Not Just DeMo: PM Modi’s Black Money Chase Is “X” Factor In Growth Slowdown 

The sharp drop in fourth-quarter GDP growth in fiscal 2016-17 to 6.1 per cent from 7 per cent in the previous quarter, and the even sharper drop in GVA growth (from 6.7 per cent to 5.6 per cent), has largely been attributed to the demonetisation (DeMo). For 2016-17 as a whole, GDP growth was 7.1 per cent (versus 8 per cent earlier), and GVA 6.6 per cent (versus 7.9 earlier).

But, as chief statistician TCA Anant pointed out, the real reason for the drop cannot be attributed solely to DeMo. “Every policy decision has an implication…so has demonetisation, but to disintegrate the impact of one decision is a complex task,” Anant is quoted by The Economic Times as saying.

While Prime Minister Narendra Modi’s political critics will be happy to attribute the entire slowdown to DeMo, the reality is that the economy was decelerating well before 8 November 2016. Look at the GVA (gross value added) numbers below and they tell their own story: GVA, which is GDP minus product taxes plus subsidies, peaked at 8.7 per cent in the January-March quarter of 2015-16. In the following four quarters, it declined steadily, to 7.6 per cent (April-June 2016), 6.8 per cent (July-September), 6.7 per cent (October-December), and 5.6 per cent (the January-March 2017 quarter).

The point to note: the economic slowdown preceded DeMo by at least two quarters. DeMo may only have magnified a slowdown that was already set in motion. It was not the cause of it.

The big question is: what started the slowdown? We can rule out the unhelpful global economy, which has not been any worse last year than it was in the previous four. Two consecutive years of bad monsoon could surely have tipped the economy downwards, but agriculture has a share of just 15 per cent in GDP, and in 2015-16, the second consecutive year of farm distress, GVA growth was actually perky at just under 8 per cent (7.9 per cent).

So why did 2016-17 start sliding?

The answer has to do with three factors, which we can call the X, Y and Z factors. All are inter-related.

The Z factor is corporate over-leveraging and bank bad debts. With companies desperately trying to cut debts, and banks trying to get what they can from debtors, there was obviously very little money left for fresh investment. Gross fixed capital formation (GFCF), which shows the level of investment in the economy, has dropped like a stone over the last six years, and stood at just 27.1 per cent of GDP in 2016-17, down from 34.3 per cent six years ago.

With bank bad debts at over Rs 7 lakh crore now (the December 2016 figure was just under that level), and with corporate after corporate having to sell asset after asset to prevent broader group defaults, investment is unlikely to pick up anytime soon. The latest to teeter on the brink of default is Anil Ambani’s Reliance Communications (RCom), which had debts of over Rs 47,000 crore and was looking to sell its tower business and merge itself out of default. But it can’t do so without banks giving it breathing space for a few months, as cash flows right now are just not enough to service debt.

Earlier, we saw Jaiprakash selling its cement assets to the Birlas, Ruias their oil refining business to Rosneft, GMR and GVK parts of their airports and power businesses, and Vijay Mallya parts of his liquor businesses that were mortgaged to fund Kingfisher Airlines. Even the Tatas under new Group CEO N Chandrasekaran are planning to sell off non-core assets to bring down group debts. When India Inc is in downsizing and sell mode, where is the question of their increasing investment to fund growth? The one big investment that happened, Mukesh Ambani’s massive Rs 1.5 lakh crore investment in Reliance Jio, has pushed other telecom giants to the brink of loss – setting of the possibility of another wave of loan downgrades and possible NPAs (non-performing assets). The RBI has already raised warnings signals about telecom debt. This is a sector crying for new investment, but is currently too over-leveraged (debts were over Rs 4.2 lakh crore) to seriously invest in growing the business.

Then there is the Y factor – which is the pre-emption of large corporate funds by bringing in transparency in the allocation of costly natural resources like spectrum and mines.

In 2015, Rs 1.09 lakh crore was raised at spectrum auctions. Coal auctions raised another Rs 2 lakh-and-odd crore. In 2016, a second round of spectrum auctions raised over Rs 65,000 crore. While not all the money has been collected – it is to be paid in stages – the short point is this: many of India’s biggest business groups have had to sink hundreds of crores to buy natural resources and inputs linked to the businesses they were already in – power, coal, telecom, cement, etc.

When such large amounts of money are pre-empted from the corporate kitty, resources for new investment automatically get crunched.

Then we come to the big X factor, which is the war on black money launched by the Modi government. No Indian government has been so consistent and so relentless in putting in place policies to reduce avenues for easy money from corruption and rent-seeking. This process actually began under UPA-2, which was rocked by scam after scam, but anti-black money policies have been followed aggressively only under Modi.

To track the origins of the slowdown, consider the chronology of several measures to curb black money.

#1: In 2015, Modi announced his first major scheme – the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act. Disclosures under the scheme attracted 60 per cent tax, and the scheme was a flop, garnering just Rs 2,428 crore in taxes. But the scheme effectively ensured that undisclosed foreign assets remain abroad.

#2: The Reserve Bank under Raghuram Rajan also decreed that banks have to disclose all their bad loans by the end of March 2016. This partially explains why after GVA peaked in that quarter of 2015-16, growth has been steadily falling off as banks started spewing red ink all over their balance-sheets and battled with bad loans, curtailing further lending. Borrowers battled with repayments and defaults, reducing appetite for investment.

#3: In 2016, Modi launched his Income Disclosure Scheme for domestic black money, and this garnered over Rs 65,000 crore of disclosures, yielding taxes of over Rs 30,000 crore.

#4: In November 2016, the Benami Transactions (Prohibition) Amendment Act was notified. The Act prescribed draconian measures to ferret out benami properties, which is where most of domestic black money is hoarded. At last count, over 140 notices had been issued for the attachment of benami properties.

#5: This, of course, was followed by demonetisation of Rs 500 and Rs 1,000 notes, thus denting the stock of black money held in cash, or resulting in deposits which may now be scrutinised for sources of funds and possible tax evasion. A lot of loose cash has thus been immobilised at least temporarily. To complement DeMo, the government also introduced its PM Garib Kalyan Yojana, under which undisclosed deposits can be legalised by paying 50 per cent tax, and offering another 25 per cent as a four-year interest-free deposit. This scheme too did not get much of a response, but directionally it is one of a piece with all of Modi’s anti-black money laws.

#6: Three other measures were also taken in 2016 to impede the flow of unaccounted money between India and foreign destinations. In May, the government modified the Mauritius Double Taxation Avoidance Act (DTAA) to tax the short-term capital gains of entities based in that Indian Ocean island. In September, the same was done with Cyprus, and in December, the Singapore DTAA was also amended. The net result: starting this April, capital gains will be taxable at half the domestic rate till April 2019, and after that at the full rate. Tax loopholes have been closed, especially those that allowed domestic black money to “round-trip” and avoid taxes.

#7: On another front, Sebi, the market regulator, started crimping the flows of portfolio investments through participatory notes (P-notes). P-notes are derivative instruments through which investors based abroad can participate in Indian markets without disclosing their identities. The trades are settled abroad. Sebi cracked down on excess anonymity in May 2016, and last month the investment rules were tightened further to ensure that there is more transparency on who is buying or selling. P-notes are now in decline. In 2007, P-note outstandings were as high as Rs 4.5 lakh crore; a few months ago, the outstandings were down to a third of that amount.

The net impact of the closing of anonymous investment flows and tax loopholes means that only legitimate investors can now invest in India, and Indians who want to route their black money into domestic stocks or even their own companies cannot easily do so.

In the past, when India Inc was in trouble over bad debts or dud projects, they could do one or all of these three things: get government and public sector banks to write off their loans; generate easy money by speculating in stocks by using P-notes and other anonymous investment instruments (now closed); or inflate business incomes at home by overinvoicing exports or underinvoicing imports (another way of using funds abroad to fund local corporate revival). All these routes are now harder to adopt.

Under Modi, these avenues are closing or already closed. Funds held abroad are stranded and can’t easily come in, and domestic black money is now tougher to generate. Add the pre-emption of funds for participating in auctions, and there are few rent-seeking opportunities in India. Demonetisation broke the back of the realty industry, by denting demand further. Thus black money held in benami properties is also temporarily impounded as buyers are less willing to pay cash, and are additionally demanding huge discounts.

In the year ahead, with the goods and services tax about to kick in from 1 July, more businesses will be squeezed to enter the tax net. So profits will be harder to come by till the system settles into a fine rhythm.

And then there is banks’ unresolved bad loans mess. This may be gradually brought down only over the next 12 months, with the Reserve Bank now being empowered to force banks to settle their biggest NPAs as soon as possible.

The pincer of bad loans and corporate deleveraging, coupled with the attack on black money, tax evasion and benami transactions, and the final assault on cash-based transaction with demonetisation points in only one direction: India Inc does not have the profit or cash leeway to invest in growth. Growth will not revive too soon.

The price for having a cleaner economy, with more taxpayers, less evasion and less corruption, is being paid in terms of postponed investments and growth.

This is good for us in the long run, but in the short to medium term, there is only pain.