Political Economy

Demonetisation and the Art of Tackling India's Black Economy

The latest goalpost shift in Modi's black money quest has been the targeting opposition party leaders over a series of scam allegations.

Three years ago, demonetisation was announced on the night of November 8, 2016. What can we now say about this surgical strike which led to chaotic conditions across the country for months?

The prime minister recently said in Thailand that red-tapism, cronyism and corruption are history in India and it has become one of the most attractive destinations for investment. This implies a belief that the policies implemented to check the black economy in the last five years have been successful and demonetisation was the big bang policy.

During the 2014 election campaign, Narendra Modi promised that he would eliminate the black economy in India and would get back all the black money held abroad. In fact, he said there was so much black money abroad that if it was brought back, each Indian family could get Rs 15 lakh.  Many believed this and when Jan Dhan Yojna was announced, many opened accounts believing that money would come into these accounts. But nothing came and many of these accounts remained zero-balance accounts.

The first step the new government undertook in May 2014 was to set up of the Supreme Court-monitored SIT on black money. After that, other steps like the Foreign Money Bill, Income Declaration Scheme and so on were announced to check the black economy. But none of them yielded the desired results. The opposition taunted the prime minister on his failure during the state assembly elections.

Also read: The Vast Difference Between What Demonetisation Achieved and How It Was Perceived

Modi likely thought something drastic had to be done, especially before the Uttar Pradesh elections. So, demonetisation was the ‘brahmastra’ to slay the demon of black money and silence the critics.

The prime minister implied in his speech announcing demonetisation that it was his decision and even his cabinet colleagues did not know of it. What it meant for cabinet functioning and later for parliament where Modi did not make any statement in spite of the demand from the opposition is another matter. The credibility of the Reserve Bank of India and the entire banking system was dented, since they faced enormous problems dealing with the sudden rush. So, institutions were damaged.

The flawed notion that ‘black means cash’ is what led to the note ban. The idea was that demonetisation, by squeezing out cash, would eliminate the black economy. The public also believed this to be so, but it was a monumental misperception since black cash is less than 1% of black wealth, and it does not hamper generation of fresh black incomes. Clearly, one invests to get a return and holding cash does not give a return so, little of black wealth is held as cash.

It also contradicted the idea that most of the black money is held abroad. If that were so, how would devaluation of the Indian rupee help? Black money held abroad would not be in rupees but in foreign currency since the Indian rupee is not convertible. It is not acceptable outside India, except in some of the South Asian countries. If most of the black money is held abroad, one would need to devalue the foreign currency in which it is held and demonetization of the rupee would not help.

Demonetisation could at best tackle black money held in India. Since it is easy to hold large sums of money in big denomination notes, the government decided to demonetise the largest denomination notes then in existence – Rs 1,000 and Rs 500 currency notes. They ceased to be legal tender from the night of November 8, 2016. They constituted 86% of all currency with the public at that time – Rs15.44 lakh crore out of the total of about Rs 17.9 lakh crore.

According to this author (and later confirmed by the RBI) by January 10, 2017, 99% of the demonetised currency was returned to the banks. Clearly, people with black money converted their hoards of old notes into new notes. Even if the black cash hoards had not been returned to the banks, as argued above, only 1% of the black wealth would have been eliminated.

Furthermore, black income generation is a process that has not been impacted at all. A friend had to pay Rs 5,000 for getting a driving license in Gurugram and another who was caught last week in Mumbai smoking in public was asked to cough up Rs 30,000 by the cops, but the final settlement was for Rs 9,000. These are not stray instances. The big bank scams and other scams that are surfacing with great regularity are an indication of persisting corruption. This is not possible without political backing.

In India it is known that the corruption money, like hafta, goes right up to the top. Ruling politicians usually believe that they are safe because of their control over the investigative agencies. But now it is clear that when out of power, they can be caught.

The failure of demonetisation led the government to shift goalposts to digitisation, cashless economy and formalisation of the economy. It is another misperception about the black economy that the informal sector generates black incomes. A vast majority of the incomes earned in this sector are way below the taxable limits, so whether or not they are declared, they are not black incomes. Actually, in India, most of the black incomes are generated in the organised sectors.

In recent times, the goal post has again shifted once again to the prosecution and arrest of high-profile opposition leaders as a symbol of the fight against black. But it has taken a political hue; many believe that these attempts are to either get the opposition leaders to join the ruling party or to go quiet. But what about the corrupt ruling party leaders? The cow vigilantes were called goons by the prime minister who extort money. How many of them have been caught? Clearly, the fight against black money is being used as a political tool to decimate the opposition and rule unopposed. This weakening of democracy is now a bigger national danger than the black economy.

The failure to check black income generation has also meant that tax collection has lagged and led to a resource crunch. So, businesses are being pressurised to pay up and they are complaining in private of tax terrorism. When the French CEO complained to the defence minster of tax terrorism, it reflected the business mood in India and abroad. Angela Merkel, the German chancellor, during her recent visit, embarrassingly flagged the difficulties faced by German businesses.

The issue is how to fight black economy without destroying business confidence, which a recent RBI study says has declined? As a response to this, in the last three months after the budget presentation, the government has offered big sops to the corporates, even though that is not the solution to the lack of demand.

Black income generation is indeed a menace which impacts the poor the most. But the recession following demonetisation has caused a bigger loss to the poor, who were the worst affected. They have lost lakhs of crores of incomes and have got further marginalised. The weakening of democracy is an even bigger danger for society and especially for the poor. There is no silver bullet to tackle the black economy quickly. The need is to raise public consciousness through socio-political movements, and that implies strengthening democracy and bringing about accountability of those in power. Demonetisation, on the other hand, did not do any of this.

Arun Kumar is Malcolm Adisesiah Chair Professor, Institute of Social Sciences and author of `Demonetization and the Black Economy in India’. N Delhi: Penguin Random House. 2017.