Unintended consequences. We've all encountered them. The era of Alcohol Prohibition, for instance, is seen as the opportunity organised crime outfits needed to not just prosper, but ultimately solidify and increase their dominance in other illegal activities.
Sometime, these consequences are so disconnected that rational thought and logic would not account for them. Other times, these consequences are an indication that maybe not enough deliberation took place. Whatever be the case, governments are by no means immune to these unintended consequences. So too, the Narendra Modi dispensation.
The surcharge scuffle
Finance Minister Nirmala Sitharaman's Budget 2019 decision to increase the tax surcharge on High Net Worth Individuals (HNIs) is the most recent of such ‘Oops! moments’ the Indian government has created for itself. The move originated with the idea of taxing the superrich, and enhancing their contribution to social welfare schemes. A noble idea. But as it turned out, the law applied to a whole bunch of investors who were not registered as corporate entities because of circumstance, or other extraneous legal requirements. Foreign Portfolio Investors (FPIs), specifically. Apparently, the idea that this levy could be applied to this section of the financial community had not crossed anyone's mind when the proposal was being drafted.
The proposal resulted in considerable consternation among this section of the investor community, which immediately fell back on its much-favoured offence-is-the-best-defence strategy. It whittled down positions in the Indian equity markets and withdrew its money. Nearly Rs 12,000 crore left Indian equity in July alone, after the budget announcement. Naturally, the stock markets fell rather sharply, and investor wealth to the tune of over Rs 3,000 crore was wiped out. By the time August rolled around, overall market capitalisation slipped below $2 trillion for the first time in six months.
The sour mood was reflected in the currency markets, where the rupee depreciated for seven successive weeks. To be fair, FPIs had begun withdrawing before the surcharge idea was mooted, thanks to a slew of other factors like an overall sluggish economy and the trade war the USA had begun waging on China and its other trade partners. But for the perpetually tax-averse investor community, the surcharge was the proverbial straw that broke the camel's back.
Since then, the palpable trepidation of the investor community, which the government initially dismissed, has prevailed. The hike in surcharge has had a (gratifyingly for some) short life. Embodying a "spirit that India respects wealth creators", the finance minister has rolled it back.
Charity begins at the balance sheet
One other ‘Oops! moment’ that comes to mind is the decision to introduce, through amendments to the Companies Act, a monetary penalty and a jail term for any corporate entity, domestic or foreign, which did not contribute to nation-building, through very specific initiatives and projects. That many of the acceptable initiatives which could be funded in the name of Corporate Social Responsibility were babies of the administration was not lost on anyone either.
The earlier rule mandating 2 percent of profits go towards a Corporate Social Responsibility initiative was already chafing. The addendum that such projects could not be used to further business goals added to the friction. Bringing in an element of criminality for not bending the knee the desired angle within a stipulated timeframe proved to be salt to an already festering wound.
Domestic industry did not like it, but could only grimace, and cautiously ask for a review. Foreign companies may have made it clear their money could always go elsewhere, that their shareholders came first.
When the high-powered committee on CSR from the Ministry of Corporate Affairs submitted its report a month after the law was passed, it recommended that violations be treated as a civil offence and not a criminal one. This exposed a chasm within the government itself, and effectively pushed the administration onto the back foot.
In the corridors of power, when the discomfort and displeasure became apparent, appeasement ensued. The finance minister has since clarified that jail terms would not be enforced. Not very reassuring, when the jail term has already been written into law. An explanation that the element of criminality was only thrown in to ensure corporates did not “explain away” their failure to meet mandated CSR spending, has also been offered. But surely, there were more ways to skin that particular cat?
The demon in demonetisation
The much bigger, and far more memorable "Oops! moment" of the Narendra Modi era (so far), though, is probably the extinguishing of high-denomination currency notes from circulation. When Prime Minister Narendra Modi made that now-historic announcement, it's quite likely he had no inkling its ramifications would shake the foundations of the Indian economy, and contribute significantly to India losing the distinction of being one of the fastest growing economies in the world.
Physical inconvenience to the layman aside, small businesses were forced to shut down, larger ones had trouble maintaining profitability, and people found themselves without jobs. An investigative report in The Hindu highlights that a report submitted by a taskforce for drafting a new direct tax legislation (which has so far not made public) contains data showing a 60 percent drop in aggregate investments disclosed by the corporate sector in FY17, the year demonetisation was announced. This same taskforce report also contains data that demonstrates nearly 46 percent of the 7.8 lakh companies that filed tax returns in that year reported book losses, up from 42 percent in FY13.
The unorganised sector, which has a greater dependence on cash transactions, was worse hit, and an economy that stood tall on the shoulders of a large unorganised sector was pretty much gutted, and the after-shocks can still be felt.
Eventually, the numbers didn't add up, and what started as a measure to crack down on black money was quickly repurposed into a catalyst for a migration to an online payments economy among other things. The problems from demonetisation did not end there.
As people flocked to banks to turn in soon-to-be-worthless currency notes, bank accounts saw a large inflow of funds. Banks, which had been struggling with deposit mobilisation, had to cut deposit rates because the surge in deposits made paying interest unfeasible.
Conversely, all that excess money meant the shadow banking system comprising non-banking finance companies, housing finance companies and micro-finance institutions now had a lot more money to draw on. This easy access to funds, and an underlying (and unspoken) urgency to spur credit offtake to help the economy along, saw lending to projects and entities that latterly turned delinquent. This has mushroomed into a liquidity crisis that has seen many finance companies head to insolvency or litigation, lenders losing money, and investors -- even those who invested indirectly in these entities through mutual funds -- staring at a starkly lower net worth.
It’s been almost three years since the note ban was announced, and the aftershocks of that decision are still being felt, with tremors and fissures making themselves known ever so periodically.
So if this administration would love to forget one 'Oops! moment', I guess demonetisation would be it.
First Published: Aug 28, 2019 6:00 AM IST
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