Demonetisation as I understand it.
By Anand Thakoor
I am not an expert in economics or finance but would attempt to give my understanding of the current demonetisation exercise. I do not have access to any statistics and hence figures in the narrative are only my estimates.
To understand the process we need to split it into intended purpose and the various effects in the immediate (upto 15 days), short term (6 months), medium term (1 year) and long term (over 1 year) for various groups of people, businesses, etc.
A good place to start is a look at the last demonetisation. In 1978 PM Mr. Morarji Desai demonetised the 1000, 5000 & 10000 rupee notes. Yes there were 10,000 rupee notes. In those days well over 95% of the population had never even seen a 10,000 re note, leave alone handled it. Even the 1000 re note was not common so over 90% of the population were not affected by the demonetisation.
Fake currency hardly existed in the high denomination sector, Cross border terror did not exist, some militancy in the north-east and naxal groups were there, but they hardly used the above notes. The main purpose thus was only so called ‘Black Money’. It was not a digital world and all records were on paper. Aadhar or similar id’s were not there and even the PAN number had not started. Property was sold with just 30~40% white and upto 70% black component. Similarly almost all trade had a large black component. Altering or missing records was no big deal. Media was not as active, more so as communication was poor.
Thus when the demonetisation was done, almost all could manage to change their demonetised notes by some means or another. Some notes were burnt or destroyed and that was the small gain for the govt. Some money came into the banking system, but hardly anything. There was no follow-up action and soon the so called black money was back and growing. Therefore on the whole, the operation was a total failure.
Now coming to 2016. It can safely be said that over 99% of the adult population in India have at some time or the other possessed a 500 re note. Thus the demonetisation will affect 100% of the population.
Let us consider the intended purpose.
Fake currency – This takes a direct hit. The full stock becomes useless. Full immediate and short term gain, medium to long term gain will depend on follow up action.
Cross border terror – Infiltration is mainly funded from the other side so little direct effect, but there is dependence on local assistance and safe houses which takes a hit without cash so terror strikes may not be so successful. Sleeper cells will find it difficult to activate and if not funded will wilt in some time. Instigation for local disturbance will be largely hit as it strongly depends on cash incentive. Will give short to medium term relief which should be used to quickly develop employment and positivity. Strictly shut of funds to instigators by any means.
North-east militancy – This has a fair amount of ideological conviction resulting from years of neglect. Cash crunch will give good breathing space. Clean government, quick development, good border management with Bangladesh and Myanmar will convert most. The final few will require more pro-active counselling with carrot and stick.
Naxal movement – This started with noble goals of justice for tribal people but over time degenerated to a level where, for sustenance of the movement they were feeding on the blood of the very tribal people who they were fighting for. The vicious circle is that without peace there is no development and without development there is no peace. Cash crunch will again give good breathing time and if the fund supply can be controlled for long, then the movement will die out. This should be used for rapid health care, education and employment generation.
Black Money – This is the most complex part. There are various types of black money some of which is not so black. Each requires different treatment and affects different groups of people and businesses. There is some overlap in black money and all of the above. Let us first divide black money in 2 groups. 1. Black money from crime & 2. Black money from evasion. Other groups are ‘Dead Money’ which may or may not be black but is hoarded and thus out of circulation, and there is ‘Unaccounted Money’ which is in circulation in cash but out of the formal banking system and having no record, such as with hawkers, small vendors, domestic help and other service providers, unorganised labour etc.
Black money from crime can be sub-dived into money from violent crime such as bank and cash van robbery, looting, chain snatching, burglary, theft, vehicle or commodity theft, kidnapping, ransom, blackmail, enforced prostitution, smuggling, drugs, making and dealing in illegal weapons bombs etc., supari killings, paid violence etc.
Money from non-violent crime fraud, debit/credit card & bank account hacking, conning, chit fund scams, bribery, etc. In all black money from crime there is an adversely affected person or persons.
Immediate to short term effect – Small timers may get away, big guns will lose some to bulk of their cash stack.
Medium to long term – May limp back to old ways if nothing is done.
Action required – Making large cash transactions very difficult without digital trail. (partly in progress) and quick prosecution of criminals.
Black money from evasion – This is legal money but converted to black to avoid taxes such as Income Tax, Sales Tax, Service Tax, Capital Gains Tax, Stamp Duty, Import/Export Duty, Excise Duty etc. In this category other than the govt. no other person is affected and so these cases normally do not land up in court. For example: Say a professional (employees have TDS) earns Rs. 1 Cr per year. At 30% his I.Tax is Rs. 30 Lakhs. He declares only 50 lakhs income and pays 15 lakhs as tax. In the tax office he pays Rs. 5 lakhs as bribe to ensure no enquiry. He has generated Rs. 5 lakhs as black money from crime and Rs. 45 lakhs as black money from evasion. As can be seen this is the area where large chunks of black money is generated, which does not go in the formal banking system. This is also the area where a very large population is, in big or small ways involved and thus all will point fingers but no one really wants to bell the cat. All political parties, builders, Bollywood & entertainment industry, doctors, lawyers and almost all non-salaried class have some skeletons in the cupboard.
Therefore PM Modi has taken a very bold step which will ruffle a large part of the population, including many in the BJP and to some extent the BJP also.
Immediate to short term effect – As above, the small timers may get away with little to no loss but will get the message. Big guns will try all means to paint the money but those with large stacks will lose bulk of it. (Big guns need not mean industrialists. Core business of big industry does not work on cash. A car maker does not pay his work force in cash and cars are not sold in cash.)
Medium to long term – Many will get the message and avoid evasion if the tax rates change, although some may still go back to old ways.
Indians are by nature not criminal minded if the system supports them. There is a good example for this. Mumbai can be considered as a mini India as it has people from all regions, languages, religions, castes and economic class. If we recollect the few days after 26th July 2005 when the devastating floods Mumbai took place, the city was bad shape with almost all houses, shops, offices, industries etc. lying open. Strangely in those few days there were no major cases of looting, theft, molestation house brake etc. even though the law enforcement was almost non-existent. Shortly after the Mumbai floods, there was hurricane Katrina in south-eastern USA, with similar effect. It should be noted that the few days after had large scale looting and theft from shops and homes left open. This is a point to ponder.
Therefore action required to control black money from evasion – Drastically reduce taxes especially Income Tax, Capital gains Tax and Stamp duty. (Sales Tax and Service Tax will be replaced with GST) It can be done in stages, but the first stage should cut it by at least 30~40%.
Finally the common man standing outside banks – There has been a panic created by the pessimists and doomsday sooth sayers that the world is about to end. These are fed by politicians and so-called economic experts. The media is known to always feed on negativity. The result is a hoarding of low denomination notes well beyond the requirement by those who could get it, and thereby leaving the less fortunate to suffer. With more currency coming in the situation will improve, but in the meantime stop hoarding and circulate low denomination notes especially to the weaker sections of society.
The author is a citizen of India.