Black Money

Why Demonetise Without Any Estimate of Black Money?

rupee

The prime minister Narendra Modi communicated the decision to demonetise Rs 500 and Rs 1,000 notes to the nation, on the evening of November 8, 2016. The idea was to tackle black money as well as fake notes.

As the government press release accompanying the decision said: “ Use of high denomination notes for storage of unaccounted wealth[black money] has been evident from cash recoveries made by law enforcement agencies from time to time. High denomination notes are known to facilitate generation of black money.”

Between then and now, a lot of analysis has happened on how much black money the government will be able to bring back in the public domain. And once the money is back in the public domain, how much money the government will be able to earn by taxing it.

Many economists and analysts have written research reports on this. These research reports have been turned into WhatsApp forwards which have been widely shared. People have passionately argued on WhatsApp groups, Facebook, Twitter and even in personal communications, as to how successful the demonetisation decision will eventually turn out for the government and in turn, for the nation.

Often big diagrams and flow-charts have been made as to show the thousands of crore that will come into the government kitty, at the end of the day. Any analysis along these lines starts with a basic assumption around the total amount of black money that the Indian financial system has. Black money is the money which has been earned through legal as well as illegal means but on which taxes have not been paid.

As it turns out that the government has no estimation of the total amount of black money in the financial system. This is something that the finance minister Arun Jaitley told the Lok Sabha in a written reply to a question that had been asked by Anant Kumar Hegde, a BJP Lok Sabha MP from Karnataka.

As Jaitley said: “There is no official estimation of the amount of black money either before or after the Government’s decision of 8th November 2016 declaring that bank notes of denominations of the existing series of the value of five hundred rupees and one thousand rupees shall cease to be legal tender with effect from 9th November 2016.”

What does this mean? It basically means that while taking the decision to demonetise Rs 500 and Rs 1,000 notes, the Modi government did not take into account any estimate of the total amount of black money in the Indian financial system. It further means that the government has no idea of how much money it expects to gain through this entire manoeuvre.

It is amazing that such a huge decision that impacts every citizen of this country was made, even without taking a basic estimate of black money into account. Of course, all big decisions in life, require some leap of faith. The perfect data and the perfect conditions are never there. But at the same time there should be some analytical basis to them as well. There must be some expectations of a payoff for the government that will make it worth all the trouble that the people of India have been be put through.

The surprising thing is that in 2011, the Congress-led UPA government had asked three institutes, the National Institute of Public Finance and Policy (NIPFP), the National Institute of Financial Management (NIFM) and the National Council of Applied Economic Research (NCAER), to estimate the total amount of black money in India.

An October 2016 PTI newsreport points out that: “Replying to an RTI query, the Ministry said study reports of NIPFP, NCAER and NIFM were received by the government on December 30, 2013, July 18, 2014 and August 21, 2014 respectively.”

The reports from these institutes have still not been put up in the public domain. “Reports received from these institutes are under examination of the government,” Finance Minister Jaitley had told the Rajya Sabha in May 2015.

Hence, the government has access to three estimates of black money. There must be some explanation behind why it chose not to take any of these reports into account while deciding to demonetise high denomination notes.

In fact, in May 2015, Jaitley had also told the Rajya Sabha: “There is no official estimation regarding the amount of black money generated in the country. Varying estimations of the amount of black money have been reported by different persons/institutions. Such estimations are based upon different sets of facts, data, methods, assumptions, etc. leading to varying inferences. However, sectoral analysis of seizure of valuables and admission of undisclosed income in the searches conducted by the Income Tax Department in the last three financial years indicates that the main sectors in this regard are real estate, trading & manufacturing, contractors, gems & jewellery, services [emphasis added], etc.”

To conclude, the question is how did the government decide to go about to demonetise Rs 500 and Rs 1,000 notes, and put the citizens of this country through great trouble, without even having a basic estimate of black money in place. On what pretext was such a disruptive decision made? This is a question that Modi and Jaitley need to answer to this nation.

The column originally appeared in Equitymaster on December 19, 2016

 

4 Things Modi Could Have Done Instead of Demonetisation

narendra_modi

The decision to demonetise Rs 500 and Rs 1,000 notes when it was first announced was to tackle black money and fake currency. As the ministry of finance press release accompanying the decision said: “High denomination notes are known to facilitate generation of black money”.

What the Modi government was essentially saying is that it is easier to store black money in the form of high denomination notes. Having demonetised Rs 500 and Rs 1,000 notes, the government decided to launch a Rs 2,000 note, going precisely against its own statement.

The assumption was that people had stored black money in their homes in the form of cash. And by demonetising Rs 500 and Rs 1,000 notes, these notes would be rendered useless. Holders of black money in the form of currency would deposit it into banks and post offices, for the fear of generating an audit trail. Demonetised currency can be deposited into banks and post offices up to December 30, 2016. This money will be credited into the bank account or the post office savings account.

Things haven’t turned out like that. By December 6, 2016, close to 75 per cent of the demonetised currency had already made it back into the banks. Government officials are now saying that they expect almost all the demonetised currency to come back to the banks.

What this essentially means is that those who had black money in the form of cash have managed to get it converted into currency which continues to be legal tender. The hope now is that the government will use information technology to identify people who have deposited their black money into banks, tax them and raise some money in the process.

To what extent this happens remains to be seen. Nevertheless, if the idea was to attack black money in India, there are four things that the Modi government could have done, instead of demonetising high denomination notes and disrupting the entire economy. This would have hit at the heart of the nexus between politicians and builders, which thrives on black money.

1) Stop cash donations to political parties: Currently, political parties need to declare a donation only if it is greater than Rs 20,000. In 2014-2015, 55 per cent of the donation of the national political parties came from those making donations of Rs 20,000 or lower. Hence, the details of these donors are unknown.

If citizens are expected to share their identity with the bank or the post office while depositing their demonetised notes, why should donors of political parties be allowed to hide behind an archaic law, is a question worth asking. This needs to change.

2) Political parties should be brought under Right to Information(RTI): This is currently not the case. If the political parties are brought under the ambit of RTI, they will have to function in a much more transparent way in comparison to what they do now. This would mean keeping proper records of where the funds to finance them are coming from.

3) Real estate should be brought under the Goods and Services Tax(GST): If real estate is brought under GST, builders if they want to claim input tax credit must request documentation from all the suppliers and the contractors that they work with. This will hopefully start cleaning up the real estate business as more and more builders will have to operate through legitimate means. Once they stop using cash in dealings with their suppliers, their proclivity to ask for cash from their customers will also go down.

4) Slash stamp duty rates on real estate transactions: This is one reason why the real estate sector is at the heart of black money. If stamp duties across states are reduced and brought to realistic level, the tendency of people to under-declare the value of real estate transactions will come down. Hence, the proportion of cash transactions will come down.

These four moves would have hit at the heart of the generation of black money. What the government chose to do instead was to demonetise Rs 500 and Rs 1,000 notes, and throw the entire country in a huge disarray.

The column originally appeared in Bangalore Mirror on December 14, 2016

 

Demonetisation: How Much of Black Money is in Cash

rupee

One of the original aims of demonetisation was to eliminate “Black Money which casts a long shadow of parallel economy on our real economy.”

Since then through some deft marketing, the prime minister Narendra Modi has shifted the goal of demonetisation towards going cashless and digital payments. Nevertheless, given the fact that demonetisation of Rs 500 and Rs 1,000 notes was carried out to curb black money, it is worth asking how much black money did Indians hold in the form of cash.

Black money is essentially money which has been earned through legal as well as illegal means but on which tax has not been paid. It is also important to understand that people do not hold all their black money in the form of cash in their homes. They convert it into gold and real estate, and move it abroad to tax havens. From there it comes back through Foreign Institutional Investors(FIIs) and is invested in the stock market as well as debt market.

Hence, black money can be held in several forms. From real estate to gold to bonds to stocks. And of course, cash as well. The idea behind demonetising Rs 500 and Rs 1,000 notes was to hurt those who stored black money in the form of cash.

As the government press release accompanying the demonetisation decision pointed out: “Use of high denomination notes for storage of unaccounted wealth has been evident from cash recoveries made by law enforcement agencies from time to time. High denomination notes are known to facilitate generation of black money.”

This essentially leads to the question what portion of black money was held in the form of cash. In May 2012, the finance ministry released a White Paper on Black Money. And that had some very interesting data points. Take a look at the Table 1 below, which deals with the search and seizure operations carried out by the income tax department.

Table 1: Value of assets seized (in Rs. Crore)

YearCashJewelleryOther assetsTotal Undisclosed Income
Admitted (in Rs Crore)
2006-07187.4899.1977.963,612.89
2007-08206.35128.0793.394,160.58
2008-09339.86122.1888.194,613.06
2009-10300.97132.20530.338,101.35
2010-11440.28184.15150.5510,649.16
2011-12499.91271.40134.309,289.43

Source: White Paper on Black MoneyThe cash seized at the time the search and seizure operations were carried out by the income tax department, is a small portion of the total undisclosed income. This becomes clear from Table 2.

Table 2:

YearCashTotal Undisclosed Income
Admitted (in Rs Crore)		Proportion of cash in total
undisclosed wealth
2006-07187.483,612.895.2%
2007-08206.354,160.585.0%
2008-09339.864,613.067.4%
2009-10300.978,101.353.7%
2010-11440.2810,649.164.1%
2011-12499.919,289.435.4%
Total1,974.8540,426.474.9%

Source: Author calculations based on White Paper on Black Money 

If we look at data for the period of six years of close to 24,000 seizure and search operations, cash formed 4.9 per cent of the undisclosed wealth. Also, the proportion varied from 3.7 per cent to 7.4 per cent over the years.

What this data tells us is that people who have black money do not store it in the form of cash. There are better ways of storing that wealth.

The next question that crops up here is that what is the total amount of black money in India. The official sources of the total amount of black money in the economy as a proportion of Indian GDP are very old. Take a look at Table 3.

Table 3:

YearBlack money as a
percent of GDP
1975-197615 to 18
1980-198118 to 21
1983-198419 to 21

NIPFP estimate. Source: White Paper on Black Money. 

As the White Paper on Black Money published in May 2012 points out: “The last official study for estimating black money generation was conducted at the behest of the Ministry of Finance by the NIPFP [National Institute of Public Finance and Policy] in 1985.”

In 2010, the World Bank came up with estimates of the size of black money in India between 1999 and 2007. Take a look at Table 4.

Table 4:

YearBlack money as a
percent of GDP
199923.2
200023.1
200122.8
200222.6
200322.3
200422.0
200521.7
200621.2
200720.7

Source: World Bank 

Both the White Paper on Black Money and the recent press release on demonetisation refer to these data points. But they end up flipping the figures. As the press release on demonetisation points out: “The World Bank in July, 2010 estimated the size of the shadow economy for India at 20.7% of the GDP in 1999 and rising to 23.2% in 2007.” As can be seen from Table 4, this is exactly the opposite of the World Bank figures.

I wonder how a mistake of this kind can be made in the case of something as important as demonetisation is. I guess what must have happened is that the Babu drafting the demonetisation press release must have lifted the figures straight from the White Paper on Black Money, which had them wrong in the first place.

Anyway, the nit-picking aside, what these data points clearly tell us is that the black money in India amounts to around one-fifth of the GDP. The Indian Gross Domestic Product (current prices) for 2015-2016 stood at Rs 135.76 lakh crore. Hence, the total amount of black money amounts to Rs 27.15 lakh crore, using these estimates.

Data from the search and seizure operations of the Income Tax Department tells us that black money in the form of cash forms just 4.9 per cent of the total black money. This means that the total black money in the form of cash amounts to Rs 1.33 lakh crore (4.9 per cent of Rs 27.15 lakh crore). This is the money that the government is going after through demonetisation.

The question is, is this worth all the trouble? Take a look at Table 5.

Table 5: Recovery of Black Money

Financial yearSeized assets
(in Rs. Crore)		Undisclosed income
(in Rs. Crore)
2015-2016(up to November 2015)4706,167
2014-201576210,288
2013-201480810,792
2012-201357510,292
2011-201290614,017
2010-201177510,649
2009-20109648,101

Source: Annual reports, Ministry of Finance. 

Table 5 clearly shows the limited abilities of the Income Tax Department when it comes to digging up black money in the economy. Even if we ignore this and assume that this time around given the government focus, the Income Tax Department will be able to do better, the question is how much better?

The total amount of black money in the form of cash amounts to Rs 1.33 lakh crore. If the government can recover 50 per cent of this, by taxing it, it amounts to around Rs 66,000 crore. The fall in GDP growth because of demonetisation will turn out to be much greater than this. The Centre for Monitoring Indian Economy estimates that just the transaction cost of demonetisation will amount to Rs 1.28 lakh crore.

To conclude, this brings us back to the question, whether all this was worth the trouble?

The column originally appeared on Equitymaster on December 13, 2016.

Dear RBI, It’s Not About Hoarding Notes, It’s About Shortage of Cash

RBI-Logo_8

In the press conference that followed the monetary policy on December 7, 2016, R Gandhi, one of the deputy governors of the Reserve Bank of India(RBI), said: “We reiterate that there is adequate supply of notes and hoarding of notes helps nobody’s cause.”

The impression that the RBI is trying to create is that all is well and that it is the hoarders are responsible for the mess that prevails on the cash front, all through the country. But is that really the case?

In a press release dated December 8, 2016, the RBI said: “During the period from November 10, 2016 and December 7, 2016, banks have reported that banknotes worth Rs 4,27,684 crore have been issued to public either over the counter or through ATMs.”

The total value of the Rs 500 and the Rs 1,000 demonetised notes amount to Rs 15.44 lakh crore. Hence, the notes replaced amount to close to 27.7 per cent of the demonetised notes. Before the notes had been demonetised the total value of currency stood at Rs 17.87 lakh crore. This basically means that around 23.9 per cent of the currency that was in circulation before demonetisation has been replaced.

Hence, around one-fourth of the currency is back in circulation. The question is why doesn’t it feel like one-fourth? Why does it continue to be difficult to carry out cash transactions? The answer is straightforward.

To replace the Rs 500 and Rs 1,000 demonetised notes, the government printed the Rs 2,000 note, first. This means that there is no note between Rs 100 and Rs 2,000. Hence, every time one tries to spend the Rs 2,000 note, it is tough going because the other party simply doesn’t have enough change going around.

This, despite the fact that the RBI has supplied: “lower denomination of the notes, that is Rs 100, Rs 50, Rs 20 and Rs 10… over its counters,” as well. In fact, it has supplied 19.1 billion pieces of denomination of these notes over the last one month. As deputy governor Gandhi put it “This is more than what the Reserve Bank had supplied to the public in the whole of the last three years.”

While the RBI said that a total of 19.1 billion pieces of notes of small denomination were printed, it doesn’t provide us with a breakdown of numbers. It doesn’t tell us how many Rs 100 notes were printed, how many Rs 50 notes were printed and so on. Hence, there is no way of finding out the total value of these notes that had been printed.

Nevertheless, it is safe to say that the total value of the lower denomination notes printed and pumped into the economy, would essentially amount to around 5-6 per cent of the total currency in circulation before demonetisation. Hence, the bulk of the notes printed have been Rs 2,000 notes. Given this, there isn’t enough change going around, which means even those who have Rs 2,000 notes are finding it very difficult to use it.

What this means is that the 23.9 per cent figure of the total amount of currency replaced in comparison to the currency in circulation before November 8, 2016, when demonetisation was carried out, is overstated to that extent.

There is another problem with the Rs 2,000 note. There is a huge rumour going around that it has been launched as a stop-gap arrangement and is likely to be demonetised soon. This rumour perhaps comes from what was mentioned in the press release accompanying the demonetisation decision. As the press release said: “High denomination notes are known to facilitate generation of black money… Infusion of Rs 2,000/- bank notes will be monitored and regulated by RBI.” It is well worth remembering that the original motive of demonetisation was to tackle black money and fake notes.

How will the situation play out in the days to come? Will things improve by the end of this month as the prime minister has repeatedly told the nation? As Urjit Patel said during the course of the monetary policy press conference: “What we have done over the last two weeks is recalibrated our production towards the 500 and the 100.” This is going to improve the situation a little, given that as more 500s hit the market, the chances of the 2000s being accepted will also go up, as more change becomes available.

Having said that it will take some time for the situation to get back to normal. With 500s and 100s being printed the rate of currency replacement will slow down. It takes four 500 rupee notes to replace the currency that one 2000 rupee could.

Further, it is worth remembering here that the capacity of the printing presses supplying RBI with notes is around 300 crore notes per month. This, when the presses work 24 hours a day and for the full month.

The total number of 500 rupee notes demonetised stand at 1716.5 crore. At 300 crore notes a month, it will easily take five to six months to replace the total lot. Even if all the notes are not printed, given the push towards cashless, it will be a while before there is enough cash going around in the economy.

Hence, the point is that people are not hoarding cash. There simply isn’t enough cash going around. But what about all the raids all across the country and the cash being found during these operations? Isn’t that hoarding cash? Yes. Nevertheless, these seizures at best amount to a few hundred crore, which is a minuscule part of the overall currency that has been printed and pumped into the economy. At times, one does get excited looking at absolute numbers, but to put things in a proper perspective, it always makes sense to look at percentages.

To conclude, currency or cash is not the only form of money going around. There are other forms as well. Nevertheless, for a country where 98 per cent of the consumer transactions happen in cash, cash remains the major form of money. How difficult it is to understand this basic fact?

The column originally appeared on Equitymaster on December 12, 2016

Demonetisation and the Mystery of Rs 3 Lakh Crore

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As soon as prime minister Narendra Modi announced the decision to demonetise Rs 500 and Rs 1,000 notes, the analysis of the decision started.

Any such analysis needed the total amount of black money held in the form of cash. Of course, no one knew the right answer to the total amount of black money held in the form of cash by Indians. So, assumptions were made. The one assumption that many analysts and economists ended up making was that 20 per cent of the demonetised notes were black money held in the form of cash.

The 20 per cent figure was just assumed. No explanations were offered for it. It was probably because it was not too big nor too small. And gradually almost everyone who was analysing the issue was using it. But where did the number come from? Or was it just a case of a case of circular mill of ants, where the analysts and economists writing later, just followed the assumptions of the ones who had already written on the topic.

Here is how the argument worked. The total value of demonetised notes stood at Rs 15.44 lakh crore. Let’s assume that 20 per cent of the demonetised notes are black money held in the form of cash. This implies that around Rs 3 lakh crore is black money held in the form of cash.

This money will not be deposited into banks because it is black money (which has turned out to be a totally naive assumption) because any black money deposited into banks would generate an audit trail for the income tax department. Further, every rupee out there is a liability for the Reserve Bank of India(RBI). If Rs 3 lakh crore of demonetised notes do not make it back to the banks, then the liability of RBI shrinks to that extent.

If the liability side of the balance sheet of the RBI shrinks by Rs 3 lakh crore, the asset side needs to shrink as well. And that implies that the RBI would give a special dividend of Rs 3 lakh crore to the central government.

Many economists wrote long reports on this. The long reports led to some editorials as well (including one by an editor who I tremendously respect). These reports were then turned into WhatsApp forwards and passionate discussions happened around it.

In the press conference following the monetary policy on December 7, 2016, the RBI governor Urjit Patel, put the special dividend theory to rest. He clarified that just because the notes don’t come back to the RBI, it does not mean that the liability of the RBI will come to an end. As he said: “They still carry the RBI’s liability as long as only the legal tender characteristic is withdrawn.”

But the question of where did the 20 per cent assumption come from, remains. Could a better assumption have been made?

In May 2012, the finance ministry released a White Paper on Black Money. And that had some very interesting data points. Take a look at the Table 1 below, which deals with the search and seizure operations carried out by the income tax department.

Table 1: Value of assets seized (in Rs. Crore)

YearCashJewelleryOther assetsTotal Undisclosed Income Admitted
(in Rs Crore)
2006-07187.4899.1977.963,612.89
2007-08206.35128.0793.394,160.58
2008-09339.86122.1888.194,613.06
2009-10300.97132.2530.338,101.35
2010-11440.28184.15150.5510,649.16
2011-12499.91271.4134.39,289.43

Source: White Paper on Black MoneyThe cash seized at the time the search and seizure operations were carried out by the income tax department, is a minuscule portion of the total undisclosed income. This becomes clear from Table 2.

Table 2:

YearCashTotal Undisclosed Income Admitted (in Rs Crore)Proportion of cash in total undisclosed wealth
2006-07187.483,612.895.2%
2007-08206.354,160.585.0%
2008-09339.864,613.067.4%
2009-10300.978,101.353.7%
2010-11440.2810,649.164.1%
2011-12499.919,289.435.4%
Total1,974.8540,426.474.9%

Source: Author calculationsIf we look at data for the period of six years of close to 24,000 seizure and search operations, cash formed around 5 per cent of the undisclosed wealth. Also, the proportion varied from 3.7 per cent to 7.4 per cent over the years.

There are multiple things that this data tells us. First, that people who have black money do not store it in the form of cash. There are better ways of storing that wealth. And more importantly, the government had this information. In fact, the government would have updated information on this and not just to 2011-12.

Second, assuming that 20 per cent of the demonetised notes were black money held in the form of cash, was a terribly wrong assumption to make. This also explains why so much demonetised money has already come into the banks.

In the press conference following the monetary policy of December 7, R Gandhi, one of the deputy governors of the RBI said that close to Rs 11.55 crore of demonetised notes had already made it back to the banks. This amounts to close to 75 per cent of the demonetised notes. Of course, some black money has been converted into white in the process as well. Nevertheless, what Table 2 tells us very clearly is that very little black money is held in the form of cash. Hence, what is coming back to the banks is largely white money.

What this clearly tells us is if the analysts and economists hadn’t worked with the 20 per cent figure of black money held in the form of cash, they would have never come up with the Rs 3 lakh crore special dividend that the RBI would pay the government.

If they had assumed a 5 per cent figure (as per the White Paper) they would have come up with a special dividend of around Rs 77,000 crore (5 per cent of Rs 15.44 lakh crore of demonetised notes). And Rs 77,000 crore sounds nowhere as sexy as Rs 3 lakh crore.

I guess that explains everything.

The column originally appeared on December 9, 2016.