A monetary move to strike at pain points to investment

It is, arguably, the most daring, and far reaching, economic reform ever. The demonetisation of Rs 1,000 and Rs 500 notes by the Narendra Modi government hits at the roots of several problems ailing the Indian economy and addresses many of the pain points that deter foreign investors from entering India. Just consider some of the issues that scare away all but the most intrepid of investors:

• A byzantine bureaucracy where unaccounted cash is usually the best lubricant

• Having to engage “consultants” who pay speed money on your behalf from their “fees”

• A government perennially short of cash because many transactions take place outside the tax net

• Manufacturers of equipment in the West who often receive requests to route shipments through tax havens to facilitate over-invoicing in order to generate black money

The demonetisation of high value currency notes has struck a death blow to all these activities. The Narendra Modi government has largely succeeded in eliminating top level corruption in the government. But petty corruption by the lower bureaucracy still remains a big hurdle to the ease of doing business. Now, customs inspectors and tax officials will be doubly wary about raising specious objections with the sole intention of seeking rents.

This is certain to improve India's poor rank of 76 in the next edition of the Corruption Perception Index brought out by Transparency International. Then, the expected extinguishing of over $70 billion in high value notes, about 30 per cent of all currency in circulation, will ease the Government of India's fiscal burden, ease the cost of money and provide the Reserve Bank of India space to cut interest rates by up to 100 basis points (bps;100bps=1 percentage point).

This, and the expected buoyancy in the government's revenues as a result of a greater percentage of transactions coming within the tax net, will give Finance Minister Arun Jaitley sufficient headroom to reduce the corporate tax rate to 25 per cent as he has promised. This will address a long standing demand of industry and bring Indian tax rates closer to its peers abroad and act as another magnet for foreign investors.

Critics and some Opposition parties have highlighted the problems being faced by the ordinary people and small traders - the BJP's core constituency - in accessing cash to demand a rollback of the demonetisation initiative. They have also, prematurely, started celebrating what they think is the beginning of the end of the Modi phenomenon that has driven them to the periphery of India's mainstream political discourse. Such celebrations may well be a case of counting chickens before they hatch. Modi is an instinctive political gambler. Recall his tough stance as Gujarat chief minister when he overruled the advice of his core team and decided to fine over 100,000 farmers caught stealing electricity to run their pumps. State party satraps were wary of antagonising the powerful farm lobby that had made and unmade many governments in the past. But Modi stuck with his instincts and it paid off. He went on to win two more terms with thumping majorities before moving to Delhi as Prime Minister. This latest gambit, he has promised, is only the first move in a long and protracted battle against black money. There is no evidence yet that ordinary people are upset at Modi for the short-term inconvenience that many are going through.

If Modi can deliver on his promise of freeing the country from the scourge of black money, he will have achieved the impossible. And this alone can take India zooming up the ranks of the World Bank's Ease of Doing Business Index, in which it currently languishes at the 130th position. Both Indian and foreign investors will be closely watching these developments.