India’s Economy Is Headed for Structural Breakdown

In order to eliminate corruption, the government has waged a war against the informal economy. But a large portion of the economy, especially in rural regions, is informal, so this becomes a war on the economy itself.

By Ravi Kant and cross-posted from Asia Times.

In November 8, India marked the third anniversary of demonetization, the single biggest monetary experiment in human history to curb black money. Prime Minister Narendra Modi surprised India and the rest of the world with the announcement that 500- and 1,000-rupee banknotes would no longer be legal tender. Overnight, more than 86% (US$206 billion) of the total currency in circulation at that time was affected. The prime reason given by the government for such a bold move was to root out corruption. But cash only accounts for about 6% of all illegal holdings in the country.

The suddenness of the announcement and printing-press constraints prevented the immediate replacement of the demonetized currency with new notes. The total amount of currency used as legal tender declined by 75% overnight. This acted as a shock to the economy and created a liquidity crisis. It also hit consumption badly, which directly impacted production, and following the domino effect, employment, growth as well as tax revenue went down. The GDP growth rate of 8.01% in the 2015-16 fiscal year fell to 7.11% in 2016-17 after demonetization. With this monetary exercise, India took its biggest ever risk with its domestic consumption driven economy.

Before Indians had a chance to recover from this shock, the government implemented the most complex tax reforms in its history, the GST (goods and services tax), on July 1, 2017. The old license regime (an elaborate system of licensing, regulations and red tape for setting up a business) was back with a new name, in the form of a complex tax rate mechanism.

There were several issues with the GST, such as multiple tax rates, surcharges, and the requirement to file monthly returns. It imposed criminal penalties for a sale without an invoice, misuse of tax refunds, and manipulation of tax credits. In a country as big as India with a large informal sector, the high GST rates and complex compliance needs make doing business quite difficult

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