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Narendra Modi wants to boost formalisation. How is he faring?

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WATCHING money drain from your bank account has never been so much fun. On WhatsApp, a messaging service ubiquitous in India, sending rupees is now as easy as posting a selfie. Set-up is a breeze, because all Indian banks have been corralled onto a common payment platform on which anyone, from Google and Samsung to local payment firms and banks themselves, can build their own user interface. Money zips instantly from one bank account to the other, without any need to set up a pesky digital wallet or download some new app. At least outside China, there is no simpler way to shift money today.

WhatsApp’s offering is being rolled out gradually. The number of transactions routed through the United Payments Interface (UPI), the system on which WhatsApp and the rest are riding, has soared from almost nothing in early 2017 to over 150m a month in January. On current trends, UPI transfers will overtake cash withdrawals from banks within weeks. Some 665bn rupees ($10.2bn) will have shifted hands—or phones—in the year to March.

All this is good news for tech-savvy Indian citizens. It is even better news for the taxman. Electronic transactions, unlike those in hard currency, leave a digital trail that makes it harder to do business informally. Just as an Uber driver cannot hide his income in the same way as a cash-in-hand cabbie can, money routed through bank accounts is easier to track, trace and tax. That is helpful because pushing more of the Indian economy out of the shadows, where perhaps half of all activity takes place, and onto the authorities’ radar has been a central policy of Narendra Modi, the prime minister.

Informality has long been the norm in India. Economists estimate that nine in ten workers toil in the grey economy (recent research from the finance ministry suggests the figure may be somewhat lower). Informal outfits, often small, employ two-thirds of all manufacturing workers, at far lower pay than in formal manufacturing jobs. The informal sector remains the employer of last resort. So Mr Modi’s claim that widespread formalisation would be akin to turning “an old civilisation into a modern society” is no overstatement.

As so often in India, data are patchy. But Mr Modi can claim some success. A new Goods and Services Tax (GST) introduced in July has boosted the number of firms registered to pay indirect taxes by 50%, to nearly 10m. This has become the most serious challenge to those looking to do business under the radar. It subsumed a plethora of nationwide and state taxes adding up to 40% of India’s total take. A sort of value-added tax, it compels businesses to declare both their purchases and their sales if they are to qualify for tax refunds. Plenty of loopholes have been built in, and lots of features have had to be delayed because of IT problems. But the miseries of implementation—and the nearly two decades of political bickering it took to get GST passed—should yield more gain than pain.

That is more than can be said for “demonetisation”, which in November 2016 compelled Indians to trade or deposit most of their cash holdings at banks before their notes turned to worthless pieces of paper. It led to the abrupt withdrawal of 86% of all bank notes from circulation. Only now is currency in circulation, which some see as a proxy for informality, creeping up to previous levels even as the economy has grown (see chart).

The costs were clear: India’s economy slowed markedly. Fans argued, though, that it jolted India onto a new, more formal track. But if so, that track has not visibly diverged from the one it was on before. Though there was a rise in the number of Indians signing up to pay income tax, the revenue from income tax is expected to come in at 2.3% of GDP, up only a little from around 2% in previous years. Even the jump in indirect-tax registrants because of GST has led to a relatively modest increase in revenue. But at least there is a sense that dodging taxes is less acceptable in polite society than it used to be.

Saurabh Mukherjea of Ambit, an investment bank, argues that market forces have done more to nudge businesses to go formal than any government scheme has. Better infrastructure and logistics have made it easier for formal businesses to achieve economies of scale, and so to take on informal rivals whose sole competitive advantage is their ability to dodge taxes and regulation. Moderate inflation, due in part to the low price of crude oil, of which India imports oodles, has allowed for lower interest rates. That has made financing cheaper for formal firms, while informal ones have still had to make do with loans whose interest is measured in monthly, not annual, rates.

But whatever edge a formal business might have gained is more than undone by a thicket of labour laws that prevent small firms from growing into mid-sized or big ones, which tend to be more formal. These have barely been touched since Mr Modi came to office in 2014. The fear of being shaken down by venal bureaucrats and taxmen remains a powerful reason to stay below the radar. As a result, only one in 20 Indian workers toil in firms that employ more than 25 people, compared with around one in four in China.

Indians have everything they need to lead a formal life. Thanks to a financial inclusion drive launched by the previous government and enthusiastically continued under Mr Modi, nearly all have bank accounts. Hundreds of millions receive government subsidies for fertiliser or gas as digital payments, rather than as in-kind rations, which were often pilfered. As paying digitally becomes easier than paying in cash, India’s government should ask itself why so many citizens would still rather the authorities know nothing about them.

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Japan still has great influence on global financial markets

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IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.

“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.

This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.

One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).

But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.

Tokyo storm warning

These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.

Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.

What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.

Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.

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