Demonetisation and the Mystery of Rs 3 Lakh Crore

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)

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

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.

Why Modi Govt’s Latest Spin on Black Money Doesn’t Make Much Sense


Late last week it was reported that the amount of money held by Indians in Swiss Banks has come down. After the news came out, it was said that this reflects the success of the Narendra Modi government’s policy on black money.

As The Economic Times reported: “India’s drive against black money seems to have yielded some results with the latest Swiss National Bank (SNB) data showing a sharp decline in Indian deposits in 2015, the year New Delhi enacted a tough law.”  The Press Trust of India, reported the Revenue Secretary Hasmukh Adhia as saying that the “the data indicated the government’s steps to recover black money were in the right direction.”

Sambit Patra, the national spokesperson of the Bhartiya Janata Party claimed the same on Twitter, when he tweeted: “What #ModiGovt has done against Black Money!!-India slides to 75th slot on Swiss bank money list.”

But as we shall see, this is nothing more than marketing spin.

For a tax haven, Switzerland is very open about the total amount of money that has come from different countries and is with Swiss Banks. The Swiss National Bank has been declaring this data for a long time. Take a look at the following table. This shows the total money that Indians have in Swiss banks.


YearIndian money in Swiss banks (in Swiss francs)
Source: Swiss National Bank 


So Indian money in Swiss banks in 2015 stood at around 1.207 billion Swiss francs. This is the lowest in 20 years. So doesn’t that make it an achievement for the Modi government? Doesn’t it mean that the Modi government’s crackdown on black money has been successful? Not really.

The advantage of looking at data across a very long period of time is that it doesn’t bluff. As we can see from the above table, Indian money in Swiss banks peaked in 2006, when it was at around 4.99 billion Swiss francs. The trend has been largely downward since then. In fact, the biggest fall in absolute terms came between 2006 and 2007. In 2007, Indian money in Swiss banks fell to 2.92 billion Swiss francs.

Back then Narendra Modi was the chief minister of Gujarat and Manmohan Singh was the prime minister of India. So does that mean Manmohan Singh did better than Narendra Modi? The answer again is no. In fact, the Indian money in Swiss banks fell dramatically between 2007 and 2008, and even between 2011 and 2012. All these times, Manmohan Singh was the prime minister.

The total amount of Indian money in Swiss banks coming down doesn’t indicate the success of India’s politicians in tackling black money. Black money is essentially money which has been earned but on which tax has not been paid. Firstly, not all Indian money in Swiss banks is necessarily black money. Individuals are allowed out to take some money out of the country, every year.

Take a look at the data carefully. The total amount of Indian money in Swiss banks started to fall in 2006. Since then, the amount has largely had a downward trend and is now at a 20-year low. In fact, 2005-2006 was the time when the Indian economy was really taking off. The stock market as well as the real estate market were both doing well.

What the initial fall clearly indicates is that a lot of black money that had left India simply came back to India. In fact, the Finance Ministry’s White Paper on black money published in 2012, makes this point: “The two topmost sources of the cumulative inflows from April 2000 to March 2011 are Mauritius (41.80 per cent) and Singapore (9.17 per cent). Mauritius and Singapore with their small economies cannot be the sources of such huge investments and it is apparent that the investments are routed through these jurisdictions for avoidance of taxes and/or for concealing the identities from the revenue authorities of the ultimate investors, many of whom could actually be Indian residents, who have invested in their own companies, though a process known as round-tripping.”

A similar sort of round-tripping also happens in the stock market through an instrument known as participatory notes (PNs). As the White Paper points out: “Investment in the Indian Stock Market through PNs is another way in which the black money generated by Indians is re-invested in India. PNs or overseas derivative instruments (ODIs) are issued by FIIs [foreign institutional investors] against underlying Indian securities, which can be equity, debt, derivatives, or even indices. The investor in PNs does not hold the Indian securities in her/his own name. These are legally held by the FIIs, but s/he derives economic benefits from fluctuation in prices of the Indian securities, as also dividends and capital gains, through specifically designed contracts.”

Hence, the fall in Indian money held in Swiss bank accounts simply indicates that a significant part of this money has come back to India. Further, between 2005 and 2011, the real estate market was going great guns. Hence, it is safe to say that a lot of black money which would have otherwise left the country, continued to stay in India and found its way into real estate. This is now reflected in the lakhs of home which have been bought and lie locked all across the country.

It also needs to be pointed out here that since 2008, after the start of the financial crisis, the fixed income returns in Western financial markets have been very low. That is another explanation of why a lot of black money may not have left India.

Further, there is this huge misconception that people have, that all the black money in the world goes to the Swiss banks. While this was correct until a few decades back, this isn’t true anymore. The world now is full of tax havens. There are around 70 tax havens all over the world and the black money that has left the shores of India can be almost anywhere in the world. It need not necessarily be in Switzerland.

While Switzerland was the original tax haven where people who did not want to pay tax in their home countries, took their money to, things have changed since the 1980s. New tax havens like Singapore, the Bahamas, Luxembourg, Hong Kong etc., have emerged over the years.

As Gabriel Zucman writes in The Hidden Wealth of Nations—The Scourge of Tax Havens: “In all these tax havens, private bankers do the same things as in Geneva: they hold stock and bond portfolios for their foreign customers, collect dividends and interest, provide investment advice as well as other services, such as the possibility of having a current account that earns little or nothing. And, thanks to the limited forms of cooperation with foreign tax authorities, they all offer the same service that is in high demand: the possibility of not paying any taxes on dividends, interest, capital gains, wealth, or inheritances.”

Further, many tax havens are not open about their data, as Switzerland has been over the years. In fact, it is safe to say that the focus of the Indian government on black money over the last few years, may have made people move their money from Switzerland into other tax havens.

Hence, the point is that Indian money in Swiss banks falling, doesn’t really mean that the Modi government’s black money policy is working. If it was the success it is being made out to be then many more people would have declared the black money they have overseas, during the compliance window offered between June and September, last year.

Taking advantage of the compliance window 638 declarants declared assets and income of Rs 4,147 crore in total. This meant that the government was able to collect around Rs 2,488 crore (60% of Rs 4,147 crore) as tax revenues. This obviously is an extremely low amount.

The column was originally published in Vivek Kaul’s Diary on July 7, 2016

The Govt Should Ignore Jewellers’ Strike


The jewellers went on a strike on March 2, 2016. On March 20, it was reported that they had called off their strike after suffering losses of Rs 18,,000 crore. But that did not turn out to be the case. Media reports suggest that on March 21, a section of the jewellers continued to strike.

A PTI reports suggests that: “Most jewellery shops and establishments in the national capital remained shut on Monday despite government’s assurance that there will be no harassment by excise officials. Some jewellers kept their shops shut in Mumbai as well.”

Meanwhile the strike has caused a lot of trouble and heartburn for brides to be. A recent report in The Hindustan Times discusses the plight of women who are about to get married and do not have their gold jewellery in place. The report quotes one such bride to be as saying: “I’m hoping this strike will come to an end soon otherwise I have to go for imitation jewellery on my D-day.”

The brides to be have been left in limbo because the gold jewellers have been on a strike for close to three weeks. The jewellers are striking against an excise duty of 1% on “articles of jewellery [excluding silver jewellery, other than studded with diamonds and some other precious stones]” that the finance minister Arun Jaitley proposed in the budget of the government, for 2016-2017, that he presented last month.

The jewellers are also protesting against the mandatory quoting of the Permanent Account Number(PAN) for cash transactions of Rs 2 lakh or more. This change came into effect from January 1, 2016, and hence, has been place for well over two months. Before this, quoting the PAN was necessary for cash transactions of Rs 5 lakh or more.

Media reports now suggest that the jewellers are claiming that this change has had a huge impact on their sales. Given this, they want the Rs 5 lakh limit to be reinstated.

So what is it that the jewellers fear? They want the government to withdraw the 1% excise duty because they fear harassment by excise inspectors. While this is a legitimate concern, the government has asked excise officials not to make factory visits. A section of the jewellers called off the strike on this assurance from the government. Also, it is important to understand that the 1% duty will generate an extra audit trail.

Further, it is important to understand that gold in its various forms remains an important conduit for black money. Black money is essentially income which has been earned but on which taxes have not been paid.

As the White Paper on Black Money released by the ministry of finance in 2012 points out: “Cash sales in the gold and jewellery trade are quite common and serve two purposes. The purchase allows the buyer the option of converting black money into gold and bullion, while it gives the trader the option of keeping his unaccounted wealth in the form of stock, not disclosed in the books or valued at less than market price.”

The beauty of gold is that a lot of wealth can be stored in a very small space. A lot of black money in the form of gold can be stored in a single locker. Hence, instead of holding on to paper money the holders of black money prefer converting it into gold. Also, with gold there is no fear of wear and tear as is with paper money.

A study on black money carried out by business lobby Federation of Indian Chambers of Commerce and Industry(FICCI) points out that: “Nearly 70-80 % of the transactions involving Jewellery are made using cash (black money).” This clearly explains how those with black money like to hold their wealth in the form of gold.

As the FICCI study points out: “Undisclosed sale of gold, silver etc. results in escapement of applicable tax liabilities Tax authorities have estimated purchases of gold bullion and Jewellery as the second-largest parking space for black money, next to Real Estate.”

Given this, the move to make PAN card mandatory for cash transactions of Rs 2 lakh or more when it comes to making jewellery purchases, is an important move. If it leads to the sales of jewellers falling, then so be it. The black money wallahs might figure out alternative parking spaces for their money, but then why should the government make it easy for them? I mean you should not be able to get out of your house, walk down your street and convert your black money into gold. It has to be a little more difficult than that.

The FICCI study further points out that: “Apart from unreported cash transactions that lead to black money, jewellers (specifically small jewellers) often sell ornaments that are made using adulterated gold. This practice also contributes to black money, as the jeweller typically does not report the full profit made by selling ornaments at premium rates (when they were made using adulterated gold, which is cheaper).”

Hence, while gold jewellery is a conduit for black money, it also helps generate black money. Further, many jewellers discourage the use of plastic money and customers who want to use their credit card or debit card to make the payment, are typically asked to pay 2% extra.

One excuse offered by jewellers is that many buyers do not have a PAN card. Well, if someone is in a position to pay Rs 2 lakh or more for jewellery, I am sure he can get a PAN card made as well. It shouldn’t be that difficult.

Once these factors are taken into account, it is in the best interest of the country that more jewellers are brought under the tax ambit. And that being the case, the government should not back down on its recent moves and let the jewellers’ strike continue.

The column originally appeared in the Vivek Kaul Diary on Equitymaster on March 23, 2016