Economic Highlights

New Delhi, 15 November 2016

Demonetization: A Beginning

BUT WILL IT RID BLACK ECONOMY?

By Shivaji Sarkar

The Modi Government took a unique decision to demonetize Rs 500 and Rs 1000 currency notes for easing out black money, rooting out counterfeit currency notes, stopping terror funding and devastate those who have stacked huge currency notes.

Importantly, this is the second demonetization, the first being by Prime Minister Morarji Desai in 1978 whereby he demonetized Rs 10,000 and Rs 1000 currency notes. However, the common man never felt any impact because for Rs 10,000 one could purchase a 150-yard plot. Moreover, the average income even of a Class I Government officer was less than Rs 10000.

This doesn’t hold true today as over the last 38 years the economy’s dynamics have changed. Today, even a labourer or a small trader earns around Rs 10,000 a month and the Rs 500 note has become the basic currency. Even children in average homes gamble with this amount during Diwali season. Women too also keep part of their husband’s income in supposedly high-denomination notes in ‘piggy banks’. Consequently, Modi’s demonetization impacts almost everyone.

This has led to a chaotic situation. Think. The retail market is unable to function, people cannot buy vegetables or other commodities, weekly mohalla markets are non-functional, banks are witnessing long queues and trading has come to a halt.

Undeniably, these are pangs of transition to a new series of Rs 2000 currency notes and the problems faced by the public would gradually subside.

Finance Minister Jaitley avows to reach a solution in a few days. However, according to the Smugglers & Foreign Exchange Manipulators Administrator PK Prusty, the world over such moves has not succeeded. Recall, the EU too demonetized the Euro 500 currency in May 2016 to eliminate black money. Whether it is successful is debatable. Thus, India might see reduced black money for some time but it might not be eliminated.

Prusty also underscores that it is not black money but the country’s “black economy” that one needs to be wary of. Black economy refers to all illegal activities including smuggling, drug peddling, money laundering, ‘round tripping’ – routing illegal funds through foreign institutional or portfolio investors (FII/FPI) back into the country for investing in shares, bonds or other instruments. Even Daish (ISIS) operates international black economy.

Black money on the other hand is an earning through legal means. It is called “black” because tax on the earning has not been paid. Once a tax is paid, even with penalty, it becomes white. The recent voluntary disclosure with 45 per cent penalty earned Rs 30,000 crore revenue and legitimized incomes of over Rs 65,000 crores. In 1997, Rs 33,3339 crores was declared and Rs 9584 crores were realized as taxes.

Undoubtedly, there have been similar disclosures earlier as well. Yet the generation of black money or evasion of taxes did not stop. Estimates state that there is about Rs 12 lakh crores illicit money around.  Notwithstanding, that some today might have burnt their wealth!

In fact not a few economists suggest that if income tax rates are reduced to 15 per cent the number of taxpayers would double.

True, the ramification of black money is not so grave. But a black economy has a ruinous effect as it not only impacts the nation’s social and economic fibre but also promotes illegal activities, many of which tend to be extremely dangerous.

Yes, demonetization might check terror funding and eliminate counterfeit currency notes given that the black economy is presently 60 per cent of India’s GDP. This was 4 per cent in 1955.

Besides, some of the trends suggest that operators know how to replace their demonetized currency. Gold sales unexpectedly sky-rocketed the very night the Prime Minister announced demonetization.

Even hawala operators are hyper active. Surprisingly, some religious and other so-called social organizations have also joined “operation exchange”. Experts’ apprehension that operators are one step ahead of the Government game seems to be proving correct. Their cuts vary from 5 per cent to 20 per cent.

The Government’s move has also struck hard some political Parties. There are reports that many Parties received donations from “unknown” sources in cash which were stacked in cash for the impending polls in five States. Would they be able to replace the notes? And have the time to do so?  None knows.

Pertinently, corporates also have huge cash but are smart enough to know how to have these replaced.

Questionably, is a cash economy a bane? That is how it is being projected. Certainly, there are lobbies which want transactions to be done through banks to be clean and “prevent” generation of black money. But this is not a correct argument. As hawala is reportedly now functioning through the banking system.

Remember, the US and European economy collapsed as banks like Lehman Brothers and AIG (largest US insurance company) were swindled in 2007. This resulted in a global crash and turmoil.

Indeed, India has the advantage of a large cash economy. More. It has sustained through many crisis in the past, including the worst balance of payment in 1990, 2007-8 global crisis and the recent Rs 12 lakh crores scandal of bank NPAs. Hence banks are not safe havens nor in a position to insulate the economy and eliminate black money generation.

In addition, many large depositors have withdrawn from banks as tax deductions at source erode their deposits. So, elimination of TDS on deposits would bring back large depositors to banks and be less of a burden on the Government for their recapitalization.

Clearly, the cash economy is the country’s biggest strength. For instance, over 80 per cent of the wholesale and farm trade is done in cash. It also has the least default, there is no chasing for realization and it ensures smooth trading. Furthermore, all cash transactions are not black. And a failure in payment has limited impact. On the contrary, a failure of bank transactions can have wider economic and social impact.

As it stands, the NPAs are eroding the common man’s deposits. As this tantamounts to virtual swindling of public money. Now even the NDA Government is finding it difficult to recapitalize the banks. As a result depositors are being penalized because banks are forcing them to suffer interest rate cuts on their deposits. Worse, they are not even passing on the repo rate cut benefits to lenders.

In sum, the insistence for operations through banks should be given up for a larger, open and safer economy. Ways to encourage cash economy should be pondered over albeit with regulation. No matter, demonetization is a necessary move. However, the operations must be widened to counter black economy --- now a global menace. ---- INFA

(Copyright, India News and Feature Alliance)