PM Modi’s move to purge high denomination rupee notes isn’t India’s first tryst with this kind of economic stunt. Back in 1946, and then 1978, the government of the day had tried to pull off similar policies, but without much success. The primary reason was that the impact on currency in circulation was minimal. However, this time may be different. R1,000 notes alone account for close to 40% of the stock of currency; while the share of R500 notes is 45%. For the next few days, around 85% of cash in circulation is effectively out of the system.
Needless to say, the slimy real estate agent who nonchalantly mentions in passing that 15% of the down-payment for your dream flat has to be paid for in cash is not in the least amused. Nor is the low-profile government servant in charge of setting government exam papers—a millionaire if you consider the cash hidden under sofa sets, inside trunks and invested in property. Nor are hundreds of thousands of small businessmen, traders, contractors and brokers who stash underneath the proverbial carpet cash worth 30% of GDP—the estimated size of India’s black economy!
World over, countries have been fighting the shadow, or black economy by battling cash. And that is because there is something beautiful about cash, that is absent in other forms of money transfer—it is anonymous! Most other forms of transfers have some form of traceability. It is of little surprise that the biggest sectors globally that have shadow economies also happen to be those that are extremely cash reliant, like construction, real estate, trading, transport, wholesale and retail businesses. And, of course, terrorism, human trafficking, drugs, money laundering, and politics, all require anonymity for survival.
It is interesting that even in Europe; the Nordic countries that generally rank higher in transparency also happen to have the least transactions in cash. On the other hand, down south, Italy, Portugal, Spain, etc, which have shadow economies worth over 20% of their respective GDPs, are heavily cash dependent. In fact, some of the European countries have lately imposed caps beyond which transacting in cash is illegal.
It is imperative to know what led to black money. Or else, after the new notes of R500 and R2,000 will roll out, new black wealth will be generated using these!
It is a subtle, yet important, point that there may be a distinction between ‘good’ and ‘bad’ black money. Not all of the shadow economy is necessarily unethical. Some are genuinely not in a position to issue receipts for their services. In India, where around 90% of the workforce is in the informal sector, and financial penetration and literacy are still at nascent stages, cash remains the primary form of money transfer. The local plumber, carpenter, maid or the grocery store owner, all expect cash payment. Most of this business is naturally beyond the tax net of the government—and hence in theory is part of the shadow economy. Naturally, the way forward is to offer better incentives, jobs and skills for the informal economy to blend into the formal one. Banning notes only makes them collateral civilian victims in this crossfire between the government and the crooks.
And of course, then there are the crooks—the people who are in the active business of tricking the taxman. While different countries have different triggers for such behaviour—the top three reasons behind black money are: (i) high and complicated taxation structure, (ii) burdensome regulatory and licensing regime; and (iii) lax financial and tax monitoring. The first dissuades citizens from paying taxes; the second incentivises corruption, especially when rules and regulations are overtly business unfriendly; while the third promotes evasion. There is a fourth reason, which is germane to India; i.e., inadequate regulatory oversight in sectors like real estate and politics, which further promote a thriving parallel economy.
Of these, India has only so far seriously thought about the third reason, i.e., around tax evasion. Indian governments have a rich history of blowing hot and cold with voluntary declaration schemes peppered with draconian sounding legislations, and going on wild goose chases behind offshore accounts. However, the wider milieu that promotes black money has only been scratched at the surface. And they need not be very politically difficult reforms either. For instance, one of the ways Philippines tackled black money was to introduce an ‘Ask for Receipt’ campaign, aimed at raising public awareness on sales underreporting.
The Indian government has a golden opportunity at hand this time. Over the next few weeks, there will be a spanish inquisition on the existing stock of black money; and in a few months’ time we would be having the cleanest slate we could have hoped for in decades. The time is ripe to attack the more fundamental triggers for Indians to accumulate black money. Or else it may soon risk being much ado about nothing. To that extent, it is encouraging that the government followed up its midnight strike, with the implementation of legislation around ‘benami’ properties—which will now increase the penalties around dodgy property transactions with shadow owners.
After all, the Mahatma Gandhi on the new notes deserves a cleaner future than its predecessor!
The author is a senior economic adviser to a foreign mission,based in New Delhi. Views are personal