India’s Turn to Transform

India is in the midst of a major anti-corruption and tax-reform programme, but the jury is out on how effective and transformative it will be, given as some steps such as the recent demonetization of high-denomination currency notes have caused enormous collateral damage and have been highly contentious.

In Davos, public policy experts and practitioners discussed whether India is on the right track, whether and how demonetization could have been implemented better, and what more could be done to achieve the goals of eradicating corruption, shrinking the black economy and expanding the tax base.

Nirmala Sitharaman, the Indian Minister of State for Commerce and Industry, says her government came to power two years ago on the promise of fighting corruption and black money, and has taken wide-ranging steps in this direction. These include the launch of a limited-period income disclosure scheme, renegotiation of double taxation avoidance agreements with other countries to prevent practices such as round-tripping, and introduction of legislation to outlaw various dishonest practices.

As an emerging economy with the potential to launch a probe to Mars, India can no longer continue to allow 87% of its economy to remain in the informal, cash-driven, no-tax segment in which only 5 million individuals admit to earning more than R1 million a year and, therefore, pay tax. “We owed it to the country and we don't regret it,” Sitharaman says, pointing out that it takes leadership with the vision and courage to take a contentious step and the stamina to see it through.

Kenneth Rogoff, Thomas D. Cabot Professor of Public Policy at Harvard University, who advocated getting rid of paper money in his recent book The Curse of Cash, says demonetization could have been handled better, most obviously by preparing a stock of new currency notes that could be quickly introduced to replace the demonetized ones. He says it will be years before it is clear how successful or not India’s demonetization has been.

According to Arundhati Bhattacharya, Chairman of the State Bank of India, the country’s largest bank, the Reserve Bank of India could have communicated better to assuage people’s fears. However, she says it was remarkable that despite 86% of cash suddenly going out of the system and huge crowds queueing at banks there had been no riots or even complaints of misbehaviour. Bhattacharya says part of the support for this move that hugely inconvenienced common people was the feeling that not enough is being done to spread the gains of growth.

Argentina is considering a similar move, largely with the aim of bringing more people into the formal economy, expanding the tax base and improving security. Federico Sturzenegger, Governor of the Central Bank of Argentina, says there are also efficiency gains from electronic payments as it is costly to print and disburse paper money and the current system effectively subsidises cash.

Carmen M. Reinhart, Minos A. Zombanakis Professor of the International Financial System at the Harvard Kennedy School of Government, agrees that demonetization would prove a case of short-term pain for long-term gain, but says that India should have demonetized after introducing the proposed and potentially game-changing Goods and Services Tax (GST) regime, and not before. She says that risk of political backlash against demonetization would further delay introduction of this tax reform, which would not be good for the economy.

Responding to the criticism that the Indian government erred in not preparing a stock of replacement currency notes, Sitharaman says it wanted to retain the element of surprise to catch tax evaders. She is confident that the move towards digital payments will completely transform how the economy operates while helping to widen the tax base and shrink the flow of black money.

With 1.2 billion Indians’ biometric data already available to them on their unique identity cards, claims that it is possible to leapfrog to a biometric payments system by 2020.