December 2016

'It's a forward-looking move'

India is going through a phase of fiscal upheaval right now, with demonetisation of the Rs500 and Rs1,000 notes affecting 86 percent of the cash in circulation. Praveen P Kadle, managing director and CEO of Tata Capital, shares his perspective on the demonetisation drive, its short-term impact on the economy and the brighter prospects ahead

My personal view is that initiatives that work towards curing the country of its problem of untaxed funds and digitisation of payments, along the lines of the demonetisation move, are the right moves for India. Previous attempts to stem what India calls black money (the untaxed funds) had limited success. More to the point, this move is forward looking and, combined with a host of partner initiatives and deployments, could potentially solve the problem of India’s parallel economy, which some studies have pegged at 25 percent of India’s official GDP.

Having set this massive exercise in motion, the government needs to show clarity on how India can achieve a permanent solution to this problem. In order to prevent more money from entering the parallel economy, the government has to tackle the root cause of tax avoidance — our high tax rates. The gross rate for the highest income tax slab works out to over 36 percent. Then there are other taxes and levies like service tax, VAT and more.

It is important for the government to work on rationalising the tax structure. For example, while the implementation of the goods and services tax (GST) is a positive move, if the GST rate and other tax rates are perceived by industry to be on the higher side, there again may be risk of non-compliance. Lowering of taxes should be considered to incentivise more people to disclose their untaxed income.

However, what is significant is that the government has sent out a clear signal that it is serious about cracking down on tax evaders. It has already taken a number of steps to block high-value cash transactions, and there may be new announcements in the future as it tries to make black money unattractive.

While flushing out black money may be the primary reason behind the demonetisation move, there are other nation-wide benefits that are predicted: there will be a squeeze on terrorism and other anti-national activities; the use and role of black money in elections could come down; counterfeiting activities could see a drop as the new notes have additional security features. All of these are big positives for the nation.

Inconvenience for individuals
From an individual’s point of view, demonetisation has led to the frustration of not having adequate cash in hand for day-to-day transactions.

At Tata Capital, we have seen the impact in a few areas. Our rural financing scheme (mainly for tractors) works mostly on cash, wherein the farmers make loan repayments in cash from their earnings after selling their produce. Even the construction equipment financing operates with a fair amount of repayments coming through cash. There will be a short-term impact here as our customers are finding it difficult to make these payments.

On the positive side, we see Jan Dhan accounts receiving an influx of funds. In the long term, this may trigger rural consumption demand for certain categories like consumer durables, two-wheelers, etc.

Impact on real estate
Another area of impact is the real estate sector. One of our businesses is real estate financing, ie loans to small and medium enterprises (SMEs) against mortgages on their residential properties. We expect to see these SMEs face a severe cash crunch and consequently there may be an impact on repayment ability. Big builders may also get impacted.

However, in the long term, we feel there will be a positive impact due to the fact that real estate prices could come down by about 10-20 percent. Affordability will improve and the demand for housing finance will proportionately increase.

Impact on the finance sector
With many financial institutions now flush with funds after the demonetisation, we expect the lending rates to drop, which in turn could help increase the offtake of loans for all financial services companies, including Tata Capital.

Another benefit is that entities will now find informal and unofficial sources of funding drying up, and will have to move towards the official financial sector. This should lead to an upsurge in credit demand.

Additionally, the cashless economy may help open up the rural market, where NBFCs have been able to penetrate till the last mile. If the real economy grows through demonetisation, the impact will be favourable.

A positive outlook
When it comes to the impact of demonetisation on GDP, I personally feel there will be a small negative impact, visible only in the short term. From April onwards, we believe interest rates will drop, inflation will come down and this will spark industrial growth, which will reflect in a positive outlook for the GDP.

Another positive impact of a cashless economy is the proliferation and increasing popularity of digital solutions and payment platforms, such as Uber, Ola, Paytm. Going forward, the digital sector will play a bigger role in the Indian economy.

To sum up, the negative impact of the demonetisation drive, linked to cleaning up of the unofficial economy, will largely be limited to the short term. If we can tide over the current period of pain and inconvenience, there will be a positive outlook for India’s economy.