Opinion The other 50 per cent

Now,a large part of the privately held gold in India is unrecorded in terms of ownership. It just loosely resides under the custody of large families,especially in rural India,and is used from time to time for the purposes of raising money from the informal money market for either business or social purposes.

Unlike the massive,unrecorded derivative assets of the West,India’s shadow economy proved to be a great virtue during the financial crisis. Global investors are convinced that India’s shadow economy has great value and actually acts as a bulwark in times of crises. Samir Arora,a prominent hedge fund promoter in Singapore,unabashedly argues that India’s privately held gold reserves are a permanent source of confidence for investors.

It is also true that India’s shadow economy in rural India helped maintain India’s 7-plus per cent growth rate in the worst global recession after the Great Depression. This was largely because rural consumption was robust. According to the National Council of Applied Economic Research,the bottom 80 per cent of India’s population account for 65 per cent of total consumption. The bulk of these people reside in rural India.

For the first time,corporate honchos have openly admitted that their company sales grew in 2009-10 largely because of robust consumption in rural India. A good part of this consumption actually comes from the cash economy. For instance,rural construction was one of the key factors driving growth across many states. This largely occurs in the cash economy.

The challenge for the policy maker today is to come up with a radical idea which creates a big enough incentive for the shadow economy to eventually get registered as part of the official GDP. Finance Minister Pranab Mukherjee can use the 2010-11 budget to seriously kickstart the process of gently coaxing the shadow economy to come out into the open. This could be the central theme of the budget,which can actually lay down a broad three-year road map for doing so.

The finance minister already has one big tax policy instrument in his hands to capture the shadow economy in the years ahead. The goods and services tax (GST) proposal is precisely aimed at bringing into the official fold large parts of the black economy on terms that are reasonable.

The GST framework,if implemented well,can result in a dramatic improvement in the overall revenues of the Central and state governments. Widening of the tax base is the only way to ensure robust funding support to health,education and other social sector schemes in the years ahead. It must not be forgotten that the massive surge in the UPA’s social sector spending became possible only because there was continued boom in the economy which resulted in the Centre’s revenues growing more than twice between 2004 and 2009. The total revenue receipts of the Centre grew from about Rs 2,65,000 crore in 2003-04 to Rs 5,60,000 crore in 2008-09.

Since revenue receipts more than doubled in five years,the UPA could politically package its robust expenditure programmes in the social sector. Between 2003 and 2009 the budgeted expenditure increased more than 300 per cent for the ministry of human resource and development,nearly 300 per cent for rural development,253 per cent for women and child development,about 212 per cent for health and family welfare and so on. All this became possible only because there was robust growth in revenues.

For such spending to continue,the government must treat the task of widening the tax base with the utmost urgency. New tax reforms are at the heart of this process. A reasonably attractive tax structure as envisioned in the Direct Tax Code (DTC) as well as the goods and services tax will act as a big catalyst to bring India’s massive shadow economy into the officially recorded GDP framework.

Hypothetically,if the shadow economy becomes part of the official GDP then the problem of high fiscal deficit run by the Centre will also get solved automatically. If the overall output expands by 50 to 60 per cent by simply bringing the black economy into the official net,the fiscal deficit as a ratio of GDP drops proportionately. In fact,economists often ask why India has never faced an internal economic crisis,like some of its Latin American counterparts,in spite of running a consistently high fiscal deficit of close to 10 per cent of GDP for a decade. The answer to that could be that India’s GDP is substantially understated. The actual fiscal deficit or gross borrowings by the Centre and states is possibly much lower as a ratio of the official plus the shadow GDP. If that is so,it is time we came out of our shadows.

The writer is Managing Editor,‘The Financial Express’

mk.venu@expressindia.com