by Vivek Kaul
An editorial in The Economic Times stated: “This is three times as much as the revenue garnered from the amnesty scheme of 1997.”981
Human beings have a habit of looking at absolute values and ignoring the denominator. Economists refer to this tendency as the denominator neglect.
The denominator neglect has been on full show in the case of the IDS. The denominator which the media did not take into account was the size of the Indian economy, which has grown significantly larger in the past two decades.
The nominal GDP at current prices, a measure of the size of the economy, in 1996-1997 (the financial year before the VDIS 1997 scheme) was Rs. 13.02 lakh crore. The total tax collected by the government under VDIS 1997 amounted to around Rs. 10,000 crore. This works out to 0.77 per cent of the GDP.
The nominal GDP at current prices in 2015-2016 (the financial year before the Income Declaration Scheme of 2016) was Rs. 135.76 lakh crore. This is 10.4 times the GDP in 1996-1997. Hence, the size of the economy is 10.4 times larger, though the tax collected has grown only three times.
The tax which the government expects to collect from the Income Declaration Scheme of 2016 is Rs. 29,363 crore. This amounts to 0.22 per cent of the 2015-2016 GDP.
This is significantly lower than the tax collected under the VDIS of 1997. The media obviously did not take the size of the Indian economy into account before going to town toasting the success of the scheme.
One reason for lower collections under the 2016 scheme lies in the fact that the rate of tax to be paid is 45 per cent. Under the VDIS of 1997, it was 35 per cent for corporates and 30 per cent for individuals. Of course, more people are likely to declare black money at a lower rate of tax. But, even after taking this into account, the difference between 0.77 per cent of the GDP and 0.22 per cent of the GDP is fairly significant.
In fact, if the idea were to ignore the size of the Indian economy, then the media could have come up with an even better result. Instead of taking the VDIS of 1997 and saying that the tax collected under the Income Declaration Scheme of 2016 would be three times, it could have taken the Voluntary Disclosure Scheme of 1975.
The total black money disclosed under this scheme was Rs. 738 crore and the total tax collected had stood at Rs. 241 crore.982 The total tax expected to be collected under the Income Declaration Scheme of 2016 is Rs. 29,363 crore, which is 122 times Rs. 241 crore.
The point being that even though the government has managed to collect some reasonable amount of tax under the Income Declaration Scheme of 2016, it is nowhere as significant as it has been made out to be.
Furthermore, the total number of declarants of black money in 2016 was 64,275. In fact, the total number of declarants of black money in 1997 was 4.7 lakh.983
Also, an extremely minuscule proportion of black money in the country has been declared under the IDS. This becomes clear from the number of declarants being less than 65,000 and the average declaration being around Rs. 1 crore. One estimate made by the economist Arun Kumar suggests that “barely 0.2-0.3 per cent of the black wealth has been declared in the 2016 scheme”.984
In fact, the collections of the scheme picked up only in September 2016. It was reported that by mid-August 2016, declarations worth just Rs. 4,000 crore had been made.985 After this, a spate of income tax raids was carried out to instil fear into those who had black money and to get them to declare it. And that seems to have worked. This leads to the question as to why this can’t be done in the normal scheme of things.
In fact, an early October newsreport in the Business Standard pointed out that only 15 per cent of the black money declarants came out on their own. The Income Tax Department had conducted 200 surveys across the country and sent letters to around 7 lakh possible evaders, asking them to declare their black money under the IDS.986 This method of identifying tax defaulters needs to be continued with in the days to come.
Several reasons have been offered for why the tax collections under the scheme were not as high as they had been in the past. One is that the tax rate of 45 per cent is way too high in an era when taking money out of the country isn’t exactly difficult. The second is that, despite repeated assurances from the government, people who have black money were sceptical as to whether their confidentiality would be maintained.
In fact, in September 2016, the government gave the assurance that payments made under the Income Declaration Scheme would not get reflected in Form 26 AS, the regulatory filing form which contains all the details of the tax paid by the taxpayer during the course of the year.
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In a late-evening announcement on November 8, 2016, Prime Minister Narendra Modi said that Rs. 500 and Rs. 1,000 notes were being demonetised. Come midnight, and they would be useless pieces of paper.
The demonetised notes could be deposited in “bank or post office accounts from 10th November till [the] close of banking hours on 30th December 2016 without any limit”.987 The notes being deposited would be credited into the depositor’s account.
Initially, up to Rs. 4,000 of demonetised notes could be exchanged for notes of smaller denominations, which continued to be legal tender, as well as new notes of Rs. 500 and Rs. 2,000. This limit was briefly increased to Rs. 4,500 and then brought down to Rs. 2,000. Finally, no exchange was allowed. Demonetised notes could only be deposited into bank accounts or post office accounts.
As of November 11, 2016, the total currency in circulation amounted to Rs. 17.87 lakh crore.988 Three days earlier, on November 8, 2016, 1,716.5 crore Rs. 500 notes and 685.8 crore Rs. 1,000 notes had been in circulation.989 Ideally, the currency in circulation data for November 8, 2016 should have been used, but given that this is not available, we will work with the currency in circulation data as of November 11, 2016.
The value of the high-denomination notes of Rs. 500 and Rs. 1,000 amounted to Rs. 15.44 lakh crore. The Rs. 500 notes amounted to Rs. 8.58 lakh crore, whereas the Rs. 1,000 notes amounted to Rs. 6.86 lakh crore. Hence, notes forming 86.4 per cent of the total currency by value had been demonetised.
Basically, a major chunk of the currency in the financial system was rendered useless overnight. Why would any sensible government do something like that? As per the Modi government, the idea behind this move was two-fold. As the press release explaining the decision pointed out: “With a view to curbing [the] financing of terrorism through the proceeds of Fake Indian Currency Notes (FICN) and [the] use of such funds for subversive activities such as espionage, smuggling of arms, drugs and other contraband into India, and for eliminating Black Money, which casts a long shadow of parallel economy on our real economy, it has been decided to cancel the legal tender character of the High Denomination bank notes of Rs. 500 and Rs. 1,000 denominations issued by [the] RBI till now.”
With the old Rs. 500 and Rs. 1,000 notes being demonetised, all the fake high-denomination currency was suddenly rendered useless. Also, the hope was that, with the demonetisation of high-denomination notes, those holding black money in the form of cash would end up with useless pieces of paper. This would lead to the total amount of black money in the system coming down. The idea was to attack the stock of black money that people had in the form of cash.
This was a classic Big Government move: the government trying to come up with ambitious solutions without considering its own implementation capabilities. Before I explain this, I would like to take a slight detour and narrate a story from the Second World War.
I first came across this story while writing what would become the first chapter of the first volume of the Easy Money trilogy, which I had written previously. This is a story about cigarettes and how they were used as money in the prisoner-of-war camps during the Second World War. (These camps had cropped up all over Europe during the War.)
The prisoners used to receive standard food parcels from the Red Cross during the war. These parcels included biscuits, butter, cigarettes, canned beef, chocolate, jam, milk, sugar, etc.990
As soon as the rations arrived, prisoners
used to start exchanging them. One of the earliest transactions used to be that of non-smokers exchanging their cigarettes for chocolates that the smokers had got. Sikhs who had been fighting for the British Army used to exchange their allocation of beef for other goods, like butter, jam and margarine.
But, gradually, cigarettes went way beyond the status of a normal commodity and became the standardised medium of exchange. A prisoner of war even recalled exchanges like “cheese for seven cigarettes” happening in the camps. He also recalled an individual who sold coffee, tea and hot chocolate at the rate of two cigarettes a cup. This individual eventually scaled up his business, but ultimately failed, incurring a loss of a few hundred cigarettes.991
So, what made cigarettes a viable form of money during and after the Second World War? A cigarette has some of the qualities of ‘good’ money. It is reasonably durable. It can easily be carried (in pockets, I presume). It is easily divisible, from crates to packets, to a single cigarette. And inside a prisoner-of-war camp, it was difficult to counterfeit.
There were always some people who ‘shook out’ a bit of tobacco from cigarettes they had got until they had enough tobacco to roll up a new one, though it would be immediately obvious to the other party that the cigarette was a hand-rolled one and not the real thing that everybody was accepting as money.
But these were minor disadvantages in comparison to what happened when the weekly Red Cross parcels did not arrive. At other times, the stress of heavy air raids near the camps made people smoke away their money, i.e., cigarettes.992
In such situations, there was not enough ‘money’ going around in the prison market, which led to a situation wherein prices fell. Since people did not have cigarettes to buy goods, those who were hoarding food, toiletries, and so on had to cut prices in the hope that they could make a sale.
At other times, many prisoners received parcels from home full of cigarettes. This meant that the number of cigarettes in the camp would shoot up. Suddenly, the money supply was up, and with more money chasing the same number of goods, prices would go up.993
Dear reader, you must be wondering why I am bringing up this story seven decades later. What is the link with the demonetisation issue?
The point of this story is that the total amount of paper money or currency going around in any economy, which is a part of what economists call money supply, has an impact on the way the economy behaves. Typically, we tend to hear stories of how governments and central banks stuff the financial system with paper money by printing it, and that leads to high inflation.
A good recent example is that of Zimbabwe. Between August 2007 and June 2008, the money supply in Zimbabwe went up 20 million times, sending inflation through the roof. In early 2008, the consumer price inflation was said to be at 2 million percent. By the end of the year, it had shot up to around 230 million percent.994
What happened in Zimbabwe was that the supply of paper money went up at a dramatic pace, but the supply of goods and services that money could buy continued to remain the same. As excess money chased the same amount of goods and services, it led to a rise in prices, or inflation. Paper money rapidly lost its value. Hence, an excess of paper money in the financial system is bad for the economy.
This is something that is well known and has been spoken about quite a lot over the years. What has not been spoken about enough is the opposite scenario, wherein the money supply suddenly gets sucked out of the financial system and there isn’t enough money going around as there had been in the past.
The example of cigarettes as money during the Second World War is a good example of what happens when there isn’t enough money going around. When prisoners smoked away their cigarettes because of the excess cold or when the Red Cross rations did not arrive, there was suddenly a shortage of cigarettes (or money) going around.
And when there was a shortage of cigarettes going around, the transactions happening within the camp collapsed. The buying and selling of things came to a standstill. With no cigarettes going around, how could prospective buyers buy things inside a camp? This meant that the sellers had to cut prices in order to get those who still had cigarettes to buy goods.
The simple point here is that, for a market to operate, there needs to be enough money going around. In modern economies which tend to use a high proportion of cash to carry out transactions, like India does, this means that there needs to be enough paper money, or currency notes, going around.
Paper money is primarily a token deemed to have a certain value by the government (or the central bank) which everyone accepts and is used to carry out transactions in the everyday economy. Without enough paper money in the economy, people can’t carry out transactions, and the economy comes to a standstill. This is precisely what has happened in the aftermath of the Modi government’s decision to demonetise Rs. 500 and Rs. 1,000 notes. Suddenly, there was too little currency going around.
The Modi government’s move to render more than 86 per cent of the currency useless basically brought transactions across almost all markets to a grinding halt. Mobile phone sales have collapsed. People aren’t buying two-wheelers as they did before demonetisation. The farming economy has slowed down tremendously. Daily-wage workers, like plumbers and electricians, are not getting enough work.
As I write this, a few days into 2017, just under two months after the demonetisation announcement was made, things don’t look good. It is safe to say that the Indian economy will be in shaky territory well into 2017.
As we saw earlier in this section, Rs. 15.44 lakh crore worth of currency was demonetised. By December 19, 2016, the latest data available at the time of writing this (in early January 2017), only a part of this demonetised currency had been replaced. Data from the RBI suggests that close to Rs. 5.93 lakh crore had been issued to the public. This basically means that around 38.4 per cent of the demonetised currency had been replaced close to six weeks after demonetisation. People had withdrawn this money from their bank accounts as well as ATMs.
Given that, a little under two-fifths of the demonetised currency which had been in circulation was replaced by December 19, 2016. This best explains why transactions across markets in the country have collapsed. Also, initially, only Rs. 2,000 notes were released. This meant that the next highest denomination note was Rs. 100. Hence, this created the problem of obtaining change during transactions in the economy, pretty much rendering the Rs. 2,000 note useless.
Furthermore, between November 10, when banks started accepting demonetised notes, and December 10, 2016, Rs. 12.44 lakh crore of demonetised currency had been deposited into banks.
This meant that, in a period of one month, close to 81 per cent of the demonetised currency (Rs. 12.44 lakh crore divided by Rs. 15.44 lakh crore) had already made it back to the banks. Between then and January 3, 2017, the RBI did not update the data on the total amount of demonetised currency that made it back to the banks. But given the past pace, it is safe to say that more or less the entire demonetised currency must have come back to the banks.
The original idea of demonetising Rs. 500 and Rs. 1,000 notes was to destroy black money. The hope was that those who had held on to black money in the form of cash would not deposit it with banks, given that it would generate an audit trail, and the total amount of black money held in the form of cash that did not make it back to the banks would basically be the black money that would be destroyed. But that doesn’t seem to have happened.
The lesser the black money destroyed in the form of cash, the more relevant the question as to whether the demonetisation was really required. In fact, it will raise more questions. Were the people who had black money in the form of cash able to exchange it for new notes? There are stories going around on how merchants and businessmen have forced employees to deposit black money into their bank accounts. In one particular story that I came across, I was told that a merchant had given Rs. 50,000 to each of his employees and asked them go and deposit it into their accounts. He would then deduct that
money from their salaries in the months to come. This way, his black money would become white.
There are other stories of agents helping to convert demonetised notes into dollars for a cut. There are other agents helping people convert black money into white by getting it deposited into Jan Dhan Yojana accounts. There are even stories of bank managers themselves helping convert black money into white by providing new notes. Many of them have been caught in the process as well.
How close we eventually got to Rs. 15.44 lakh crore will become clear only once the RBI and the government choose to release the data. But by looking at the data that is available, it is safe to say that as far as destroying black money is concerned, the demonetisation move has failed.
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It is important to point out here that currency is not the only form of money. Over and above currency, deposits held in savings bank accounts are also money. One can use debit cards to spend this money. Over and above this, the fixed deposits held in banks are also money. While they are not immediately available to depositors when it comes to spending, they can be broken and the money thus got can be spent.
Furthermore, people can also spend money using credit cards, e-wallets, and so on. The point being that paper money is not the only form of money that can be accessed and spent. But, in a country like India, where a bulk of all transactions take place in cash, paper money is very important to keep transactions going and markets operating.
Assurances have been made about banks having enough new notes, both by politicians as well as the RBI. But that is really not true. The reason for this is straightforward. There aren’t enough new Rs. 500 notes going around simply because they haven’t been printed. Some basic maths tells us that it will take at least another five to six months to print enough new Rs. 500 notes and get them out there.