With a tax-to-GDP ratio languishing around 16 per cent, India’s resource base is not nearly enough to fund its development needs. It is below the emerging market average of 21 per cent and substantially lower than that of the OECD at 34 per cent. With the primary intent of correcting this imbalance, the Modi administration ventured ahead with a move to demonetise 86 per cent of cash in circulation. There have been damaging consequences in the short term on consumption and consequently economic output, but in the longer term the benefits may well outweigh these. Ultimately, the government hopes that cash as a percentage of retail transactions will reduce. Estimates vary, but many economists believe this is as high as 80-90 per cent. Scandinavian countries on the other hand have moved completely digital. Cash as a percentage of GDP hovers around 12 per cent in India compared to half as much in comparable countries. The hoarding of cash or its use in transactions enables tax evasion. It would seem logical therefore, that the ultimate rationale behind the demonetisation has merit.
Whilst it is early days yet, some figures on digitisation provide reasons for cheer. For instance, the volume of credit card transactions spiked from an average of 76 million a month to 97.6 million in November. Debit card merchant purchases doubled from 120 million transactions a month to 235 million while mobile wallet transactions increased from 61 million a month to 138 million in November. Digital money is cheap, easy to move and possible to trace. Cash on the other hand is cumbersome and comes with huge costs to the economic system. According to a paper on the subject by Tufts University, this is a whopping Rs 21,000 crores per annum. This includes the printing of money, its transportation, insurance costs, agency fees, ATM costs, among others. Secondly, digital money makes it harder to evade taxes since digital fund flows cannot be kept off the books.
The demonetisation move, despite common perceptions, is not an ‘elite versus deprived’ story. Nor is it about nationalism and it is wrong to make it out as so. The arguments really ought to be grounded on economic logic and facts. Going forward, if the government succeeds in increasing the share of digital transactions by encouraging citizens to switch and providing the backbone infrastructure that enables it, the demonetisation episode would have been worth the pain. Most importantly, should the tax to GDP ratio over the next 5-7 years move upwards from 16 per cent to say, 22-23 per cent then a lasting benefit of epic proportions would have been delivered. It is early days yet, but the odds instinctively appear to be in favour of the move.