash; it is stopping the flow that now needs to be addressed. India’s famed regulatory burden is what drove such a large part of the economy into the informal sector—until this is fixed the costs of demonetisation will be prohibitive even if the PMGKY numbers tell us the scheme was wildly successful.



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