Taking out high-value notes can affect the stock but not the flow of black money | analysis | Hindustan Times
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Taking out high-value notes can affect the stock but not the flow of black money

The drive against the black economy will be more efficacious by targeting the processes of generation and flow of unaccounted money in the Indian economy with more reasonable rates of income taxation

analysis Updated: Nov 09, 2016 16:18 IST
New Delhi: Rs 500 and Rs 1,000 notes, which will be discontinued from Tuesday midnight, as a step to curb black money
New Delhi: Rs 500 and Rs 1,000 notes, which will be discontinued from Tuesday midnight, as a step to curb black money(PTI)

There is, no doubt, bound to be short-term disruption with the Modi government’s decision to withdraw from circulation high-denomination currency notes. High-value notes were similarly demonetised in 1978. The rationale for this drastic measure is to strike at the black economy, fake currency and financing of cross-border terrorism. This measure is also intended to encourage cash-less, credit card-related transactions in the formal economy to enable the tax man to garner revenues for the exchequer. The big question is whether such a shock and awe policy turns the black into a white economy.

Read: 10-day survey ahead of PM’s move shows majority favoured currency withdrawal

According to top finance ministry officials, the circulation of high-denomination notes has far outpaced growth in the nation’s economy or gross domestic product. These notes account for a little more than eight out of 10 currency notes currently in circulation. Over the last five years, the circulation of Rs 1,000 notes expanded by 109% while the economy grew by only 30%. Rs 500 notes circulated 2.5 times faster than GDP — all of which suggested that there is a disproportionately high usage of such notes as a store of unaccounted black money in the Indian economy.

Read: Modi second PM to scrap high-value notes, first to introduce Rs 2000 note

Taking out such notes, however, only affects the stock but not flow of black money. Replacing them by new Rs 500 and Rs 2,000 notes doesn’t really check the process of generation of unaccounted money in sectors like real estate and stock market speculation. If anything, normalcy will soon return after the immediate disruption with new notes getting into circulation. Such a measure will not curb the financing of electoral expenditures by most political parties, either. The former RBI governor, Raghuram Rajan, observed a disproportionately high usage of such notes ahead of crucial state elections.

Analogously, the misperception persists of a stock of funds held abroad by Indians in Switzerland and tax havens waiting to be brought back by a pro-active government. The government too has nurtured this objective but has not succeeded till now. The reason is simple. There is only a limited idle stock abroad but one that is more in circulation. Much of what has left outside has indeed returned as participatory notes in the stock market and foreign direct investment inflows in sectors like real estate. This has derailed efforts to get back the alleged hoard of illegal money stashed abroad.

Read: Withdrawal of Rs 500, Rs 1000 notes may affect poll campaigning in UP

Domestically as well, taking out high-value notes only targets the idle stock of black money. Their impact is limited as efforts to make citizens disclose their unaccounted wealth have not worked well so far. The last income disclosure scheme a few months ago only netted tax revenues of only 0.2% of GDP. The drive against the black economy will be more efficacious by targeting the processes of generation and flow of unaccounted money in the Indian economy with more reasonable rates of income taxation. The tax regime must also extend to hitherto politically sensitive sectors like agriculture. Electoral financing reforms are also imperative to attack the black economy.

N Chandra Mohan is an economics and business commentator

The views expressed are personal