16 Nov 2016 13:31 IST

Flushing out black money is a long haul

Tackling it calls for a range of responses

Is demonetisation the only way to curb black money? Surely, this question is on the minds of most of 1.2 billion Indians who have been dragged into difficulties, thanks to the withdrawal of ₹500 and ₹1,000 notes from circulation from November 9. To arrive at alternatives, it is imperative to look at the sources of black money. Many economists take into consideration factor incomes such as profits, interest and rent which remain out of tax net.

Corruption is also seen as an aspect of the black economy; undisclosed payments such as bribes to facilitate businesses and other sorts of illegal gratification will only add to the parallel economy.

It has also been argued that the black economy gets nurtured by the triumvirate of corrupt politicians, businessmen and the bureaucracy.

Unbridled access to tax havens is also a matter of concern. Various studies on tax havens have shown that they are typically small countries/jurisdictions with low or nil taxation for foreigners. A promise of strong confidentiality and secrecy guarding wealth and accounts has also made them preferred destinations to keep unaccounted wealth.

A white paper on black money brought out by the ministry of finance in 2012 observed that money earned through tax havens was coming back to India through various methods such as hawala, mispricing, foreign direct investment through beneficial tax jurisdictions, raising of capital by Indian companies through Global Depository Receipts and investment in Indian stock markets by participatory notes.

Some others postulate that land transactions and infrastructure projects especially given the flexibility of provisions under change in land use norms are another major source of unreported income.

Academic estimates (not from government agencies) from time to time show a phenomenal increase in the extent of black money from five per cent of the GDP in the beginning of the planning second five year plan in 1955-56 to 50 per cent by the first decade of the current century and almost equivalent to GDP now!

Economic theory offers various approaches to estimate black money. The most prominent ones used globally are input/output method — an estimation based on comparing velocity of money and income circulated annually with income captured on national accounting system (NAS) — the survey approach consisting of conducing sample surveys, and the fiscal approach. However, none of these prove to be accurate given the multiple sources of black money. Hence, what is required is a multi-pronged approach to curb this hydra-headed monster.

The efficacy angle

It is in this context that the efficacy of demonetisation, which has made billions of the poor in the country poorer albeit temporarily, becomes pertinent.

If we turn to history, the last demonetisation measure was in 1978 when the Janata Government had scrapped ₹500, ₹5,000 and ₹10,000 notes. If the move was effective, why was black money seen to be rearing its head from 1980 itself? Much has been written of late on this experiment. Without being repetitive, it would suffice to say that experts including the then RBI governor IG Patel did hint at the non-desirability of the move. In a 2014 lecture, former RBI governor Raghuram Rajan too expressed his displeasure over deploying demonetisation as a tool to hit black money. In the present episode of demonetisation, the Government has gone for a faster, less effective and more painful (for general public and poor) approach.

In contrast, long term measures such as rationalisation of taxes (the Laffer Curve approach), increasing the tax base, real estate (a major contributor to black money) reforms from which the Centre has been generally been shying away leaving a larger field for the States, tightening measures in mining, not-for profit and cooperative sectors, effective tax deterrence and integration of data bases should have been taken up.

But then all this will require a long-term commitment from the policy makers and government and are apolitical in nature.

Fake currency

The dramatic announcement by Prime Minister Narendra Modi last week pulling out over 80 per cent currency in circulation in the economy also has a fake currency angle.

Interestingly, in its November 12, 2016 RBI update on currency does not refer to black money but only talks of fake notes. If that is the case, there can be no justification for the hurried manner in which the currency is withdrawn without adequate preparations including readying of ₹100 rupee notes and recalibration of ATMs for the new notes.

This has literally thrown a billion people on to the roads waiting for days to get their legally earned money for carrying on their daily lives. Rural India is reeling under more pressure as there are few banks supported by currency chests and fewer ATMs.

The road ahead should also be clear. An internal study of the SBI November 10, 2016 makes some key points. It suggests that RBI and the Government should keep the ratio of ₹1,000 and ₹500 notes in the same proportion in circulation even after printing new ₹2,000 and ₹500 notes. Any deviation from the existing proportion will increase costs, it warns.

Looking beyond

At the time of 1978 demonetisation, 25 per cent of cash with public did not return to the banking system, possibly for the fear of getting tracked and thereby penalised. “If we safely assume that 25 per cent of the cash with public not converted this time also (though this figure may be significantly higher), it turns out to be ₹2500 billion or ₹2.5 lakh crore,” SBI says.

In all of this, one point emerges clearly. A common man cannot be punished for others’ black money. There is an urgent need for long term measures. Otherwise, the cycle of black money will begin again and we will have to wait for another round of demonetisation, or perhaps more comprehensive, multi-pronged steps.