The small and medium-sized enterprise (SME) sector, as we understand, is a big chunk of the economy, contributing to eight percent of the GDP whilst employing more than 80 million people year on year.
Before we analyse the impacts of demonetisation on the industry, we must understand how we reached this stage in simple words. Most SMEs are traditionally-operated, family-run businesses. Broadly, there are two kinds of players in the market in this segment. One, the businesses that were formed because their promoters saw the opportunity early on before anyone else could and went on to become successful businesses quickly.
The other are the players who joined the race and could do reasonably good because of the vast underserved market. Traditional mindset and early success convinced them to not upgrade or change the way they do their business and therefore they continued to remain in the SME sector and not scale beyond a point.
An SME entrepreneur has been a master at this art. He was quick to spot ways to get through with the compliances and taxes and the officials were happy to receive the unaccounted benefits. Soon it was also noted that the return on investment on taxes paid was meager and there always were alternatives available to a frugal mindset. This gave rise to the parallel economy of black money. It’s a classic case of poor processes at the government level.
Processes are always interlinked and therefore whilst constructing them one has to look at all the sub-processes they will impact. Processes need a monitoring and audit mechanism that is independent and cannot derive benefits from allowing incorrect ways in the system. All of these aspects somehow were missed.
Demonetisation, in my opinion, is an extremely bold step taken by the Prime Minister, especially when a large portion of the economy is run on cash transactions and the economy is largely how people feel and interpret the situation. My personal views are as follows:
- Demonetisation is not a surgical strike; it is carpet bombing. It impacts everyone. Replacement not only takes time, it also slows down the spending process as everyone tries to protect the newly acquired currency to secure themselves from the uncertain future. In case of SMEs, most will be unsure of payments coming from customers for some time; this as liquidity in the form of unaccounted currency has dried up. If customers don’t pay, SMEs will protect what they have and that will mean they purchase less and produce less. Purchasing less will mean further slowdown for the people who provide them with raw material and producing less will mean shortage of supply leading to inflation on what is available.
- Reforms in the form of incentives is what we see will happen soon. I am positive that the government is aware of the first point and will take measures to restart the money wheel rolling in the market again. This could happen in several forms, early announcement of GST and BTT, elimination or drastic reduction of Service Tax and VAT until either GST is introduced or something else. Taking steps on taxes will encourage people to spend without having the fear of tax, which is currently seen as systematic 'loot' with minimum or no returns.
- Improvement in government procedures and monitoring of the monitor. This will happen as a measure to avoid generation of black money in new currency. The government will redesign processes to acquire licences and approvals with ease, and older redundant requirements will be abandoned. Tax and other compliance officers will need to be monitored to ensure that policing does not give birth to ‘under-the-table settlement’ culture again.
- Visible use of collected money in banks on development of infrastructure that brings benefits to people quickly. 'Quick' is the keyword. We will see money invested in aspects that bring quick results for all classes. The current change has got quick pain with a promise of long-term gain but we have to remember that a large section of our society will need quick gains to survive before they can enjoy the long-term benefits.
- SMEs will invest in self-development and improvement in terms of technology, infrastructure and training to self-utilise the increased profitability with unaccounted income now becoming a part of the books that are taxable.
- SMEs and businesses now by design will have two options. Pay tax or spend on doing more for scaling up and this will have a spiral effect on the overall improvement in the economy.
There are loads of positive and negative impacts of the current move. No one currently can be sure of the future and this uncertain environment is certainly not good. Outcomes in uncertainty depend on the mindset and, currently, whilst people are taking it positively, they definitely are starting to realise possible pitfalls too if measures are not taken at the right time. Communication will be the key to ensure stability. And, while I am impressed with the bold step taken by the prime minister, I am also concerned about the mammoth task ahead of him to make this a success, because in my mind the war against black money has not started yet. Demonetisation is only a war cry that declares the start of a war.