Ever since PM Modi announced demonetization, people are debating whether this is a good move or bad. Labeling any move as good or bad is a very difficult job. But one can always look at every aspect of it and do an objective analysis of same. Let us look at various aspect of it.
Stock vs Cycle
This move is apparently to unearth the stock of black money and not to stop cycles of black money generation forever. By banning the notes, the Govt want black money stock holders to deposit their money which will attract the tax and penalty eventually. This move alone will not stop someone from generating black money by running the business on cash and not accounting the income to avoid tax. The black money economy is going to continue without any additional measures to stop it. The introduction of 2000 rupee notes makes logistic of carrying such business even easier. And even if 2000 rupee notes are taken away too, it will still make no difference to the cycle of generation of black money.
So first thing first. This move is targeted to unearth current stock of black money and not to end black economy.
Cash Stock vs Asset
The large part of existing black money is in form of properties, assets in foreign tax heavens, then gold and ornaments and other high-value assets. According to IT Dept data, of all the black money recovered all through past many years, only 6% were in form of hard cash currency notes. Rest was in form of other types of assets.
So this means this entire exercise is only to target this 6% of the total possible black money.
People have begun to settle their cash stock of 500-1000 notes through various ways.
1. Jewelers and gold
Jewelers are buying gold from black money holders on paper and giving them a cheque (increases their gold stock on paper) at discount (they get more in cash than they pay by cheque). Then they raise invoices for selling that on paper stock and raise cash receipt and deposit money in banks and earn the commission.
- Commission mafias
There are commission mafias who are taking old currencies from black money holder at 30-35% commission rate. They deposit in various accounts and pay back later after few months by withdrawing it. They, in turn, pay commissions to various account holders.
- Backdated FD in co-operative banks
Since large numbers of such banks are operated on manual records. Black money owners are now getting such backdated FDS in names of villagers and will get the refund in new currency notes.
- Temple trusts and religion organization donation
Influential people who have relationships with trustees of temple trust and other religious organization trust are giving huge amounts of donations. Since such organizations are out of the purview of tax, they can show this as legit donations, deposit in the bank account, withdraw it later in new currency notes and give back to donors with some commission. Surprising right?
- Giving interest-free loan
Many people are giving small amounts as loans to multiple low-income rural people. Or sometimes with a negative interest rate. Since they can deposit the amount and exchange with new currency notes, so black money owners get their money back in new currency at no or little loss.
- Direct exchange via co-operative banks
Although it now restricted by Govt, lot of people have already directly exchange old currency notes with new notes through co-operative banks with some bribe to officers. Now that Govt has banned the co-operative bank from this exchange and deposit exercise. No new currency notes will be given to co-operative banks.
- Pay advanced salaries- Many businessmen are opening salary account of employee and depositing advanced salary of less than, say 2 Lac such that it doesn’t raise suspicion.Small black money owner can easily settle by depositing in accounts of multiple people. Big ones are resorting to methods mentioned above. If someone declares large amount, they have to let go of 90% given the 200% on 30% tax. So instead of that, they will let 30-40% go by various methods to retain at least 60-70% of value. The value they let go in those cases is not the value that goes out of circulation and ends up Govt’s coffers. It’s what chain of post-demonetization commission mafia and channel operators earn. Of all black money holder, very few will declare the money and pay 90% tax plus penalty.If Govt would have kept 30% tax and 50% penalty (total 45%), it would still make sense for black money holder to disclose and deposit, and be done with it. But at 90% of tax plus penalty, very negligible numbers of people will disclose their black money. Either they let go entire money or they convert at 30-40%.
Prior information to few people
There are many theories and proof that are emerging which are making the possibility more eminent that few people already had prior information.
As per RBI there was abnormal rise in deposit in last quarter. Let’s consider only September month. As per RBI report, deposit in September rose to 6.2% from 96.10 lac Cr to 102.08 lac Cr. A rise of 6 Lac Cr. Considering the history of fluctuations in deposits in past month, let’s assume 1% of the increase in deposits is natural. So 5 lac Cr is the amount of unusual and suspicious deposits.
Now people argue that it’s due to voluntary income declaration scheme. The scheme, as per govt claims, generated 65000 Cr in taxes. At 30% of normal tax, the total income declared must be 2.17 lac Cr. Now let’s assume 50% of this declared income was deposited in banks (which is highly unlikely as it was self-declaration and didn’t require deposits in banks and some of it could be in form of non-cash asset too). So 1.1 lac out of 5 lac Cr was the deposit due to income declaration scheme. Now you still have 4 Lac Cr of unusual and suspicious of deposits. Yes, 4 lac Cr.
Some rumors were out in April and multiple media house carried the stories including ToI and small regional newspaper in Gujarat named “Akila”.
The access of 2000 rupee notes in large amounts to many people before the release of notes in public too raises questions. Since many people related to BJP have posted photos of big bunches of new notes prior to 8th Nov. Even such photographs that surfaced after 10th Nov are suspicious. As the daily limit of exchange is 4k, how can anyone get big bunches of 2000 rupee notes?
According to open letter by ex-confidante of Modi-Shah duo and ex-BJP MLA from Gujarat Yatin Oza, Amit Shah and his operators were openly exchanging old currencies in crores for anyone at 34% commission. While a BJP MLA in Rajasthan said on record that likes of Adani-Ambani were informed. According to one theory, Reliance used its black money for cash expense in their huge Reliance Jio investment and will now get returns in accounted white money.
Since the currency notes are invalid, this will surely be a blow to all counterfeit current owners who are mostly involved in terror activities. But again this is one time. It doesn’t do anything to stop counterfeit money from being generated. With 2000 it will be even easier. The RBI officials have categorically said that these new 2000 rupee notes have no extra security feature. Recently new 2000 rupee notes were
Also within 3 days fake 2000 rupees notes were in circulation. A person awarded for Make In India program was found to be running a racket of printing fake notes . Recently new 2000 rupee notes were found with terrorists killed on 22nd November in Kashmir.
Govt and their supporters are saying this move will reduce corruption. It would silly to think that this move is going to reduce corruption. The process of corruption has nothing to do with possible invalidation of existing stock of black money. Yes, if corrupt politician and officers have corrupt money in form of cash stock, it will be a bit of trouble for them and if they chose not to convert it into white with above-mentioned methods, it might be seized. But this does nothing to stop corruption from happening. The way black money cycles will continue, as explained above, corruption will continue to happen too. People will pay bribes as usually as they did in past.
It is needful to note here that, all the while, Govt okayed the changes in Prevention of Corruption Act, such that now any investigation agency including CBI will be required to take permission from Govt before investigating a corruption case against any central or state Govt officer.
This move is affecting 86% of total currency in circulation. As per Govt figures 90% of workers are in unorganized sectors which rely on cash completely (Ie those involved in agriculture, construction, or home-based micro businesses like tailoring etc.) generating more than 50% of India’s GDP. And with this move, they are the most affected ones.
Small traders, farmers, small shop owners and more who largely run their businesses with cash, aren’t able to make transactions. Even if buyers has 2000 notes to make small transactions, shop owners, and small vendors don’t have lower denomination notes to give back. They don’t have sufficient cash to buy from wholesalers. Lack of currency has started a chain reaction that is going to be worse in coming days if currency shortage continues to be there.
The impact on unorganized sector biz is likely to affect GDP of the country. While some of the slowed and pending transactions will be fulfilled later on, hence, there will quick bounce in transactions, the effect of reduction in purchase power and low consumption for the period of almost two quarters will certainly affect GDP negatively. According to various economists, this could be somewhere between 0.5 to 2%. Even considering 1% it’s still an erosion of $11.25 billion dollar which is INR 1.53 Lac Cr. According to a study by Center for Monitoring Indian Economy, by conservative estimate and for the time window of just 50 days, the demonetization will cost 1.28 Lac Cr.
There is dreadful suffering for hundreds of millions of country’s low-income and rural people. 68% of Indian population lives in rural area, where access to banking is difficult. There are only 7 banks per 1,00,000 people in rural India. Most have to travel 5-10 km to reach to the bank and stand in long queue for couples of hours, affecting their day to day work. Moreover, people are not educated and have difficulty in following through procedures.
Daily-wagers, low-income labors, farmers including women have to stand in queues to exchange their note for days and losing their wages. They have difficulty in buying day to day items and feed their families. Even if they convert their old currency notes, they can’t buy items as the shop owner doesn’t have enough change to give back. Many migrant laborers and others are sleeping hungry.
Many people who are amidst situations like family weddings or hospitalization and medical emergency are suffering a lot. Many women’s hidden saving is now vulnerable to exploit by oppressive husband and other family members. Single women or lonely elderly couples have a lot of trouble converting their hard earned money. More than 80 people have died in various circumstances related to demonetization. The actual number could be bigger.
After 3 weeks there is even worse currency notes crunch at banks. Many banks in rural areas aren’t supplied with cash. Banks have been asking for police protection as the situation has turned violent at many places. All of these certainly cannot be categorized into minor inconvenience by any stretch of an imagination.
Printing new currency notes of 2000 will cost 12,000 Cr. Apart from all special arrangement that will be required for the exchange and deposit of old currency notes at such a large scale, will cost RBI significantly too.
Possible untold motive behind move
The declared reason for this move is to target black money and counterfeit currency. There are other potential reasons which, for one or other reason, the government might not want to disclose. One such speculated reason is stressed out bank capital. In last few months, capital in public sector banks has been drying up due to a huge amount of Non-Performing Assets. Bad performing loans in PSB doubled from 3.2 Lac Cr to 6.2 Lac Cr in last 12 month. Also, 1.15 lac Cr worth of loans were written off by state-owned banks between 2013-15, which is more than half of what was written off between 2005 to 2013.
As per this very detailed story, there were other parameters like risk avoidance due to any future volatility along with much-needed capital infusion, that Govt could have been advised to go for this move.
Modi government’s appeal to urban educated middle class was degrading since past 2 years. Issues like high inflation, farmers suicides, low job creation were haunting Modi government. Modi came to power on the premise of “Achchhe Din” and “Vikas”. But two years of government didn’t reflect that for common Indian. Demonetisation could strengthen people’s belief of Modi as Vikaspurush and bold leader. Since elections are approaching in many states, this could be a game-changer for BJP. The announcement of the demonetisation has added stock of enthusiasm in his urban educated middle-class supporter base. While with this move, BJP will be able to retain its urban middle-class support base, there’s a huge disappointment with rural class and traders, which could cost BJP significantly.
All opposition party has opposed such a bold move affecting millions of Indian with various arguments. The main argument of opposition is why Govt is not acting on Swiss account holder list or those mentioned in Panama paper leak and why Govt gave away inputs to selected people in advance all the while poor and common people are suffering great misery due to poor planning and implementation. AAP Govt seems to be most vocal in opposing the government. Although on other hand AAP seemed to be participating constructively by sending volunteers to help people in queues with water, tea and filling forms etc.
Opposition parties have been demanding Prime minister to speak about demonetization in Parliament and answer the question related to cost-benefit analysis of demonetization, which, Prime Minister seems to have arrogantly ignored. Prime Minister, although, is seen talking about demonetization in couples of speeches in election rallies in Punjab and Uttar Pradesh.
It is also interesting to note that BJP itself opposed heavily the UPA govt’s decision to similar move. The argument presented by BJP then were same as what opposition is doing now.
As many skeptics apart from loyal supporters are now praising the PM Modi on going after black money and corruption, many questions remain unanswered on Government intentions.
Questions like, if Govt’s intention was to curb black money menace, why some long-term steps like curbing cash payment are not being taken and instead of jeopardizing socioeconomic fabric of large part of the country?
It is very well established that black money and assets are stashed in Swiss banks and foreign tax heavens. The names of such account holder are with Govt, including the recently revealed list of tax-evaders mentioned in of huge international Panama papers leak. Why is the Govt not acting on those big fishes?
While people are depositing their money SBI has written off 7000 Cr worth of loans including that of Vijay Malya’s 1200 Cr loans and . While PM Modi made comments like “Those involved in 2G scams are standing in line” and “Poors are sleeping peacefully and Rich has to take sleeping pills”, it becomes difficult to come to term with the fact that Govt has cleared the suggestion by the parliamentary committee regarding amendments to Prevention of Corruption Act that requires any investigation agency including CBI to take permission from government before probing any central or state government officers. If it is widely perceived that political parties accept unaccounted money in large amounts, why Modi Govt is reluctant to bring political parties under ambit of RTI ?
Instead of going for such an extreme step, the Govt could’ve implemented many long-terms measures to reduce black money economy as a process instead of focusing on targeting black money stock which is easily being settled by various means now.
Imposing cash payment threshold for large ticket consumer purchase like appliances, vehicles etc. is one such measure. Which not only enforces banking, cashless transactions, and deposits but also help choke black money generation process over the time. If people have lesser means of utilizing cash stock of black money, there will be lesser motivation to generate black money.
Govt should act on the list of swiss account holders and Panama companies holders. There is and there was a huge amount of money stashed there. Govt should make political funding transparent by requiring all payments to be received in white. Afterall, if the government can urge citizen to adopt cashless economy, why shouldn’t it be begun from political parties?
Empower and run honest tax administration. We already have lower rates of income taxes. We need more traceability and big data analytics technology should strengthen IT dept. to detect suspicious activities along with public awareness about taxation. In this digital age, rural banking and co-operative banks are still far more traditional. Regulation can be formed requiring banks to acquire technology to align with RBI’s traceability goals. Jan Dhan Yojna was already good initiative. Businesses should be incentivized to accept card or digital payment by various banking policies. Accepting cards is still very costly for merchants.
To a certain extent, it won’t be wrong to say IT dept. itself helps in tax evasion. Corruption is kind of part of the process for smaller tax evasion investigation process. Most IT officers take the bribe and clear the cases for businesses. This is considerable leakage in tax collection. So anti-corruption measure in IT dept alone can make big change.
By now it can be concluded that government failed to plan adequately. The reason of ‘Secrecy’ that is being brought forward is futile in most kind of preparations. For example, preparing ATM for 2000 notes has nothing to do with Secrecy of demonetization. Already the information of introduction of 2000 was leaked while in process of printing etc.
Until an entire wee, 500 rupee notes didn’t reach the banks. There’s a huge shortage of new 2000 and 500 rupee notes. Notes could have been printed in adequate number. By an estimate with all presses running at full capacity, it will take 6 months to print new currency note of equivalent amount that was invalidated. There has been news like half-printed and faded notes are being dispensed by ATM.
Govt is coming up with new circulars almost every day since the initial announcement. This only shows that government didn’t plan for possible outcomes and were responding to salvage the situation.
Who says what?
A lot of people are influenced by who has said what about the Govt’s decision. There has been a lot of speculation.
Demonetization move wasn’t widely praised by international media likes New York Times , BBC , The Guardian , Huffington Post , Washington Post , The Independent , International Business Times . While some international financial institutes have to politically correctly acknowledge the movement by world’s largest democracy and fastest growing economy, Indian economists belonging to different school of thought weren’t much in favor of demonetization.
Kaushik Basu, a former economist at world bank said, “collateral damage is likely to outstrip its benefits”. Prabhat Patnaik and Arun Kumar had similar views and so some other. While economist like Arvind pangariya thinks this move will help reduce inflation and bring black money back to some extent. Ex-RBI governor like Raghuram Rajan was wary about the move stopping black money menace. Internationally reputed economists like Nobel Prize winner Amartya Sen, US ex-secretary of Treasury Larry Summers, Jean Dreze, Paul Krugman also criticized the demonetisation move. All the while Supreme Court pulled the government for the situation at banks and difficulties of citizens.
Out of 14.5 Lac Cr of invalidated currency, 8.5 lac Cr is already deposited by 26th November. By an estimate about 5 Lac Cr was already with Banks, Treasuries, ATM machines, Govt and public sector enterprises. So, a very small amount of currency will be destroyed. The recovery done through demonetization will mostly be in the form of tax plus penalty collection. Given the cost of demonetization and losses in GDP, if the government doesn’t generate more than 2 lac Cr, demonetization is futile.
So how do we evaluate the success of the demonetization move? As a result of a recovery of black money, there should be unusual rise in income tax collection in this fiscal as well as next fiscal. Also, the black money that goes undeclared, If RBI reprints then the debt and budget deficit should go down significantly. If it doesn’t, inflation should reduce dramatically and rupee should become much stronger against the dollar. The indirect effect should be lower taxes and increase in budge spending for various schemes.
The move will bring back very little black money and it will certainly not stop the black money economy and flow itself. Unless the recovery goes beyond 2 Lac Cr, this whole exercise will remain futile considering the losses due to a direct cost of demonetization and losses in GDP. The cost is out-weighing the recovery or income to the government.
The government and RBI need to come up with right measures for black money cycles or flow to stop, this step will do nothing. It may trigger mindset change but such change is mostly evolving in nature and could’ve been done better with gradual introductions of correct measures and improvements like traceability and better tax administration, expanded and tech-enabled bank network etc.
The move will certainly fuel the banks with capital but it is yet to be seen how sternly the government acts on the bad loans and defaulters.