Economics

Fear of the Taxman Blights Modi's Quest to Expand Formal Economy

  • India’s small businesses are reeling from demonetization, GST
  • Avoidance of taxation scutiny drives companies to avoid sales

Twice in the past year, Mohammed Mohsin’s textile design business was buffeted by major changes in the Indian economy. First, a ban on high-value notes, then a new tax system. Now, he senses yet another threat.

“There’s a new fear,” says Mohsin, 33, one of half a million people plying the saree trade in Varanasi, in the heart of Prime Minister Narendra Modi’s political constituency in the northern state of Uttar Pradesh. “It feels like the government is watching every move.”

A silk saree workshop in Varanasi.

Photographer: Dhiraj Singh/Bloomberg

While demonetization a year ago and the introduction of a goods and services tax in July were designed to fight black money and the shadow economy, and create a unified, common market across India, some business owners say the changes have left them vulnerable to accusations of tax evasion. And one way to avoid scrutiny is to slow transactions. In Varanasi, known internationally for its Banarasi woven-silk sarees, business is down about 60 percent from a year ago, Mohsin estimates.

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“There have been too many changes,” he said. “We hadn’t recovered from the cash ban when they introduced a new tax, which needs us to use computers and hire chartered accountants.”

Worthless Paper

The impact has spilled across the broader economy, which is slowing. The central bank expects annual private investment in India to fall by more than half to 694 billion rupees ($10.7 billion) in the year that began April 2017 from 1.54 trillion rupees the previous year. The amount of cash in circulation is a fifth less than in October last year, a month before Modi ordered invalid 500- and 1,000-rupee notes, essentially turning about 86 percent of the money in the $2.3 trillion economy into worthless paper.

“Unless this amount has been replaced by bank finance and there has been a rise in credit growth, it will be reflected in the production,” said Pronab Sen, country director at the New Delhi-based International Growth Centre and India’s former chief statistician.

But credit to industries shrank by 0.4 percent in September from a year earlier, the latest central bank data show. In the textile economy, India’s second-biggest employer at 45 million people, growth slowed to 1.7 percent in the financial year ended March 2017, compared with a 2.1 percent jump the previous year.

The reason for the downturn is obvious, according to Mohammad Zubair, who sells yarn in Varanasi from supplies he sources from Surat, in western India. He bemoans having to pay a chartered accountant 1,500 rupees ($23) a month to prepare and file his GST returns.

Mohammad Zubair

Photographer: Dhiraj Singh/Bloomberg

“I have to pay the tax, but I can’t pass the charge onto most of my weaver-buyers who are poor,” Zubair, 39, said. “So, who bears the extra cost? Me.”

Some businesses are finding creative ways to avoid the GST, which requires separate monthly, quarterly and annual filings. Zubair said he is aware of informal agreements between yarn suppliers and transport companies that routinely result in incomplete invoices.

Tax Evaders

Modi’s pledges to crack down on tax evaders after demonetization unnerved some traders, said Suresh Kesari, who runs a fabric store. Some people avoid completing business transactions altogether for fear that revealing higher earnings may attract the ire of taxation officials, he said.

Suresh Kesari’s store.

Photographer: Dhiraj Singh/Bloomberg

“People are simply cutting down on their earnings by taking on fewer orders,” the 40-year-old said.

Yet in Modi’s Varanasi, where the manufacture of 4.5-meter (15-feet) sarees woven with gold and silver brocade dominates the city’s industrial output, the cash ban that started a cycle of job losses is the main villain of the economic slowdown.

“Business never really picked up after November,” said Zainul Abedin, 40, who has been forced to idle eight of his family’s 14 saree-making looms. “My fellow weavers are flocking to other cities in search of work. We don’t have jobs if we don’t have orders.”

Abedin said he believes Modi’s economic reforms will help business in the longer term. For one thing, he’s no longer chasing clients for cash payments, and those registered on the GST network are transferring money electronically to his recently opened bank account.

A weaver uses a handloom to make a silk saree.

Photographer: Dhiraj Singh/Bloomberg

Still, Abedin and other business owners said they aren’t satisfied with the progress Modi pledged to make in bringing tax evaders and criminals to account for hoarding the 1.25 trillion rupees the government said it recovered after the cash ban.

“We welcomed the demonetization initially in spite of having to let workers go because we couldn’t pay them in the first three months or so,” said K. Velmurugan, treasurer of the Small and Tiny Industries Association in the southern state of Tamil Nadu. “But after everything, the government has still not caught any persons. So, what then was the meaning of all that suffering?”

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