On November 8, 2016 the decision of withdrawing high denominated rupee notes (of Rs 1,000 and Rs 500) resulted into squeezing out 86% of cash from circulation which severely hit economic activities, the impact of which is still being felt. The government’s move of demonetisation has been analysed by people from different walks of life across the world and several diverse opinions have been expressed on this topic.
Former Prime Minister Manmohan Singh, who is an economist of world repute, termed the move as a ‘monumental mistake’, while several supporters of Prime Minister Modi have called it ‘historic’. Irrespective of their opinion, it is hard to ignore that demonetisation is a transition to transparency and formalisation of the economy which would result in stronger economic growth in the long term.
Traditionally, people of India have been investing in gold, silver, jewellery, real estate with different objectives such as security, their ability to retain long term purchasing power and an insurance against unforeseen events. These assets fall under the category of physical assets with limitations of being less liquid, unproductive and low yielding. Despite these shortcomings, tax evaders have been parking their money into these instruments. Hence, the total number of Income Tax Returns (ITRs) filed in the month of August 2016 stood at 2.22 crore, which is a very small base of tax payers. Since the major chunk of money remained invested in non-productive assets, adequate capital formation could not take place in the economy resulting into retardation of economic growth for a long time.
Demonetisation has forced the people to re-strategize their investment policy. As a result, there has been big shift towards investment in financial assets. The boom in stock market, rise in bank deposits, unprecedented high levels of equity and debt mutual fund assets under management (AUMs) are a reflection of this move.
The large scale inflows of fund in equity markets and mutual funds could be attributed to their relative attractiveness as returns from equity held for over one year period is tax-exempt whereas interest earned from fixed deposits is taxable. Debt funds have a tax rate of 20% after indexation benefits after three years. There has been emergence of new trend wherein traditional investors who used to park their money in bank, corporate fixed deposits and PPFs are now shifting to direct equity, or indirectly through equity mutual funds and debt funds that offer higher rate of returns. The total AUM of the mutual fund industry has surpassed Rs 21.45 lakh crores. Demonetisation has added to the momentum of this investment flows from unproductive physical assets to productive financial assets. On November 1, 2016, Nifty closed at 8225 and it reached 10441 by November 1, 2017, thereby generating a return of 26.9% in one year, whereas bank pays interest between 6% and 7% on a one-year fixed deposit.
The AUM of the Indian MF industry has grown from Rs 3.26 lakh crore as on March 31, 2007 to Rs 21.45 lakh crore as on September 30, 2017, nearly 7-times rise in a span of little over 10 years. Especially, SIP (systematic investment plan) has become a popular product amongst Indian investors and investment through SIPs is picking up. Indian mutual funds had about 1.66 crore SIP accounts in September 2017. MF industry has been adding about 8.8 lakh SIP accounts each month on an average during the current financial year, with an average SIP size is about Rs 3,300 per SIP account as in September 2017. Total amount collected through SIP per month during September 2017 was Rs 5,516 crore.
The effect of demonetisation is also clearly visible in the growth in direct tax collections. As per press release of August 7, 2017 from Central Board of Direct Taxes (CBDT), advance tax collections of personal income tax (i.e. other than corporate tax) as on August 5, 2017 for FY17-18 showed a growth of about 41.79% over the corresponding period in FY16-17. Personal Income Tax under Self Assessment Tax for FY17-18 grew 34.25% over the corresponding period in FY16-17.
The aforesaid facts sufficiently demonstrate the positive result of the demonetisation in terms of shift in investment patterns, increasing the tax base and finally tax collections.