Why Centre’s demonetisation won’t eradicate black money
The demonetisation will destroy some unaccounted wealth, but people will eventually find ways to convert their unaccounted wealth into white money. For instance, many will arrange to receive monetary gifts from friends and relatives, some will convert black money into foreign exchange and have it remitted as gifts from abroad.business Updated: Nov 19, 2016 13:29 IST
On November 8, Prime Minister Narendra Modi launched a crackdown on black money, demonetising Rs 500 and Rs 1,000 notes. Though the government promises more steps in the future to tackle the menace, many claim the demonetisation has eradicated vast sums of black money.
Those hoarding black money in cash will be hit as Rs 14,50,000 crore of the Rs 17,50,000 crore worth of currency notes is now defunct. But black money is not just stored in cash, there are other more prevalent and efficient ways of storing it.
Cash doesn’t have store of value, inflation ensures that its value decreases over time, therefore, large amount of black wealth is invested in real estate, gold and other precious metals, diamonds, benami financial investments, undervalued stocks, undisclosed foreign holdings, and hawala.
It is true that India is a cash-based economy. Most farmers and the poor deal in cash because credit and debit card facilities, along with other cashless modes of banking, are largely unavailable in rural areas. One major drawback of using cash is that it doesn’t leave an audit trail, encouraging many to hoard it. Which is why the government decided to take this step.
The government also said it demonetised the high-value notes because many were fake and being used to fund terror activities. Economic affairs secretary Shaktikanta Das said that while the supply of notes of all denominations had increased by 40% between 2011 and 2016, the ₹500 and ₹1,000 banknotes increased by 76% and 109% due to forgery.
What needs to be done
But the menace of black money is so widespread that the government needs to draw out a detailed plan to root it out, only demonetisation won’t help. A report by NIPFP in December 2012 estimated black money at above INR 10 lakh crore or 10% of the GDP.
The demonetisation will destroy some unaccounted wealth, but people will eventually find ways to convert their unaccounted wealth into white money. For instance, many will arrange to receive monetary gifts from friends and relatives, some will convert black money into foreign exchange and have it remitted as gifts from abroad. Others will distribute money to friends with little or no income, have them pay income tax on the money and then return it in the form of white loans. Some will get hawala loans.
The black economy is well entrenched in India because of multiple reasons: corruption, crime, evasion of taxes, poor tax infrastructure, etc.
Highlighting tax evasion, a FICCI report said less than 50,000 taxpayers earn taxable income of over Rs 1 crore in a country of 226,800 millionaires (with net assets of over Rs 6 crore).
To check the parallel economy, the government needs to first tackle the generation of unaccounted wealth, then stop the conversion of black money into white, and lastly, clean up sectors, wherein black money is parked.
Since discussing the first two points is beyond the scope of this article, we will focus on the need to recover the black money from certain sectors.
According to a finance ministry White Paper, the real estate sector in India constitutes for about 11 % of the GDP due to the rising property prices. In 2012-13, the most amount of black money was reportedly parked in the sector. People generally underreport the transaction price to pay lower stamp duty while making the purchase. Moreover, the buyer has the option of using his black money since he can make the transaction with cash.
As per a World Gold Council report, India is one of the leading gold markets in the world and holds over 18,000 tonnes of above ground gold stocks, worth about 2/3rd of India’s current GDP and represents 11% of global stock.
Those holding black money invest in jewellery to protect its value from getting depreciated. Nearly 70-80 % of the transactions involving jewellery are made in cash (black money).
A finance ministry White Paper said the financial sector also needed to be regulated since it managed the transfer of all kinds of funds into productive activities. It said that often black money entered via financial instruments that involves money laundering.
Long road ahead
Demonetisation will only solve part of the riddle, the government will have to carry out many other steps, such as checking tax evasion, implementing anti-graft laws and checking crime, to rid the country of black money.