by Meera Sanyal
The Prime Minister spelt out his vision of a cashless India, in his Mann Ki Baat radio show on 27 November 2017: ‘Scrapping these notes has opened other avenues to make payments. Download apps of banks and e-payment options. Shopkeepers can keep card swiping facilities and everyone can ensure they pay safely using their credit and debit cards. If not a 100 per cent cashless society, I request you to make India a “less-cash” society.’
Finance Minister Jaitley’s two main goals: ‘Widen and deepen’ the tax base and create a ‘larger and cleaner’ GDP
Though initially silent on demonetization, the Finance Minister Arun Jaitley added his own objectives a few months later.
To expand the tax base Responding to a Parliamentary panel on 11 January 2017, he said, ‘Targeted verification of suspect substantial deposits is likely to widen and deepen the tax base.’
To integrate the informal economy into the formal sector and create a ‘larger and cleaner’ GDP In his Budget speech on 1 February 2017, the Finance Minister said, ‘We are moving from informal to formal economy and the government is now seen as a trusted custodian of public money.’ On 13 February 2017, he added, ‘Demonetization was a bold and decisive strike in a series of measures to arrive at a bigger, cleaner and real GDP… There is greater integration of informal economy taking place with formal economy that leads to larger and cleaner GDP, that was our objective behind the decision on demonetization.’
Other goals stated by senior officials
To lower interest rates by forcing ‘idle’ savings into the banking system On 7 December 2016, the Secretary, Economic Affairs, Shaktikanta Das, said, ‘Demonetization had been carried out to force Indians to put domestic savings lying idle at home into the banking system, so that banks can use that money to give loans at lower interest rates.’
To bring down real estate prices The first time lower real estate prices was stated as being one of the goals of demonetization was reported on 31 January 2017. The Chief Economic Advisor (CEA), Arvind Subramanian, said, ‘Real estate you do see a blip in prices, sales and launches and of course some of it may be adverse to the economy but in the long, some of that could be good, because aim of the demonetization is to bring down real estate prices.’
So how are these eight demonetization goals to be judged? The Demonetization Report Card below presents objective data on each.
Flushing Out Black Money
Of the many problems associated with black money in India, a major one is estimating how much there is!
In a written reply tabled in the Parliament in December 2016, the Finance Minister admitted, ‘There is no official estimation of the amount of black money either before or after the government’s decision of 8 November 2016…’ Naturally this should make it difficult to judge how successful, or otherwise, demonetization was or could have been.
Fortunately, there are other estimates. But before we come to these, it is perhaps helpful to better define what we mean by black money, and draw a distinction between black money, the black economy, black income and black wealth.
Simply put, black income is income on which tax is supposed to be paid, but on which it is not. This income is generated through activities in the black economy. Black income so accumulated leads to a store of black wealth.4 The portion of black wealth held in cash is black money.
It is important to note that all black income and black wealth is not cash.
It is equally important to note that all cash is not black money.
Millions of legitimate transactions take place in cash, not just in India but everywhere in the world. The cash economy is an integral and vital part of the white economy.
Note that the sources of black income, and activities in the black economy can be either:
Legal: For example, a chemist, who sells medicines without issuing a bill, and, as a consequence, pays neither GST nor Income Tax, is generating income from a legal activity, but if this is not declared for tax purposes, it is black income; or
Illegal: For example, income generated from selling narcotics, prostitution, human trafficking, etc., are immoral and illegal activities. As tax is not paid on such income, this is also black income.
Note also, that some activities considered illegal in certain jurisdictions, such as gambling, are both legal and taxable in others, and can, therefore, be a source of legitimate white income (taxed or taxable, and accounted for) and white money.
Anyone trying to tackle the menace of the black economy must understand human behaviour. A person who works to generate income, be this black or white, will protect it as far as possible, and also try and use it to generate more money. Thus, black money is rarely stashed as cash under a mattress. The holder will either try to launder it (convert it from black to white), or convert it into undeclared assets held domestically or abroad (black wealth), or reinvest it in the business which generated the income (black working capital). Of course, some people simply spend their black money on conspicuous consumption such as ‘black’ weddings!
Note that in all of these cases, the holder, launderer, or spender of the black money has to interact with the white economy at some stage or the other. The notion of a black economy as a parallel economy, which runs in perpetuity, parallel to and never intersecting with the formal white economy, is a completely erroneous one. The black and white economies are closely intertwined, and money changes colour all the time.
For example, if a salaried employee withdraws money from his bank account for expenses, this is white money. When he spends it at a grocery shop which does not issue him a bill, this becomes black money for the grocer. If the grocer then spends this money at a movie theatre, this becomes white money again in the hands of the theatre owner, and so on.
More importantly, money invariably leaves a trail, which, if diligently followed by tax authorities (or others!), can help trace the source of black income and holders of black wealth.
Neither black money nor anonymously held black wealth is restricted to India. Given the magnitude of tax avoidance and money laundering and the misuse of this money for international crime and terrorist financing, governments across the world are uniting to combat the menace of black money. The FATF (Financial Action Task Force) was created in 1989 by the G7 countries. Today, 36 countries, including India, are signatories. The US government has used this framework very effectively to trace, tax, penalize and recover money from American citizens holding black money abroad.
Considerable amount of information has been released in the public domain – most recently the Panama and Paradise Papers, with names and details of Indians with assets abroad. To date, there is no information of any conclusive action taken by the Indian tax authorities to assess whether these assets are black or white, or to bring the holders to book. Given that an effective international framework exists to trace and recover black money illegally held abroad, there is some scepticism about the NDA Government’s commitment to tracing and curbing black money. Prime Minister Modi’s 2014 election promise of bringing back Indian black money from abroad and crediting every Indian’s account with `15 lakh remains a distant dream.
Instead of undertaking diligent and targeted forensic audits to trace black money followed up by swift prosecution, which would have deterred offenders, the government’s demonetization exercise targeted India’s entire cash economy. The patchwork of jumbled and confused notifications by the authorities between 8 November and 31 December 2016 showed a lack of basic understanding of the importance of cash in the Indian economy. The standing assumption seemed to be that all cash was black and that all holders of cash were essentially hoarders of black money.
More fundamentally, it showed that our political rulers were either in collusion with, or stumped by the innovativeness of the shrewd participants in the thriving black economy, who simply gamed the system, leaving the administration with a huge hole in the exchequer, and egg on its face.
So how much black money do we actually have in India?
; Following up on the Finance Minister’s statement to the Parliament that there were no official estimates of black money, the Economic Survey tabled by the CEA on 30 January 2018 adopted an unusual method of estimating India’s black money: by assessing how dirty or clean rupee notes were!
Comparing the cash-to-GDP ratio of various countries versus their per capita income, the survey noted that India had a very high amount of cash in circulation compared to other countries in the same income bracket, even allowing for the estimated level of corruption in the system. This leads to one of two possible conclusions: either India is more corrupt than estimated, or cash is being used for legitimate purposes.
The Survey then proposed the hypothesis that notes actually being used for transactions would be more ‘soiled’ whereas notes that were black money would be just ‘stored’ and hence less soiled. To estimate how many high-value notes are actually used in transactions, it compared the rate to ‘soiled American dollar notes’ and concluded: ‘Using relative soil rates for the US $50 and $20 notes and applying them to comparable Indian high denomination notes, yields an estimate of the amount not used for transactions, and hence potentially black, of about `3 lakh crore. This is substantial, as it represents about two per cent of GDP.’
Though the Survey itself admits this is an imperfect estimation, it comes closest to an official estimation of India’s black money.
Estimates by various economists of India’s black economy have ranged between 25 per cent to 62 per cent of our GDP. Prof. Arun Kumar, eminent author and expert on India’s black economy, provided the following estimate:5
India’s GDP in 2016–17 `150 lakh crore
India’s Black Economy/Income 2016–17 62 per cent of GDP
India’s Black Income in 2016–17 `93 lakh crore/ year
India’s Black Wealth in 2016–17 3 x Black Income = approx. `300 lakh crore
India’s Black Money in 2016–17 One per cent of Black Wealth = approx. `3 lakh crore
Given that the two estimates, one in the Economic Survey and the other by Prof. Arun Kumar, are identical, even though they have been arrived at in completely different ways, one could take the sum of `3 lakh crore as a reasonable estimate of India’s black money in 2016.
Next, we can estimate how much black money was ‘flushed out’ of the system by comparing the amount of money that was demonetized on 8 November 2016, with the amount of money deposited back with the RBI (via the banking system).
The difference between the two numbers would be equal to the money that was not returned either because:
The holder could not do so in time: This would constitute white money that in effect the State had expropriated from legitimate holders of cash (e.g., NRIs who were stranded with money and could not deposit it with the RBI in time; senior citizens who had forgotten where they had stored emergency cash, etc.).
The holder did not wish to do so to avoid detection: This would constitute the black money that the Prime Minister had intended to flush out of the system. It was this money that he had referred to in his Goa speech of 13 November, when he said: ‘Those who didn’t throw a penny in the waters of Ganga are submerging their bundles into it…’
The data6 is as follows:
Amount of money (`500 and `1,000) in circulation as on 8 November 2016: `15.41 lakh crore. (`15,417.93 billion)
Amount of money (`500 and `1,000) deposited as on 30 June 2018: `15.31 lakh crore. (`15,310.73 billion)
Amount of money not deposited, or ‘flushed out’ (a-b): `10,720 crore (`107.20 billion), equivalent to only 0.65 per cent of the notes demonetized.
Clearly, demonetization did not lead people to submerge their black money in the holy Ganga waters, as almost every rupee – more than 99.35 per cent of the currency demonetized – came back into the banking system. The expectation that Indians with black money would rather throw away the money rather than deposit it in the banks was clearly misplaced.
Furthermore, the ‘black money flushed out’ through demonetization was only 3.5 per cent of the `3 lakh crore of India’s estimated black money.
Defenders of demonetization claim that black money holders used various dodgy means to convert their black money into white. This is probably true, which is why critics of the move have mockingly called it the largest and most successful ‘money-laundering’ exercise in the history of India.7
Whatever one’s views, the undeniable fact is that judged by the data points above, the 2016 demonetization exercise was a complete failure in flushing out black money and did not achieve the Prime Minister’s goal of eliminating it.
Given that the RBI spent `7,965 crore in 2016–17 and `4,912 crore in 2017–18 (i.e., a total of `12,877 crores) to print new notes – more than 120 per cent of the `10,720 crore ‘black money’ not returned to the system – this has proved to be both a bad and expensive decision, without even taking into consideration the heavy cost it has imposed on the economy and the Indian people.
The really interesting question is, could India’s 2016 demonetization have solved the problem of black money, even if it had been better planned and executed, and the entire `3 lakh crore had been flushed out? Prof. Arun Kumar gave a succinct answer:
You are only demobilizing three lakh crore rupees, at the most, for one year, but black income generation will continue as before. Say, by selling spurious drugs, narcotic drugs, charging capitation fee, under-invoicing and over-invoicing in business and trade and so on. Therefore, cash will again be generated here… In fact, 97 per cent are already the sufferers due to the black economy and now another burden is placed on them, without solving the problem of the black.
Rooting out Corruption
There is no doubt that the Prime Minister touched a deep chord in the heart of India when he talked of the menace of corruption. Who among us has not felt ‘Some people have misused their office for personal gain… that corruption and black money tend to be accepted as part of life… that it has afflicted our politics, our administration and our society like an infestation of termites…’
According to the 2017 Transparency International8 Corruption Perception Index (CPI) report, 73 per cent of the bribes paid in India were by ‘the low economy groups, who had to pay money due to unavailability of other options, or had less influence to avoid paying bribes... high bribes were demanded for accessing public education and healthcare facilities… approximately 58 per cent and 59 per cent bribery rates were seen in education and healthcare sectors in India, respectively. The times when people paid a bribe was also seen to be almost equally high for police, identification documents, and basic amenities.’
The Prime Minister’s promise that demonetization would eradicate corruption was undoubtedly one of the main reasons for the initial goodwill towards demonetization from the very poor, despite the hardships it inflicted on them. Sadly, however, this promise too was belied.
In February 2018, Transparency International reported that India continued to be among the most corrupt countries in the world. In the 2017 Global Corruption Perception Index report, India, with a score of 40 points, was ranked 81, down two places from its ranking of 79 in 2016.
More worryingly, India was named among the ‘worst offenders’ in terms of graft and press freedom in the Asia Pacific region. In their report, Transparency International said, ‘In some countries across the region (Asia Pacific), journalists, activists, opposition leaders and even staff of law enforcement or watchdog agencies are threatened, and in the worst cases, even murdered... Philippines, India, and the Maldives are among the worst regional offenders in this respect. These countries score high for corruption and have fewer press freedoms and higher numbers of journalist deaths… In the last six years, 15 journalists working on corruption stories in these countries were murdered, as reported by the Committee to Protect Journalists (CPJ).’
Transparency International’s Managing Director, Patricia Moreira, said, ‘No activist or reporter should have to fear for their lives when speaking out
against corruption. Given current crackdowns on both civil society and the media worldwide, we need to do more to protect those who speak up.’ The CPI report stated, ‘Further analysis of the results indicates that countries with the least protection for press and non-governmental organizations (NGOs) also tend to have the worst rates of corruption.’
Worse still, the report named India as the most corrupt country in the Asia-Pacific region, with 69 per cent bribery rates, which means that almost seven out of ten people had to pay a bribe to access public services. Vietnam was the second-most corrupt country with 65 per cent bribery rates, whereas Pakistan with only 40 per cent bribery rates, ranked much better than India. Japan came out as the least corrupt nation, with a 0.2 per cent bribery rate.
This demolishes one of the main arguments presented in favour of demonetization. The Economic Survey for 2016–2017 had stated, ‘Across the globe there is a link between cash and nefarious activities: the higher the amount of cash in circulation, the greater the amount of corruption... In this sense, attempts to reduce the cash in an economy could have important long-term benefits in terms of reducing levels of corruption.’
As it happens, data does not support this argument. Japan is a case in point. Japan’s Currency to GDP ratio in 2015 was 18.61 per cent, much higher than India’s at 12.51 per cent. In the same year (2015), Japan was ranked as the 18th least corrupt nation in the world while India was ranked 76th, i.e., Japan, which has a much higher currency to GDP ratio than India, has far less corruption.
Clearly, therefore, demonetization failed in its second big goal – eradication of corruption. If anything, the new `2,000 notes made it simpler for corrupt officials to take and stash away larger bribes, compounding the problem for ordinary Indians.
So, once again, the question we must ask is, could demonetization have succeeded in rooting out corruption had it been better planned and implemented?