Is it all worth it?

The Reserve Bank of India has finally spoken out about the Centre’s move to scrap the high denomination currency. On Wednesday, the RBI Governor Urjit Patel said a majority of the population believed that the move was a right decision to fight the circulation of fake currency, black money, and funding for terrorist activities. Deputy RBI Governor RS Gandhi said that between November 10 and December 5, the Central bank had released currency worth Rs 1,910 crore, which is more than that released in the past three years combined. Despite this figure and reports that 95 <g data-gr-id="82">per cent</g> of all ATMS <g data-gr-id="82">have</g> been re-calibrated, people are still suffering from a massive shortage of cash. Old notes worth Rs 11.55 lakh crore had been exchanged with banks since the Centre’s demonetisation move. “The <g data-gr-id="83">demonetisation</g> decision was not made in haste but after thorough deliberation. High-level secrecy had to be maintained,” the Deputy Governor added. It is essentially the government’s line on the subject. Before delving further into the numbers cited above, the Monetary Policy Committee on Wednesday kept the Reserve Bank of India’s repo rate – the rate at which the central bank lends to commercial banks – unchanged. The key rate, which helps control inflation, was maintained at 6.25 per cent. It is a move that has caught many analysts by surprise, considering the possibility of growth being impacted due to the crippling cash crunch since <g data-gr-id="84">demonetisation</g> was announced on November 8. In its policy statement, the RBI said the decision was made taking into consideration many factors.” Volatility in crude oil prices (as a result of the recent OPEC deal) and the surge in financial market turbulence could put the inflation target for Q4 of 2016-17 at some risk. Given these indicators of underlying inflation, it is appropriate to look through the transitory but unclear effects of the withdrawal of SBNs (specified bank notes) while setting the monetary policy stance,” said the panel’s resolution. In other words, the MPC has adopted a wait and watch brief on the effects of <g data-gr-id="85">demonetisation</g>. The Central bank has also lowered its gross domestic product growth estimate to 7.1 <g data-gr-id="133">per cent</g> in 2016-’17 from its earlier projection of 7.6 <g data-gr-id="134">per cent</g>. Despite the “excess liquidity” in the system arising from the return of demonetised Rs 500 and Rs 1000 notes, the Central bank has also withdrawn the incremental cash reserve ratio of 100 <g data-gr-id="135">per cent</g> it had imposed on banks on November 27. CRR refers to a specified minimum fraction of the total deposits of customers, which commercial banks have to hold as reserves with the Central bank. 

Before the RBI Deputy Governor’s announcement, Revenue Secretary Hasmukh Adhia said on Tuesday that the government expects the entire money in circulation in the form of currency notes of Rs 500 and Rs 1,000 which have been scrapped to come back to the banking system. In impounding the Rs 500 and Rs 1000 notes after November 8, Rs 14 lakh crore—86 <g data-gr-id="138">per cent</g> of the value of Indian currency currently in circulation—became useless tender. One of the principal justifications issued by the government is that tax authorities will now be able to trace the transactions and tax black money hoarders since all that money has entered the formal banking system. Speaking to the media, Adhia said: “Do you think that by just depositing money in the bank account makes black money into white? It doesn’t. It will become white when we charge taxes when the Income Tax department can reach up to them by issuing a notice and questioning them. The expectation is that the entire money which is in circulation has to come to the banking channel so that we can trace the transactions and trace the entire money, who does it belong to and has tax been paid on it.” However, this significantly reduces the prospect of any windfall gains accruing to the government arising from of a portion of the old currency remaining outside the banking system. Government-owned financial entities like the State Bank of India had argued that by the end of this <g data-gr-id="76">demonetisation</g> exercise, an estimated Rs 2.5 lakh crore may not return to the system. 

Experts supporting the government’s decision argued that this potential windfall will lead to massive gains for the state, with RBI’s liabilities reduced. The government may use this money to improve its fiscal situation and provide income tax relief/loan waivers, recapitalise banks and kick-start lending. Other experts claimed that anywhere between Rs 3 lakh crore and Rs 5 lakh crore of black money will be "extinguished" by the <g data-gr-id="67">demonetisation</g> drive as it will not return to the banking system. It is imperative to note that neither the government nor the RBI has stated or asserted on what they intend to do in the event of a windfall. But with reports indicating that there would be no possible windfall, questions are bound to be raised about the cost and impact of the exercise of <g data-gr-id="68">demonetisation</g> spread over 50 days. The government will now have to clearly articulate the gains of this exercise over and above the costs. The people of India have indeed suffered a great deal. One way to increase its benefits is to impose stiff penalties on those found violating the rules and closely tracking all the money that has been deposited back into the system.

Is the system capable of fulfilling these goals comprehensively? 

Even in a country where merely 4 per cent of the population filed income tax returns in 2014-15, the task of scrutinising accounts is massive. Through an algorithm called the Computer Aided Scrutiny Selection, officials at the IT department select accounts for scrutiny at random. “This algorithm has been developed by feeding certain risk factors that could point to tax evasion. There are also a small number of manual selections to fulfil statutory needs when specific kinds of declarations are made. But investigating even such a relatively small number of (bank) accounts is not easy. The scrutiny of accounts is such a complicated process that the department takes two years to complete the cases it has selected in a single financial year,” according to a report in Scroll.in, a popular Indian news website. What could further hinder the government’s efforts is the shortage of human resources. The report goes on to state that the income tax department has a sanctioned strength of 72,000 and a 30 <g data-gr-id="147">per cent</g> vacancy at the moment. In its briefing to tax officials, the government has sought the scrutiny of all accounts with deposits of Rs 2.5 lakh and over between November 9 and December 31. Revenue Secretary Hasmukh Adhia went one step further and said, “if someone has deposited Rs 50,000 in the accounts of 500 people each, he will also be caught”. 

Will the IT department be able to handle the entire workload that comes with it? Some experts contend that the government will not be able to track them all. “Modern-day fiat money isn’t born illegitimate; illegal transactions and tax evasion make it so. Indeed, it is the political executive’s poor design of tax policies and shoddy implementation of laws and compliance that create unaccounted income. Even after the ongoing disruptive exercise, the government will rely on the same army of tax officials for filtering the misreporting, or lack of reporting, of undisclosed income which earlier couldn’t be relied on up to do a credible job,” writes Rajiv Malik, a senior economist with a private firm. Under such circumstances, the entire demonetisation exercise seems pointless, with windfalls accruing only to digital payment platforms. Is the pain and disruption caused by the <g data-gr-id="66">demonetisation</g> exercise worth it?