Black Money-The long battle. Some thoughts..

 

The demonetization of the two largest denominations in circulation is an interesting move by the PM. Black money seems to be one and the second seems to be the counterfeit that comes across our borders. The counterfeit note is not a small issue. To put it in perspective, there is around Rs.15 lakh crore of bigger denomination notes. One report said that the extent of fake notes caught and destroyed amounts to over a lakh crore rupees! Surely, not a small issue.

 

Black money accumulated and in lockers and homes will either get laundered at a price or there would be some losses. Many of those with the darker shade of wealth would see some dip in their wealth.

 

The big thing is going to happen over the next few days. Banks will receive an inflow of nearly Rs.15 lakh crore in as people put them back for conversion to new notes. Yes it will include all kinds of money. I would think that there is bound to be a serious deficit in what comes back to the banks. Let us say Rs.14 lakh comes back. What it would mean is that black money of nearly one lakh crore rupees is immobilized or diminished forever.

 

Various estimates put black money at between twenty-five to seventy five percent of the official GDP figures. Cash is used today for a wide range of unreported transactions. And tax rules present an easy way to launder money. I will cite from instances that I have come across over the years:

 

1. a set of professionals who accept their remuneration predominantly in cash- from the priest who comes home to the plumber, electrician, doctor, lawyer, etc who underreport income and avoid income tax, service tax etc;
2. Traders in commodities such as chemicals, paper, pharmaceuticals, metals, hardware, etc who sell and buy a large part in cash;

• Corporates that sell part of their daily produce in cash- could be FMCG, pharma or even engineering products;

1. And the rent seekers- the politician, the government employee, the cop, the registrar’s office, etc.
2. Dealers in gold and jewelry – people buy crores worth in cash.. I have seen government servants buy a few crore worth of precious stones in a matter of minutes;
3. The Real Estate sector- from the buyer to the myriad agencies involved in giving clearances and for letting the builder violate the rules. Probably the biggest source of black money generation;

• And of course, we all hear of politicians who become big time industrialists and landlords.

 

I know the list is not exhaustive. Except the salaried person, everyone has some element of money that evades taxation and would be called as ‘black money’. Even the salaried have some tax-avoided money such as the Sodexho vouchers or the non-existent Gardener salary or the birthday bash that was positioned as ‘Business conference’.

 

The other big cause for the parallel economy to flourish is the politicians’ need to spend to get power and retain it. And then, we have those who game the system. Gold plated projects, borrowed money and a default, which never used to be pursued.

 

From benign and participative tolerance, Mr Modi has taken a stance of grabbing the issue by its scruff. The chase for the NPA was the first sign. Now this move is the second blow. And in the meanwhile, much as we hate it, the Seventh Pay Commission has made government salaries substantial enough that there is no excuse for graft.

 

So, will this one act eliminate the parallel economy? No. But it will be a big nail in the coffin. The biggest hit would probably be the political parties who use hard cash to fund their elections. Govt officials / Real Estate players will take a hit and a cascading impact could be more loan losses for the banking sector. Gold & jewelry dealers would be stuck with some working capital. Professionals would not be facing big problems. Most of those with recurring and regular unaccounted money would have converted the flow in to other assets. Real Estate & Gold has been the favourite of most Indians.

 

There is a big positive impact. A lot of money from the parallel system will flow back in to the main economy. There could be some short term deflationary impact as people re-adjust to the new system with the realization that black money could be dangerous to wealth. Will it reduce corruption? There is clearly no shortage of ways. New currency note of Rs.2000 is being introduced. Counterfeiters will take time to get in to the act. So maybe we will slip in to a new regime where some series of currencies will expire and get demonetized.

 

On the political arena, it would be advantage BJP. They would certainly have had prior knowledge and shifted their financial planning accordingly. Other parties would be stuck with the horde of currency.

 

The biggest gain would accrue to the RBI. All currency notes not surrendered, would be permanent write off of liability. The RBI can theoretically use to pay this as a dividend to GOI, but it would be poor governance. Clever accounting can use this to reduce fiscal deficit, but it would be foolish. There would be some miscalculating people who would deposit more cash and end up paying taxes and penalty on ‘concealed’ income. That would be an addition to the exchequer.

 

Corruption is an enduring trait for humanity. However, the man on the street is more bothered about the petty corruption in the day to day dealings or the corruption by the RTO, the ration shops and government offices.

 

I hope that the government pushes people to higher compliance. Maybe charge a five or ten percent income tax on all salaries, no exemptions. That would reduce administrative costs and improve collections. And now the talks on the new GST with multiple rates will also leave room for graft. The ‘exemptions’ are the culprit, since powers to ‘exempt’ or to move items from one rate to another, are possible with enticement. So every system has an inbuilt scope for corruption.

 

Gold is another big conduit. Government has shown an unwillingness to address this segment. Like gold, Real Estate is another big area. People buy land/houses etc under Powers of Attorney and do not register the transfer. This hides true ownership. If P/A can be restricted or abolished, it would be another blow.

 

It is a very long battle against corruption. Mr Modi has to fight within his party too, I am sure. But this is a good beginning. If he also makes punishment severe enough ( like a minimum imprisonment of ten years to bribe givers/receivers, concealment of income ) we can see corruption coming down. Will he take this to a logical conclusion?