A sequencing issue

Demonetisation and GST have knocked out SMEs

It is too soon to determine the overall effect of the goods and services tax, or GST. Certainly, the roll-out, while expectedly disruptive, has not so far caused widespread chaos, so the government can be pleased but watchful. While the GST is not a perfect system, it is an important advance and contains the seeds of a truly transformative reform. Yet there are effects of the GST that the government must keep its eye on, particularly on small and medium enterprises, or SMEs. As has been widely reported, the GST might indeed lead to an increase in the size of the formal, taxpaying sector, but the burden of the change would fall disproportionately on SMEs, which have been the engines of Indian growth and employment. 

It has been a bad year for SMEs. The withdrawal in November of 86 per cent of India’s currency stock — demonetisation — hit the cash-based informal sector particularly hard. Many SMEs found themselves without working capital. The sudden downturn in orders caused the more fragile enterprises to suspend operations or even to shut down. There is no clear indication as to the extent of this problem due to the difficulty of obtaining precise data about the functioning of India’s informal sector or its smaller enterprises. But the numbers issued by industry associations or by bodies like the Centre for Monitoring the Indian Economy are far from encouraging. Demonetisation may or may not have been a good idea, and it may or may not have achieved its ends; even if there is disagreement about that, there can be no disagreement that its timing was awful. The government knew that the GST was due to roll out in less than a year; and it was already obvious that the transition would be particularly difficult for SMEs. But decision-makers chose to go ahead with demonetisation anyway. This reveals a somewhat cavalier attitude to the overall health of the Indian economy that is worrying and disheartening. If the reasons for the timing of demonetisation were political — concern about building a narrative prior to the elections in Uttar Pradesh, for example — then that does not reduce the problems attached to the decision. In fact, the possibility renders the decision more problematic, not less. 

It is clear, therefore, that the SME sector will deserve extra attention. This attention should not take the form of populist policies, but of additional efforts to increase the ease of doing business for smaller enterprises that have entered the tax net. There have been reports that the very smallest enterprises are being left out of supply chains due to the structure of the GST. This problem should be examined and addressed as a priority. The government, and even the leadership of the ruling Bharatiya Janata Party, has indicated that it intends to focus on increasing small-scale entrepreneurship rather than on generating mass employment. If so, then it should own up to the hurdles it has put in the way of small entrepreneurs through its sequencing of policy, and focus on making things easier for them.