With just a day left for the presentation of the Union Budget, a look at the one presented in 1978, immediately after the demonetisation exercise undertaken that year, yields some insight into a few of the problems that the Indian economy currently faces.
Similar objectives
The stated objectives of the demonetisation effort in 1978 were more or less the same as what Prime Minister Narendra Modi announced on November 8, 2016 — not counting the subsequent steady change in the government’s message from ‘eliminating black money’ to moving towards a ‘less cash’ economy.
“The demonetisation of high denomination bank notes was a step primarily aimed at controlling illegal transactions,” the then Finance Minister H.M. Patel said in his Budget speech a month after the demonetisation exercise. “It is a part of a series of measures which Government has taken and is determined to take against anti-social elements.”
While the differing scales of the economy and relative prevalence of high-value currency notes ensure that there can be no comparison between the demonetisation effort undertaken in November 2016 and the similar exercise conducted in 1978, some of the economic conditions prevalent at that time were indeed quite similar to what exist now.
Take for example, the poor state of private investment in the economy at the moment. Back in 1978, Mr. Patel said that “there is also an urgent need to increase individual and corporate savings if increased investment expenditure is to take place without any adverse pressures on prices. This would require greater simplicity in the lifestyle of those individuals who can save, and a greater efficiency and a reduction in inessential expenditure on the part of corporations.”
This sounds quite similar to the current situation, where private investment is languishing and the government is encouraging people to put their money in banks.
The government had in 1974 enacted the Compulsory Deposit Scheme (Income Tax Payers) Act which mandated that all those earning more than ₹15,000 a year would compulsorily have to deposit a certain percentage of that amount in banks.
Mr. Patel, in his 1978 Budget speech, increased these limits significantly in a drive to force people to save.
So, those earning between ₹15,000 and ₹25,000 would have to deposit 41% of their income, up from the previous 4%. Those earning between ₹25,001 and ₹35,000 would have to deposit 11%, between ₹35,001 and ₹70,000 12% and those earning more than ₹70,000 would have to deposit 15%.
This, Mr. Patel had said at the time, would earn the government ₹25 crore in that year itself.
The demonetisation exercise of 2016 has basically been a compulsory deposit scheme, with the government forcing people to place their cash in banks and setting curbs on how much they can withdraw. While increasing financial savings is desirable, the sudden influx of funds is causing problems for banks, according to economists and bankers.
Swelling bank deposits
“Already bank deposits post-demonetisation have swelled and banks are finding it difficult to deploy these resources as there is no demand,” said D.K. Srivastava, Chief Policy Advisor at EY India. “Unless there is a policy initiative to boost demand, it would actually become a burden.”
The lack of demand was a problem even Mr. Patel had recognised at the time. One method he had employed to increase private investment was to encourage people to buy equity stake in new companies so as to provide them with the funds to invest further.
“In order to stimulate such investment, I propose to give a deduction in the computation of taxable income of 50% of the amount invested in equity shares of new industrial companies,” Mr. Patel had said in his speech. “The maximum investment in a year qualifying for this deduction will be limited to ₹10,000.”
While this would entail a loss to the exchequer, the then Finance Minister candidly said that he would “cheerfully accept a much larger loss if it results in stimulating larger investments.” The current government too could maybe consider taking a similar view, accepting losses to itself in an effort to stimulate private investment.
“This could work in the current scenario, where there is a need to encourage equity investments,” Mr. Srivastava added. “But this must also be accompanied by suitable policy measures to reduce the cost of borrowing for companies.”
