Demonetization or Demonization: An Impartial Assessment by an Ordinary Citizen

On 2^nd of April when I was reading the RBI notes in circulation after I heard the RBI Governor’s shocking revelations that the High Denomination notes in circulation have shot up alarmingly I tweeted as follows:

The question in mind then was what is going to be the Governor Rajan’s approach towards this situation, he being one of the foremost advocates of financial prudence and a stickler for governance. Always an admirer of Mr.Rajan’s approach to economic problems and a great supporter for his fiscal prudence including that of keeping the interest rates high to prevent runaway inflation, I was curious to know his mind on this subject.

Then two things happened:

1. Rajan was not seeking another term as Governor owing to certain differences with the Modi Govt.

2. Urjit Patel, his hardliner Deputy, an insider in RBI for quite some time, became the New Governor.

Fast forward to November 8th at 8 p.m.:

P.M Modi suddenly announces he is going to speak to the nation on something very important after meeting the various Services Chiefs. A lot of grandstanding going on between India and Pakistan over the recent #SurgicalStrikes as they call it. And I was intently watching the PM speak. For the first five minutes many usual statements -Kala Dhan, Athangwadh, Fake Currency- are all uttered. Then KalaDhan gets repeated time and again. Suddenly it struck me that this talk is not about Indo-Pak matters but Black Money inside India. At lightning speed my mind recalled my earlier tweet about Demonetization and then came the announcements about High Denomination notes, going forward not being legal tender.

Just a glimpse of how much of growth in High Denomination Notes has happened in the last three years will be borne out by the following picture:

Note from the picture as to how HD notes have grown exponentially between 2014 to 2016 which is the period that Mr.Rajan was at the helm of affairs. This must have prompted him to be ultra-cautious. But I wonder, why he didn’t demand any steps to act against this phenomenon. I have used the RBI figures and have marked the base year as 2011-12. Also, I have used GNP-GNI-NNI (Gross National Product-Gross National Income-Net National Income- High Denomination Notes(500s&1000s) for this picture:

How Black money is generated:

1.    What is black money and how is it brought into existence inside the economy?

General perceptions make one believe that black money is generated by only the higher echelons of the society, like Big Industrialists who pay taxes, but not fully, and substantially stash the cash away from the various arms of Government’s scrutiny;

Real Estate Owners who demand part of the consideration for the properties sold by them in cash and stashing them away;

Politicians who suck a part of these bigwigs’ vaults by way of illegal donations, other forms of bribes, etc.;
Bureaucrats’ and various govt. Officials channeling some portions of the political bosses’ loot by diverting a part of the money;

Anti-social elements that are indulging in illegal activities like smuggling gold, import items, etc. drugs, costly items like High-end watches, art paintings, artifacts;

Educational Institutions/Hospitals who thrive by demanding cash as part of their fees or services;

NGOs indulging in peddling monies from apparent foreign donations;

And finally the highly sophisticated international business of over-invoicing imports and under invoicing exports to transfer to foreign bank accounts smoothly.

Besides this, there is another huge number which creates the parallel economy possible to a very great extent. The trader class! India is said to have over five crore, small traders and entrepreneurs. Just imagine each one of them concealing a measly 20000 rupees per annum and saves the amount in cash which is less than 2000 rupees every month; This will amount to a massive 1 lac crores of concealed income/cash. I will leave it to one’s imagination about what is the capability of each individual to conceal. In my opinion, the amounts will be substantially higher than the presumed 20000 p.a. All of us tend to ignore this phenomenon as we pardon the small time crime such as this justifying that there are bigger thieves to catch. But the sheer number of people who are indulging in this makes the grossed up amount so huge that it threatens to derail any of the government’s schemes meaningless.

2.    Simplistically defining black money, one may say that it is that which is evading the scrutiny of the revenue streams specified by the government and stashed in cash or other forms of assets to be withdrawn at any convenient future for the use of the creator of that.

3.    How is Black money hoarded?

a)    Cash: This is in the form generally in High Denomination Notes

b)   Gold: As Jewellery or in bars or coins

c)   Real Estate: The registered and declared values of Real estate and the actual outflow of consideration invariably are different leading to some hidden amounts. This amount can vary from 50-50 to 80-20 depending on the vigil of the registering authorities.

d)  High-Value Items: Watches (branded items such as Rolex etc.) Art items (Paintings etc.) Artifacts, Numismatic coins, and notes are a few examples of these.

4.    How does Black money affect the lives of those living in the country:

a)    Upsets the planning by the governments. From money supply to tax collections to subsidies to be given to BPL citizens to planning infrastructure

b)    Promotes dishonesty among people. Those who are paying taxes, either by volition or by forced due to a situation, will always rue seeing that there is a class which escapes taxes and they are being made scapegoats.

c) The disparity in living standards increases. Let us consider two businessmen; one being tax compliant and paying over 30 lacs as IT for every one crore earned (not to mention the various other taxes levied) and the other being non compliant (resorting to tax avoidance/tax evasion). The savings that accrue to the latter make it that much harder for an honest businessman to remain competitive.

d)    The high cost of real estate is a major cost component for any sector. Exorbitant pricing impairs the business viability and jeopardises the Make In India concept as also driving growth and employment away.

e)    Country becomes weak and susceptible to foreign influences through trades;

5.    How these are traditionally unearthed by the various Government agencies in India:

a)    Directorate of Revenue Intelligence (DRI), CBDT, Central Excise, Customs, Enforcement Directorate (ED), are some of the revenue departments which work towards unearthing the black money from the system by raids, assessments, etc.

b)    Seizure and Forfeiture of Benami Properties.

c)    Digital trails of transactions being used for identifying transactions and their legality

d)    Constant Surveillance with public cooperation and whistle-blowers’ assistance

e)    Strict vigil on bureaucrats and their wealth accretions through annual filings and disclosures

f)    When everything else fails #Demonetization of HD notes to remove some part of illegally gotten wealth

6.    Who is to blame for this black money:

a)    Every one of us is to be blamed. If a high percentage of money is circulating in cash, I find no one else to blame. Right from the RBI Governor to the last citizen who pays in cash and doesn’t ask for a receipt;

b)    All classes of Society, be it Political, Business Class, Services Sector, Agriculturists, and Administrators are to be blamed.

7.    Who is affected by this?

a)    Primarily people below the poverty line get affected enormously as they rely mostly on the Govt. to fulfill their day to day requirements. These people are frequently used to hardships and are commonly exploited by the political classes for votes and business classes for services at low costs.

b)    Lower Middle class and the ones that aspire to become Middle class are affected the most. They bear the brunt of the effects of the black economy and they can’t avail of a majority of the govt. subsidies, both because of the present laws as well as their own pride of not seeking help or sympathies from others.

c)    The middle class is affected only to the extent of their aspirations. But slowly their bargaining strength will make them get it from their employer or their way of doing their activities.

d)    Upper Middle class and the Upper class are usually unaffected, and they are immune.

8.    Digital Economy:

a)    Mobile payments: Mobile wallets like Paytm, UPI see the light of the day in cities. You have to own a smartphone to use these apps. The majority of the population is now favoring this. Arguments against this are centered around the illiterate rural population. This argument will fall flat when the new generation of youngsters assume the mantle.
b)    Cards: Credit Cards and Debit cards.  These cards require a bank account which is promoted by the Govt. by offering Zero balance Jan Dhan Yojana a/cs in all banks. Public Sector banks lead the show here with SBI in the forefront.
c)    Net banking: RTGS, NEFT, IMPS. These are now common both in Tier 1 and Tier 2 cities. In the coming days, they will become popular in Tier 3 towns and villages too.
d)    Bitcoins:  These are a form of digital, borderless cryptocurrency wrought with extreme risks like theft, fraud, and huge price fluctuations.

9.    Benefits of a Less Cash economy: Led by the Demonetization effort by Govt.

a)    The banking system will be flooded with money. It is estimated that the deposits at Savings and Current a/c levels (CASA) will improve by nearly two lacs crores leading to a reduction of nearly 3% p.a of interest for banks. This may result in an increased income of 6000 crores for banks assuming that the interest rates fall from the present 7-8% to 5-6%. i.e. a clear 200 basis points reduction. This will make our banking system more viable and stronger.

b)    Govt will have increased tax collections post this as more transactions happen in the accounted environment. Tax collections set to soar as compliance levels improve. GST which is attempted by Centre will become a grand success as Centre will rely less on budgetary support for States. Rates of GST set to become reasonable allaying fears of many pessimists and naysayers about a runaway inflation post introduction of GST due to cascading higher taxes proposed in GST.

c)    Centre will be able to concentrate on infrastructure, education, health services to people with available cash as well as proposed increased tax collections owing to greater compliance and increased base of tax paying public. Deficits will be under control and plans of Govt. can go on smoothly.

d)    Prices will remain deflated due to less cash chasing goods and the inflation which affected India for so many decades may become a thing of the past.

e)    A stable rupee can be envisioned with Gold becoming less popular.

f)    Fall in rates of interest and land costs will spur the industries to expand and employ. Employment opportunities set to improve vastly.

g)    General discipline in spending is expected as all transactions come out in the open leading to scrutiny, particularly the political and bureaucratic class.

h)    Anonymity of cash will go leading to greater accountability

10.    So how do we Conclude this Action?

Short Term: Less than a year Medium Term: One year to 3 years Long Term: Beyond 3 years

In conclusion, I expect the good effects of a less cash economy far outweigh the small inconveniences, and one must strive to achieve maximum penetration of the efforts to go digital. The demons of the #Demonetization will be removed by moving towards a less cash economy wherein except for essentially very small transactions one can resort to digital payments.

 Those interested in a Cashless economy and its benefits can learn more from: The Curse of Cash by Kenneth Rogoff, an eminent economist from Harvard and an Alumnus of MIT and Yale.