Everyone is talking about demonetisation which has adversely affected everyone. One can argue forever if it should have been done. But now that it has, everyone has to make the best of it.
Most people don’t understand why it was done. But the explanation is quite simple: If you have gangrene, the doctors remove a toe or leg or arm etc. If you have cancer they remove whichever part is affected.
But with black money, it is like having blood cancer: you have to replace all the blood in your body, which is what Narendra Modi has done. Previous governments had tried less drastic cures, including the equivalent of chemotherapy. Nothing had worked.
Modi decided that something far more drastic had to be done if the Indian economy was to be cured of this disease. Now we have to wait and see what happens. It will take at least six months for a clear picture to emerge.
In the meantime, the level of economic activity will go down just as physical activity does when a blood cancer patient has had a complete blood transfusion. There is also a massive weakness at first, and it is only gradually that she regains her strength and vitality.
The government is saying that the weakness in the economy will last for six months. Its critics are saying it will last for two years. No one knows for sure for how long but one thing is absolutely certain: around a million temporary workers and another few million labourers on farms and related activities will lose their jobs and livelihood. Their incomes will drop to zero or close to zero for the next several months, perhaps till next July when the 2017 monsoon starts. This is the biggest downside of the demonetisation.
Since they will not be spending anything, and the middle class will also cut back on expenditure, there will be a reduction in aggregate or overall demand in the economy. This should result in a decline in prices for the next six months, especially of real estate. So if you are looking to buy a flat or house, this is the time.
No one knows for sure for how long the economy will remain weak. But a million temporary workers and another few million farm labourers will lose their livelihood.
At the same time, because the banks are now flush with funds — all that money under the mattress having been deposited with them — interest rates, too, will or should start to decline quite steeply. By this time next year, therefore, the economy could well be booming — provided the public sector banks lend. They may not because they are not very commercially oriented.
The government, too, will be richer as all that income on which tax had not been paid now begins to get taxed. Just how much richer it will be is hard to say at this point. But it can use the additional income, regardless of how much it is, on a whole host of things.
So far we have only talked about the stock of black money but what about its flow? How do you prevent a cancer recurring? How do you prevent fresh black money from being generated?
We will know when the Budget for 2017-18 is presented. There is a very good chance that income tax rates will be reduced. Hopefully, there will be only two slabs and two rates of 15 and 25 per cent, with all exemptions being removed.
Three types of income
What most commentators don’t understand is that there are three types of income in India on which tax is not paid, or we can say there are three types of black money. One comes out of the bribes demanded by the employees of the Indian State; another is the income earned by criminals; and the third is the small portion of income which honest people do not declare because they genuinely can’t afford the high taxation.
The last category is treated most harshly by the government. The criminals usually get away because they bribe the government agencies. The people know this, which is why there has been such widespread support — despite the severe hardship — for demonetisation.