1. Narendra Modi banning Rs 500/1000 notes won’t help much unless cash donations to political parties are banned and tax compliance hiked

Narendra Modi banning Rs 500/1000 notes won’t help much unless cash donations to political parties are banned and tax compliance hiked

Prime minister Narendra Modi’s decision to demonetize the existing 500 and 1,000-rupee notes will, undoubtedly, help destroy a part of India’s famed stock of black money, but how much will depend upon a variety of factors, including how much of the illicit funds are kept in cash.

By: | Updated: November 9, 2016 5:22 PM
rupee-l-reu Certainly the government’s ability to get those with black money to declare around Rs 1.2 lakh crore of this is laudable – around Rs 65,000 crore was got in the Income Declaration Scheme last month. (Source: Reuters)

Prime minister Narendra Modi’s decision to demonetize the existing 500 and 1,000-rupee notes will, undoubtedly, help destroy a part of India’s famed stock of black money, but how much will depend upon a variety of factors, including how much of the illicit funds are kept in cash. Against the pros that many analysts have enumerated – like increased bank deposits and lowered real estate prices – are pretty serious cons as well as incorrect assumptions. For instance, a very large part of the economy, including agriculture, is out of the tax net by law, so assume the high-denomination notes are all black is incorrect – yet, everyone in this segment will be inconvenienced and subjected to harassment while converting their old notes to new ones. Also, since the black economy is a big driver of consumption, anything that affects this will slow economic growth.

Certainly the government’s ability to get those with black money to declare around Rs 1.2 lakh crore of this is laudable – around Rs 65,000 crore was got in the Income Declaration Scheme last month. But this represents under 0.5% of India’s GDP while the government’s press release on demonetization itself talks of the black economy being around Rs 35 lakh crore – that is, while the government has got Rs 1.2 lakh crore of declarations from the stock of black money, the annual generation of black money is around Rs 35 lakh crore. The picture isn’t too different when you look at the value of the high-denomination notes that are to be demonetized. RBI data puts the value of Rs 500/1,000 notes at around Rs 14 lakh crore. Assume half of this represents black money – also assume, though incorrectly, that the money that cannot be laundered since all bank accounts are being linked to a PAN number and taxmen will keep tabs on suspicious bank deposits. That’s Rs 7 lakh crore which will have to be destroyed as compared to the Rs 35 lakh crore that gets generated every year. Which is why, it is critical the government keep working on trying to increase the tax-to-GDP ratio by collecting more information on tax-dodgers – implementing GST will help since there will be a lot of information on where goods and services are being produced/consumed. Between FY08 and FY16, however, India’s tax-to-GDP ratio fell instead of rising, from 11.9 to 10.6 – just being able to maintain the old levels would have fetched the government Rs 1.8 lakh crore in FY16, and that number would rise by 12-15% each year just based on GDP growth.

Apart from whatever amount of black money stocks the government is able to destroy with its demonetization move, the prime minister would do well to take action on political parties who collect large sums by way of cash. According to the Association of Democratic Reforms, between FY05 and FY12, over three fourths of funds collected were from unknown sources – according to the law, parties do not have to declare the donors names if the donation is below a certain value, potentially opening a big window for those with black money to contribute to them. Changing the law to ensure all donor names have to be made public – and then keeping a check on spending during elections – will go a long way in arresting black money since, if political parties don’t needs funds, they will be tougher on those generating black money.

  1. Indira Dandyala
    Nov 10, 2016 at 12:05 pm
    The announcement made by the Prime Minister about the demonetization of the Rs. 500 and Rs. 1000 notes is not going to yield the desired result of unearthing black money. It will have limited effect and is more like political posturing.The claim that the demonetization will check black money, fake currency, corruption and terrorism lacks substance. By the Prime Minister’s own admission, the bulk of black money generation and storage is in off-s accounts in foreign currency. Counterfeit currency can be generated for any denomination. The announcement of a new Rs 2000 note along with another Rs 500 note does not in any way prevent future possible counterfeit circulation. It’s an established fact that terrorist funds flow through electronic transfers and not through currency transactions. By allowing the conversion of the existing 1000 and 500 currency notes within the prescribed time limit, no effective measure is there to prevent benami conversions. Further, transactions through plastic will continue as usual. In effect what this would result in is a total disruption of the payments and settlements that are part of daily life of our economy. It will burden the vast m of our people from daily wage labourers, fishermen, small businesses, traders and vendors selling at the door step. What is going to happen is the disruption in livelihoods and bureaucratic harment of ordinary people who wish to change the currency notes. The basic avenues for money laundering through Partitory notes and diversions through tax havens remains untouched. There is no attempt to curb the roots of generation of black money such as in the real estate sector. This is a measure to cover up the failure of the government on the economic front, of joblessness, high prices and no pick-up in domestic demand, crippling all sections of our potion, especially the working cles, and ruining the peasantry. The government should make public forthwith the names of those holding bank deposits and accounts in tax-havens and those refusing to return humongous loans from nationalised banks estimated at over Rs 11 lakh crores, if it is really committed to recover and curb black money.
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