Demonetisation: A severe jolt to money-hoarders
Indira Gandhi had told her Finance Minister YB Chavan in May 1971 that “the problem of black money can only be tackled through some person who feels very strongly about it.” (Declassified black money files of Prime Minister’s Office, no 37 (465)/71 PMS). That man turned out to be Narendra Modi in 2016, about 45 years after her remarkable understanding of the psyche of political leaders. On November 8, India was rolling on normally until Prime Minister Modi struck at 8pm and launched a surgical strike against black money, which is called parallel economy, because it’s huge. In fact, Indians boasted that the country’s economy survived the global recession in which economies of developed countries collapsed, because of the parallel economy.
This is not something to be proud of. It is used by the unscrupulous for criminal activities, trafficking, prostitution, smuggling, terror activities and even to topple elected governments. Most expense during elections in India involves black money.
Naturally, Modi caused chaos, confusion and panic with the announcement that currency notes of denominations of Rs 500 and Rs 1000 would not be legal tender from the midnight. The opposition party leaders were outraged. They first attacked Modi saying that it was one of the biggest scams, for he informed his big money friends beforehand and then they became messiah of the poor blaming their misery to Modi.
But Modi is like the elephant who keeps moving while dogs bark and try to chase it. In fact, Modi warned of stricter action after December 31. So far, Modi is on firm ground. In fact, if as reported cash will reach all destinations in six days instead of 21 days so far, the long lines at ATMs may shorten or disappear in the next week, then demonetisation will become a lasting legacy of Modi.
He and his government realise that despite the raucous protests and defamatory allegations against Modi, about 80 per cent, according to a survey, realise that the intention of the government is honourable and the ungodly will be deprived of their kala dhan.
Virginia Mineral Resources estimates that the labour pain induced by the government decision to demonetise old currency notes of Rs 500 and Rs 1,000 will pay off in the long run, albeit if it is not too long.
It says India has amongst the highest level of currencies in circulation at 12.1 per cent of GDP. Cash on hand is at around 3.2 per cent of household assets, higher than investment in equities, or roughly around $ 220 billion. Of this cash, 87 per cent is in the form of Rs 500 and Rs 1,000 notes or roughly Rs 16 lakh crore. Demonetisation of large currency notes of Rs 500 and Rs 1,000 will push GDP and facilitate the overall growth of the economy, leading chartered accountants of Indore said in a session on impairment of cash. Manish Dafria, a chartered accountant, said, “I am expecting GDP to grow by 2 percentage point because of this announcement. Now all the hidden money will come to the bank resulting in increased liquidity and enhanced industrial development.”
India had reasons to cheer both on the inflation and external trade fronts, data for October released by the government showed that retail inflation dropped to a 14-month low of 4.20 per cent, while exports rose 9.5 per cent despite a sluggish global economy. Gold imports increased 108.3 per cent to $3.50 billion from $1.68 billion in October 2015 and trade deficit to $10.1 billion. Exports stood at $23.5 billion in October when compared to $21.4 billion in October 2015, aided by an increase in two key categories — gems and jewellery and engineering goods. Imports grew by 8.11 per cent to $33.6 billion from $31.1 billion in the year-ago period, widening the trade deficit for October 2016 to $10.1 billion from $9.69 billion, year over year. Crude oil import bill widened 3.98 per cent to $7.1 billion.
But, leaders of the opposition parties, in agony over huge deep hole in their funds to fight elections, can’t be expected to study the advantages of demonetisation. Modi has indeed caused chaos, confusion and panic with the announcement that currency notes of denominations of Rs 500 and Rs 1000 would not be legal tender from the November 8, midnight.
The short window of just four hours and the utmost secrecy was of course imperative for the success of the measure to ferret out money from hoarders, black market, and professionals like doctors and lawyers. But it also hit, indeed hit hard, bribe-takers, which means bureaucrats, politicians, Bollywood and political parties.
Leaders across the political spectrum are in despair over heavy losses. They obviously keep their funds in high denomination notes, which have been targeted. Witnesses said that one party leader returned the money that had been collected through trusted legislators and asked them to replenish the old with new currency. But it’s not only politicians who are upset and angry. A bureaucrat in UP confided to his chartered accountant that he had Rs 70 crore, which needed to be turned into the new legal notes.
It is obvious that some bureaucrats of the likes of the rupee 70 crore Collector have been dragging their feet and hindering the success of the measure.
The currency swap is entirely the responsibility of the RBI, which has enjoyed autonomy from the Ministry of Finance precisely to ensure that the Central bank directs monetary policy, while the Ministry of Finance frames fiscal policies. As the newly appointed RBI Governor Urijit Patel is in the driver’s seat on monetary policy, it follows that the scheme, which was announced not by its Governor but through Prime Minster Modi on 8 November, was the RBI’s brainchild. Of course, this must have been discussed by Patel with officials such as Secretaries Hasmukh Adhia and Shaktikanta Das as well as Principal Secretary to the Prime Minister, Nripendra Mishra, who has been a champion of the 8 November currency swap scheme from the very beginning of its being discussed.
The RBI reportedly assured it had ample currency stock but it has obviously been unable to have the currency in its possession so to reach wherever it was needed at proper time. This is the main reason for the outcry and misery of the public. Instances of people fainting, some old even dying have made people forget why demonetisation was necessary and gave handle to opposition party leaders to call for rollback and accuse Modi of ulterior motives.
The suffering of the people and harassment of bank officials is genuine and the blame has to be borne by Modi because he is the face of demonetisation. Why Modi was not informed that printing, especially of Rs 100, could not, match the expected demand once Rs 500 and Rs 1000 were demonetised. If enough cash was available the stress on the common man would not have been that much.
Also reports are that the distribution of new notes to over 1.5 lakh post offices, two lakh odd bank branches and ATMs is to one agency and it just could not cope with the pressure.
The availability of ample cash, reaching it in time to banks, post offices and ATMs was the responsibility of RBI. An analyst said, “A Prime Minister of the savvy of Narendra Modi would never have taken the political risk involved in endorsing a currency swap involving 85 per cent of the total cash in circulation, without first being assured by the RBI that currency stocks in its possession were sufficient to prevent the severe disruptions now being seen in commerce and in the citizen’s everyday life.”
The RBI Governor is seemingly in the dock. D Thomas Franco, senior vice-president of All India Bank Officers Association, told Indian Express that the RBI Governor Urjit Patel must take moral responsibility for the crisis and deaths of the people including 11 bank officers.
“From all this, it is clear that the Central bank has the means to ensure liquidity in the economy sufficient to prevent a cash shortage, which indeed is among its core functions. The fact that severe cash shortages are taking place even ten days after the swap was first announced, indicates that the Central bank of the country may not be living up to the written assurance of each RBI Governor that each currency note remains exchangeable in like value instantly on presentation,” said analyst. He has really indicted Patel.
Beat the ban
From deploying “cash coolies” to buying Rolex watches and luring taxi driver in metros, we Indians adopt and find unique ways to dodge the government’s surprise move to withdraw high value bills in a bid to tackle widespread corruption and tax evasion.
At first stunned by Prime Minister Narendra Modi’s announcement on November 8 that all 500 rupee and 1,000 rupee notes – some 85 per cent of all bills in circulation – would cease to be legal tender within four hours, the bigwigs started calling their CAs and legal teams to advise how to save some of their No. 2 money.
The announcement also threw country’s cash-dependent economy into turmoil and triggered a mad rush among people with undeclared, unaccounted cash — so-called “black money”– to exchange old notes or use them to buy gold and luxury items. Tax evasion is a way of life in India and CAs are considered experts in hiding income. Many small businesses and professionals such as doctors and lawyers do ask to be paid in cash to avoid taxes.
Only six people earning over 500 million rupees filed returns in 2012-2013, despite there being an estimated 2,100 ultra-wealthy Indians whose net worth exceed US$50 million. Hiding income is an art in India. But the government is cracking down and banks must report anybody depositing more than 250,000 rupees, while holding undeclared cash can lead to a penalty of double the tax owed.
We the Indians ingeniously planned to save as much as they could in the four hour window — 8pm to 12am. Jewellers did brisk business. A report said that a jeweller checked in a 5-star hotel in Bangalore late evening of November 8. A seth also checked in. The jeweller reportedly sold Rs 45 crore worth gold and jewellery to the seth. Almost all big jewellers did brisk business that evening but the authorities got the wind of such transactions. Many jewellery shops have been raided.
In Barailey, burnt sacks full of Rs 500 and Rs 1000 notes were found by the police. Rs 1000 notes have been seen in river Ganga. Then multiple reports of factory owners and businessmen asking staff – or even hiring casual labourers – to stand in bank queues and exchange cash for them before the December 30 deadline. The initial over-the-counter currency exchange limit was 4,000 rupees but was later
reduced to 2,000 rupees after the government said “unscrupulous elements” were paying the poor to queue to exchange their money.
The government also asked banks to ink people’s fingers – a tactic normally used to fight voter fraud – after they had exchanged bills to prevent them from queueing up again.
Wealthy Indians rushed to make costly purchases with unaccounted cash, several luxury retailers stocking brands like Rolex and Dior sent emails to clients stating their stores would be open until midnight that day, The Economic Times reported.
The daily said a leading global fashion brand store in Delhi remained open all night immediately after the move was announced, selling merchandise worth more than US$150,000 in less than three hours. Some affluent buyers have reportedly been paying almost twice the market value for gold in old notes. Jewellers who had shut up shop for the day on November 8 reopened their stores within hours and were selling gold all night, local media reported.
Customers lined up outside jewellery stores in Delhi and Mumbai with bags of cash with one report saying they paid as much as 52,000 rupees (US$762) per 10 grams of gold, almost double the going rate. Officials say they are keeping an eye on all cash deposits made into new “Jan Dhan” accounts, which were opened by the government as a part of its financial inclusion scheme for the poor and farmers and which were designed for deposits such as welfare payments.
In a sign of how desperate some Indians were to convert cash, a massive spike was seen in the number of railway ticket bookings after authorities said old bills could be used until midnight on November 11 to make reservations. Most of these were advance bookings made using old notes. Bookings can be cancelled at a later date with refunds paid out in new notes with only a small fee deducted.
Many arranged with taxi drivers for they could pay with old notes to pay for petrol or diesel. But how much they could save in these ways. The kind of a Marble wholesale dealer had a number of walls as high as four feet high walls of Rs 500 and Rs 1000 notes. Modi deserves thanks for getting such stacks of notes in general circulation.
The severe and disruptive restrictions imposed on moneys, which can be withdrawn from the accounts of citizens, added to the fact that ATMs across India are empty of cash for much of the day and often week, which goes contrary to the RBI Governor’s solemn assurance. The credibility and functional efficiency of the RBI is on the anvil.
Morarji Desai had undertaken a similar exercise nearly 40 years ago, in 1978. The problem is that in Desai’s time neither TV nor so many regional language dailies available. The long lines before every bank, locked-up empty ATMs with stories of misery and pain caused by the demonetisation fuelled anger this time, are now being repeatedly shown with stories of how the old fainted or died. The opposition parties are fanning the anger and the media most of which has been hostile to Modi, is creating more panic.
Even the Supreme Court warned of riots. It is unfortunate that if the Hon’ble Justices in their collective wisdom apprehended riots they could have discussed it with government and refrained from uttering such a dangerous development, which could give the anti-Modi elements ideas to engineer disorders all over the country. The very next day Congress workers marching in protest against demonetisation created a riot-like situation in Chandigarh and water cannons were used to disperse them.
Politicisation of the measure was much expected but the hysterical reaction of a couple of politicos surprised most observers.
It is no surprise that Narenrda Modi’s ‘surgical strike’ on November 8 was instantly politicised and more than the usual din drowned all justifications. The fact that the traditional ruling party is now a rump and feels itchy on opposition benches and is in a constant state of anger at the devil that stole their divine right to rule, and the likes of Arvind Kejriwal and Mamta Bannerji tasting power, has compounded the problem.
Rahul Gandhi, Kejriwal, in fact all opposition leaders became overly conscious of the pain of the poor and demanded rollback of the demonetisation of Rs 500 and Rs 1000 notes. According to them, the justification that it was all done to ferret out hidden money not only from black markets and hoarders but from professionals like lawyers, doctors and contractors cannot over-ride the misery and pain caused to labourer, artisans and farmers.
Rahul, Arvind Kejriwal, Mayawati and Mamta were most vociferous in demanding immediate rollback. The astute and wily Mulayam Yadav only once asked that one week should be given, but he was not heeded and after that he did not join in the chorus for a rollback. He realised that criticising the demonetisation would give the impression that he is one of the hoarders. Nitish Kumar, however, supported Modi’s move wholeheartedly. Rahul too jumped off from the rollback wagon and demanded, justifiably that the hardship of the people must be redeemed. Mayawati is alleged to have asked her MLAs and MPs to collect funds by exchanging old notes or ask for new currency. The only ones left in the field screaming for rollback are Kejriwal and Mamta. Has anyone sympathy for them? Have they been able to convince that the measure is anti-poor?
Says a noted economist, “Short-term economic disruptions are inevitable as households and the private sector have to learn to adjust to a new regime. Since India is also simultaneously moving to Goods and Services Tax (GST), the uncertainty could be compounded, resulting in some adverse economic impact in the short term. Most structural reform measures bring short-term dislocation with adverse consequences. This one would be no exception. That is why the government biting the bullet on this and sending a strong signal is a move in the right direction. This was a needed measure in many ways.”
The fight against black money assumes significance because it intersects with the country’s massive informal economy, which keeps the industrial base narrow and limits the tax-to-GDP (gross domestic product) ratio. An important reason for the very narrow industrial base and low tax-to-GDP ratio is the country’s all-encompassing informal economy. Apart from public revenue loss, the informal economy has a deeply corrosive effect on the transmission of market dynamics and market efficiency, constrains the productivity of both capital and labour, and hampers the effectiveness of public service delivery.
INDIA’s PARALLEL ECONOMY
Parallel economy, based on the black money or unaccounted money, has been a big menace to the Indian economy. It needs to be curbed. Its elimination will benefit the economy in more than one way. Although we proudly claim when the west was reeling under global recession it was the parallel economy that sustained India and no adverse effect was felt here.
According to estimates, using the dynamic multiple-indicators multiple-causes method and by currency demand method, that the size of India’s black money economy is between 23 and 26 per cent, compared to an Asia-wide average of 28 to 30 per cent, to an Africa-wide average to 41 to 44 per cent, and to a Latin America-wide average of 41 to 44 per cent of respective gross domestic products. According to these estimates, the average size of the shadow economy (as a percent of “official” GDP) in 96 developing countries is 38.7 per cent, with India below average.
An estimate by an economist had put the size of black money at over 50 per cent of GDP (at factor cost) in 1987-88. It is also stated that annual rate of growth of black economy is higher than the annual growth rate of GDP.
According to Global Financial Integrity Study of 2009, $ 1.4 trillion belongs to Indians were parked in safe havens abroad. $ 1.4 trillion is equivalent to Rs. 70 lakh crore, more than India’s national income of around Rs. 50 lakh crore.
A statement from the Swiss Central Bank declared that Indians have $2.5 billion deposits in various Swiss banks. It is suspected that the deposits of Indians in tax havens are mostly being withdrawn and shifted to a third country, making it difficult for the government to gather any further details once the accounts are closed.
Modi through various agreements has been trying to get back the money stashed in tax havens and at home through demonetisation because the circulation of black money has adversely affected the economy in several ways. First is the misdirection of precious national resources. A part of black money is kept in a form that contributes nothing/little to productive activities. Again, much around half to two third is squandered away on ostentatious consumption of goods and services.
Second, it has enormously worsened the income distribution, and has thereby undermined the fabric of the society.
Third, the existence of a big-sized unreported segment of the economy is a big handicap in making a correct analysis and formulation of right policies for it. Nor it is possible to monitor the development in the economy with precision.
Fourth, the black money has eroded the social values of the society. The undeclared income is ‘earned’ by illegitimate ways. This is spent in undesirable and vulgar manner.
Modi has taken a calculated gamble and we’re all hoping that it pays off. No transition is painless. He is pressing the reset button on corruption. We, who had so desperately wanted to kill corruption, now need to support this bold move by the government. He has many other steps planned to plug in all loopholes and get rid of corruption and black money. Let’s not forget, Modi is not a gambler but politician.
Shrinking the informal economy is, therefore, essential to India’s sustainable high-growth ambitions. Because of its pervasive and broad-based nature, action would be needed at multiple levels. They would have to be both financial and non-financial, with the latter revolving around lowering the cost of undertaking economic activities, say economists.
Apart from the obvious benefits of reducing evasion and leakages and better targeting public spending, this system could dramatically increase the efficiency of public service delivery and the utilisation of scarce public resources. It would also be a much needed step towards expanding the formal economic base and increasing the tax-to-GDP ratio. Shankkar Aiyar has written in The New Indian Express, any sustainable attempt at curbing black money has to strike at the “business model of politics”. Reforms aimed at greater transparency in campaign finance would also be the strongest possible statement of intent from the government.
If these financial-side measures could complement the various ease of doing business and small enterprise development initiatives, their cumulative effect could significantly dent the informal economy and could be the lasting legacy of this government.
Mamta is likely to check her temper after Modi, without naming her, said those involved in chit fund scams are expected to oppose demonetisation. That leaves Arvind Kejriwal, who tore into PM Modi over demonetisation terming it as the biggest scam of independent India. “People will deposit Rs. 10 lakh crore and Modiji will then waive off loans amounting to Rs. 8 lakh crore given to his corporate friends,” he claimed. Criticising the Centre’s new relaxation of rules for people who have a wedding in their family by allowing them to withdraw up to Rs. 2.5 lakh, Kejriwal asked why an income tax raid was not done on former Bharatiya Janata Party (BJP) minister G. Janardana Reddy, who spent Rs. 500 crore on his daughter’s marriage recently.
“In fact, BJP and Congress ministers attended the wedding. I want to ask, ‘did Arun Jaitley spent just Rs. 2.5 lakh on his daughter’s wedding recently? But they want us — the common people — to spend Rs. 2.5 lakh on a wedding,” he said.
Kejriwal and Mamta must not have seen the comments on their meetings in Delhi. One said these third class chief ministers instead of roaming on the Delhi streets, should concentrate on the welfare of people in their respective states.
Likewise those agitating against demonetisation have neither read what economists say nor bothered to dwell on reports in the foreign media that this operation will bring in about $49 billion to the government. That is a huge amount which can be used for infrastructure and rural welfare schemes.
We know that cost of living in India is low although its more costly than a decade ago but average incomes have also risen. Some retired senior bureaucrats are getting more pension than their salary. It will become even cheaper with decreased real estate prices, deflation, lower taxes and interest rates. Then reduction of cash-transactions and adoption of e-transactions will bring transparency, reducing corruption and crimes.
The PM has already announced that he would be pursuing benami properties next.
“In this ‘shock’ therapy, there is a reasonable chance of changing people’s behaviour from cash reliance to banking channels. MINT wrote a good editorial on this: It is widely accepted that Modi has strangled corruption at the highest levels of government. The currency swap should hurt those who have been involved in retail corruption. Other policy initiatives such as the move to GST should also bring more producers into the indirect tax net. Modi has perhaps understood the aspirations of his new voter base better than most people realise.
This is why Modi has taken personal and political risk. The referendum of his action will be the UP election.
by Vijay dutt