While the Modi government’s latest move to check black money and the counterfeit currency market will have the desired results, it needs to be supplemented with tax reforms, says Rajiv Kumar, Senior Fellow at Centre for Policy Research.

Kumar, who sits on the boards of several international and national institutions and is member of the government’s Financial Sector Recruitment and Selection Committee, in a conversation with BusinessLine said the move will not increase inflation. Excerpts :

What is your view on the government’s move to withdraw ₹500 and ₹1,000 currency notes and re-introduce them with new features, besides bringing a higher denomination note of ₹2,000? Do you think it will help in checking black money and counterfeits?

It will substantially help in reducing the black money stock in the economy, which is estimated at between 20 per cent and 40 per cent of the GDP. However, to control such flows in the future we will have to reform the direct tax structure and introduce the goods and services tax with as much simplicity as possible. The impact on counterfeit currency is of course undeniable and unquestionable. The move will hit financing of extremist and terrorists outfits as can be noticed with the cessation of hostile activity in the Kashmir valley over the last five days.

Can it be termed as demonetisation...

Any argument that it will not affect black money and that this is merely currency replacement and not demonetisation is not correct simply because it is well known that there are large holders of black money, who even if they try their various measures will not be able to liquidate their entire hoards of black currency.

Could the implementation have been handled more efficiently? If yes, what according to you could have been the approach?

Clearly, implementation has been found wanting, the bureaucracycould have handled the challenging task better. At least the ATMs could have been activated by now. The trade-off between maintaining secrecy and re-programming the ATMs is a real one. There has been enough time and by now that it could have been done if taken up on more urgent and emergency basis.

There is now sufficient evidence that queues are not made up entirely of those who are needy, but also those who are changing money on behalf of others – black money hoarders. The government will do well to try and identify such elements so that this activity is discouraged and the liquidation of black income made as difficult as possible.

How much will this move impact the consumption demand and economic growth?

Consumption demand, especially the luxury consumption demand, will be hit. I am all in favour of curbing this demand because it affects the moral fibre of our society.

However, consumption by the poor – I have visited a few villages in the last week – is not affected, because they do not need these high denomination currency to finance their basic consumption. This will pick up after a couple of quarters, but the extra fizz or steroids powering the luxury consumption may not come back for a while.

Another major sector affected will be real estate. And here also speculation demand (or so called investment demand) used for laundering of black money into white will be affected. However, this will make more supply available for genuine and first time buyers, which is good news.

Will it impact inflation? Will it have an adverse impact on rural economy?

Rural economy will not be impacted because agriculture does not attract income tax. I have seen that farmers are happily depositing money in their accounts. One example I can give is of a person, an economist turned farmer, running a large farm and agro input business in Pilibhit. To his surprise, he found that all his outstanding credit was returned to him in less than three days, something which normally took month or two to get back. He was able to deposit the large amount received in his account, without any questions asked.

Inflation, if anything, will decrease. The restriction on black money will lower the pressure on demand and improve supply-demand management. But, the large volume of deposits that banks are now attracting will encourage them to lower interest rates, which in turn will bring down their capital cost.

Banks would have larger CASA on hand and that would help them reduce interest rate on their loans, which should then spur investment demand, which is better than increasing consumption demand.

If consumption demand is replaced with investment demand, it will be benefitial for generating employment and put the economy on a sustainable trajectory.

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