Demonetisation How far will it work?
It seems the primary reason for the withdrawal of Rs 500 and Rs 2000 notes is that the government has bowed to the pressures of public demand, as this has been a long-standing request by the masses, right from the time of the anti-corruption movement launched by Anna Hazare. The public feels demonetisation is the most effective way to combat the menace of black money in the country, according to a PTI report in 2012, which detailed findings of a study commissioned by the Finance Ministry.
The other demands include bringing a voluntary disclosure scheme for black money hoarders and bringing a strong Lokpal Bill. This feedback from the 'aam aadmi' was received by the Central Board of Direct Taxes (CBDT) which had appealed to the public to share its views on tackling the problem of illegal funds and addressing new measures to curb generation of a black economy.
The suggestion of withdrawing the big currency notes, however, was categorically rejected by the top financial and economic brass of the Finance Ministry, which includes chiefs of agencies like the Enforcement Directorate (ED), Directorate Revenue Intelligence (DRI) and the Financial Intelligence Unit (FIU) and respected economists.
"One common demand from the public is that high denomination currency notes, particularly Rs 1,000 and Rs 500, should be demonetised", the CBDT chairman headed panel had said in its report to the Finance Ministry.
"In this connection, it is observed that demonetisation may not be a solution for tackling black money or economy, which is largely held in the form of benami properties, bullion and jewellery", the report said.
"Further, demonetisation will only increase the cost, as more currency notes may have to be printed for disbursing the same amount," it said. A rough estimate of the total cost of printing the Rs 12,000 crore of new currency issued by the RBI could be anything from Rs 15000 to 20000 crore.
Demonetisation "may also have an adverse impact on the banking system, mainly logistic issues, like handling and cash transportation may become difficult and may also cause inconvenience to the general public as the disbursal or payments of wages/salaries to the workers will become difficult. Besides, it may also adversely impact the environment as more natural resources would be depleted for printing more currency notes," the report added.
The public also wanted the government to bring a "voluntary disclosure scheme with or without penalty and then strictly enforce economic laws". The report was submitted to the office of the Finance Minister in March 2012.
The public, according to the report, also wanted that black money should be declared as a national asset and confiscation of illicit wealth. More stringent laws and punishments, including life-term for those indulging in corruption, black money stashed abroad should be brought back, and special courts speedily try cases of corruption and economic offences.
Other suggestions include expanding banking operations and use of modern net-driven and mobile technology in monetary transactions, more transparency in government functioning, particularly in tendering, the award of contracts, payments, and delivery of services, reduction in taxes, such as stamp duty, capital gains tax and simplify procedures.
"The public also wants the government to bring a strong Lokpal Bill to monitor and punish political corruption, dismissal of public servants found to indulge in corruption, debar corrupt politicians from contesting elections," the report said. A Centre for Media Studies report also showed that nearly Rs 30,000 crore was spent during the 2014 general election, while official spending or white money only accounted for Rs 7,000-Rs 8,000 crore of expenditure. Total income of national parties from unknown sources between 2005 and 2013 was Rs 4368.75 crore or 75 percent of their total income.
Ill-gotten wealth mostly enters the formal economic system through real estate and shell companies, according to finance ministry sources. The panel also had stated the massive amounts of black money invested in real estate and the real difficulty in detecting this. This white paper on black money prepared by the Ministry of Finance in 2012 defined black money as not only cash hoards but “assets or resources that have neither been reported to the public authorities at the time of their generation nor disclosed at any point of time during their possession”.
Thus, black money may originate from manipulating account books through multiple means, and through various transactions outside the account books. The former includes manipulation of sales, receipts, expenses, production, value of capital, closing stock and so on. The latter includes transactions without bills, use of parallel account books and unaccounted assets, and investments in shares through dummy entities. Some part of illegal earnings is transferred seamlessly as capital invested in productive activities. Another part of illegal earnings is shifted out of the country, through the hawala route, and is either stored as offshore deposits/assets or ploughed back to India through the “Mauritius route” or countries with similar economic policies.
Hence, no significant unearthing of illegal cash may be expected by demonetisation, even if it might halt or slow down illegal cash-based operations for a while. This assessment was also clearly laid out by the CBDT committee report, titled, “Measures to Tackle Black Money in India and Abroad”.
The demonetisation of Rs 500 and Rs 1000 notes by the NDA government has three claims: to end the circulation of “counterfeit notes” from Pakistan; to eliminate and stop the use of “black money”; and to create a “cashless economy”.
But the previous two attempts at demonetisation only had partial success, noted the CBDT panel. "Demonetisation undertaken twice in the past (1946 and 1978) miserably failed, with less than 15 percent of high currency notes being exchanged, while more than 85 percent of the currency notes never surfaced as the owners suspected penal action by the government agencies," the report said.
Almost four decades ago, it was a politician from Gujarat — who first was the finance minister and later went on to become the Prime Minister and under whose watch the last major demonetisation or the process of rendering high-value currency notes illegal tender was carried out. That was in January 1978 when Morarji Desai was the Prime Minister and the finance minister was HM Patel, a former finance secretary and also from Gujarat.
Narendra Modi is the second Gujarati PM who announced the government’s decision to phase out high denomination currency notes, marking it as the third time that it has been done in India —the first being in 1946. In 1946, Rs.1,000 and Rs.10,000 banknotes were demonetized. But higher denomination banknotes in Rs 1,000, Rs 5,000 and Rs 10,000 were again reintroduced in 1954, and these banknotes were again demonetized in January 1978 by Morarji Desai to check illicit money. That an enormous amount of black money transactions are done in the prosperous state of Gujarat, which has a large business community as well as many big and small jewellers, may have influenced both these Gujarati Prime Ministers in their decision.
In 1978, the law made any contravention including the false declaration by depositors and others punishable — with a fine or a three-year prison term. At the time, gold and commodity prices fell sharply. Many declared large sums of stashed money, such as Rs 87 lakh by a diamond merchant in Mumbai. But the lasting impact was limited.
In 1978, approximately Rs 125 crore came back into the system through this drive. But today, 86 percent of the total currency in circulation is in the form of Rs 500 and Rs 100 notes, with a total value of Rs 14 lakh crore. If even 10 percent of this money is declared as black money, it could mean a windfall of Rs 1.4 lakh crore. But the amount expected to be reported is much less.
Income tax data may explain why demonetisation has been widely unsuccessful going by past examples. Cash recovery has been less than 6 percent of the undisclosed income seized from tax evaders, according to data from tax raids from the financial year 2012-13 onwards.
In income-tax probes from April 1 to October 31 this financial year, black-money holders accepted having stashed Rs 7,700 crore worth of ill-gotten assets. But the cash component was merely Rs 408 crore or 5 percent. The remaining was invested in business, stocks, real estate and benami bank accounts.
The financial year 2015-16 saw the highest black-money detection in the period, of which only 6 percent was cash. The exact proportion of cash should be even lower as the tax department’s classification of seizures considers currency and ornaments as one unit. In this combined unit, the monetary value of the jewellery recovered may often be ten to hundred times more than the value of the cash seized.
One of the reasons why tax evaders and corrupt public officials prefer not to stash cash could be the sheer logistics of it. If stashed evenly, Rs 1 crore in Rs 1,000 notes occupies one sq ft and weighs 13 kg. Rs 100 crore would weigh 1.3 tonnes and fill an area the size of a three-wheeler goods carrier, making the movement of cash without detection difficult.
The committee, which also had director general (DG), currencies, as its member, was constituted given civil society unrest in 2011 and against the backdrop of a series of CAG reports on "loss to the exchequer" on account of government policies benefitting corporate houses.
The DG, currencies, pointed to the enormous economic cost of demonetising higher denomination notes and observed that "it was not a feasible idea". The RBI had also given its opinion that demonetizing large notes in favour of smaller denominations would be difficult, and the government was therefore compelled to ignore the public demand for smaller notes and print the higher denomination Rs 2000 note instead.
While counterfeit currency is definitely in circulation, there is no accurate estimate of its quantum. But claims of counterfeit money amounting to tens of thousands of crores of rupees are wrong. In 2015-16, the share of Fake Indian Currency Notes (FICN), “detected” by banks and police, among the total notes in circulation was 0.002 percent for Rs 1000 notes, and 0.009 percent for Rs 500 notes.
The results of a study, conducted by the Indian Statistical Institute (ISI) Kolkata, reported in the press and quoted by Arjun Ram Meghwal (the Minister of State for Finance) in the Parliament in August 2016, estimated that only about Rs 400 crore worth FICN was in circulation at any given point. Moreover, only a part of FICN arrived from other countries as part of terror networks. Rest was indigenous. So demonetisation may not significantly hit terror financing. Media reports have also quoted the ISI study as concluding: “the existing systems of seizure and detection are enough to flush out the quantum of FICN being infused.”
The prevalence of large amounts of cash in high denomination bank notes is a structural and persistent feature of the Indian economy. Opening bank accounts for every household (as under the Jan Dhan Yojana) altered nothing regarding this preference for cash.
Even after the opening of crores of bank accounts, a large share of bank accounts is dormant; even after appointing lakhs of banking correspondents in villages, about half of them are “untraceable” (as has been officially admitted), and many others are financially “unviable.”
Only 2 percent of India’s consumer transactions are cashless. Only 28-32 percent of Indians have access to financial institutions, including post offices and banks. Most of rural India saves its money in jewellery, followed by cash.
Till date, no proper figures have been ever released on how much black money was recovered by the governments of the time after the previous two demonetisation drives. Our neighbour Pakistan has also decided to phase out all currency notes with old designs.
From December 1, all currency notes across denominations will cease to be legal tender in Pakistan. Islamabad has been trying to bring in new designs and security features to its currency. However, its citizens have had nearly a year and a half to exchange old notes. The country had earlier demonetised 5 and 500 denomination notes. It could also be an excellent case study on the advantages and disadvantages of demonetisation.
BJP MP Subramanian Swamy today criticised the finance ministry alleging "lack of preparedness" in dealing with the demonetisation of two high-value currencies and said the ministry not being in the loop of decision-making is "no excuse".
We do hope the Finance Minister will also not punish responsible citizens who pay all their taxes and keep their savings mostly in fixed deposits. If a significant amount of money coming into the banking system causes the interest on our fixed deposits to drop dramatically, we too may be forced to withdraw our deposits and invest in property and gold.
It will lead to a bigger headache for the authorities in investigating and computing how and where most of India’s wealth is stored in the future. Many might be tempted to invest abroad, as the government had already increased the permitted remittance abroad in 2015, of up to USD 250,000 per year, and already, Rs 30,000 crores have fled to safer havens abroad in the last 11 months through this ‘Liberalised Remittance Scheme’.
Some might also rush to invest in the stock market, which is highly volatile at present, and also rife with many shady practices such as investment of black money through participatory notes, and where a sudden fall in the Sensex might wipe out much of our hard-earned savings.
(Views expressed are strictly personal.)