Let me say at the outset that I welcome the
demonetisation move but do not support:
· the shock and awe
approach that has caused hardships to a vast majority of citizens for the limited
benefit this may deliver (more about this later); and
· the hype and
hyperbole that this action will deliver a death blow to corruption and black
money, which it certainly will not, as the problem of corruption and
unaccounted wealth is much bigger and is not limited to hoarding of cash, which
if anything is less than 5% of total black money.
Hence, the claims by the Government that this will end the
menace of black money and corruption are simply outlandish. Also, the simultaneous
introduction of Rs 2,000 note undermines their claim and it simply does not fit
the storyline of an attack on black money and corruption.
Now, let's look at the extent of the possible real
benefits of this move.
As noted above, to say that this will deliver a death knell to corruption
and black money is a massive overstretch and a great exaggeration, and I will come
to that in a bit. But those who are going on an overdrive about this being an unprecedented
move of epic proportions and the next best thing since sliced bread, need to
read up a bit of history. This has
happened in the past in India in 1978 and again to a limited extent in 2005
when older notes were recalled but in a more orderly and sensible manner. This has also been tried in many other
countries and what these experiences tell us is that demonetisation on its own has a very limited
effect for a short while unless backed with several other measures of surveillance.
This is simply because of the fact that significant amount of black
money is held via overseas bank accounts or in offshore real assets through a
web of shell companies, a fact acknowledged earlier by the ruling party prior
to general elections (Kaala dhan videshi bankon mein jama hai!). However,
equally it’s undeniable that some portion of it is also held domestically but
bulk of this is in the form of real estate, financial assets through trusts, Gold
and some amount of it in cash. And it's the last part of this that demonetisation will address and deliver some benefit. This was also the political position of the ruling party back in 2005
when they protested against a move by the previous Government to recall
higher denomination notes. So, what are the real benefits of this move?
Let’s look at some of the specifics around expected
benefits of this demonetisation and the ways in which this may have an
impact:
1. For starters, it
will invalidate the fake notes being pumped by some of our neighbours through
Nepal and other porous borders;
2.
It will bring more
cash into the banking system, as even legitimately held cash with people will
find its way into the banks, at least for some time (until the cash withdrawal
limits are increased);
3. It will bring some amount
of unaccounted cash which may either flow back into the banks where people
simply decide to account for it and pay tax or otherwise use their extended
family and friends network to split the amounts into smaller amounts to recycle
into the banking network; and
4.
Finally, some cash
may simply be unclaimed (though highly unlikely with the Indian Jugaad system).
The benefits case
1.
Fake Currencies
The issue of fake currencies was becoming a serious menace
and this move clearly stamps it out. It will take a while for them to master
the art of new notes that have, purportedly, advanced security features. However, the immediate adverse impact of this
will be felt in the form of slower GDP growth and lower consumer spending. The positive effect may be in the form of Inflation
trending lower because of this.
2.
Cash flowing into the banking system
Irrespective of having a bank account, people
legitimately hold cash for their routine and emergency requirements. This move will result in this cash flowing
back into the bank, only to be withdrawn after a while. So this will only result in a temporary improvement
in the liquidity position of banks as it will leave once the new notes are
available and withdrawal limits are lifted. So the real benefit from this is
questionable.
However, the cash that was not previously within the
banking system will flow into it for the first time. This will lead to an increase in bank deposits
and perhaps a reasonable amount of this may stay for a longer period. To the extent of the stability of these
deposits, this may help the credit creation process. However, for the credit
creation to occur, the PSU banks that are weighed down by non-performing loans
have to be recapitalised. So,
no tangible benefit to the economy until and unless the banks are
recapitalised.
3.
Unaccounted Cash flowing back
This is potentially what the Government is really
targeting. If some element of unaccounted money finds its way back into the
system, this will help in improving the tax take and the Government stands to
benefit. Given the ingenuity of these
individuals in protecting their cash, it remains to be seen whether this yields
a big tax collection or results in just an increase in number of bank accounts
and balances as hoarders find ways to split the amounts. It has to be noted that
the recently concluded income declaration scheme in September 2016, resulted in
an income disclosure of Rs 65,000 crores ($10bn) and netted a tax take of Rs
29,000 Crores ($4.5 bn), much less than the expected hundreds of billions of
$.
4.
Unclaimed balances
And finally any unclaimed notes in circulation, a highly
unlikely scenario as people will find ways to recycle (remember, India is a
land of Jugaad), will result in a clear benefit to the RBI and the Government, as
RBI can extinguish its liabilities to this extent. This gain can be used by the RBI to pay
dividend to the Government which reduce the fiscal deficit. But this process cannot begin until next
fiscal year which is when the aggregate of unclaimed balances will be known as
RBIs window for accepting notes extends to 31st March 2017.
Now let's compare the magnitude of black money and
the minimal extent to which this action is going to address the problem.
Total money in circulation according RBI statistics
is Rs 16.4 lacs crores
($250bn if you can't get your head around that). Of this, about 86% or Rs 14.2
lacs crores ($ 215bn) is represented by Rs 500 and Rs 1,000 notes as per table
below.
According to the RBI's statistics, Scheduled Banks and other banks in
India hold about ~Rs 6 lacs Crores
($91bn) in Rs 500/Rs 1000 notes after applying the 86% on their total cash holdings to estimate the
amount held in Rs 500 and Rs1,000 notes, in their branches and ATMs.
Then you have organisations like the Railways, Post
offices, PSUs, Corporates, Petrol Pumps, Hospitals, Government offices, businesses
and traders holding cash as part of their legitimate daily activities. Assuming that the
legitimate portion of the cash holdings to be 2/3rd levels of banks (based on an
estimate that recognises that the number of corporates, traders, organisations
significantly outnumber the banks by several hundred folds), it comes to Rs 4
lacs crore ($60bn), then the remaining cash amount reduces to less than half of the total. So
that leaves the balance cash to ~Rs 4.2 lacs Crores (or $64bn). The table below
shows the estimates:
Details
|
Rs (Crores)
|
~ USD billions
|
% to total cash in circulation
|
Aggregate Money in
circulation (RBI statistics)
|
1,640,000
|
250
|
100%
|
Aggregate
Money in Rs 500 and Rs 1,000 notes (86% of total per RBI Statistics)
|
1,420,000
|
215
|
86%
|
Money held with
Scheduled Commercial Banks and other FIs includind Cash reserve ratio of Rs 5lacs Crores with RBI (Branches and ATMs) (estimated at 86% of total
cash in Rs 500/1000 notes)
|
~ 6,00,000
|
91
|
36%
|
Estimate cash with
Post Office, Corporates, Railways, Traders, Petrol Pumps, Govt. etc.
|
~ 4,00,000
|
45
|
18%
|
Estimated Balance left with individuals (surprisingly a number we associate with fraud and
cheating!)
|
~4,20,000
|
~ 64
|
26%
|
Out of the estimated amount of cash held by
individuals, we can make a reasonable split of cash held by urban and rural
folks:
·
Urban India
- Legitimately held cash for routine and emergency expenses (assuming an
average of Rs 2,500* per person for the 400 million urban population) - Rs 1 lac
crore ($15bn)
·
Rural and Semi Urban – Mainly cash users or not in the banking system -
say an average of Rs 500* for the 800 million - Rs 40,000 crores ($6bn)
(* average holdings based on research of Rama Bijapurkar - http://www.ice360.in/uploads/files/ibgc-wp14-03-bijapurkar-et-al.pdf)
So, if we adjust the legitimate amounts held by
individuals of ~Rs 1.4 lacs Crores ($21bn) from the aggregate Rs 4.2 lacs
Crores ($64bn) of balances with individuals, the net estimated amount of unaccounted cash would be ~Rs 2.8 lacs crores
or ~$ 43bn.
This is just about 2% of our GDP! Now cutting all the noise, compare this to
the total unaccounted money which was estimated to be ~$1 trillion and you can very easily see that it represents less than 5% of the black money problem!
Even if we made an overly optimistic assumption that
the entire amount of ~$43bn can be recognised as a gain either through tax take
or unclaimed balances, this would still represent only 4.3% of the
total black money problem. While
this is still a welcome development and needs to be applauded, but it needs to be kept in the context of
the magnitude of the overall problem.
So I would say to all those screaming that this will end black money that after all the noise subsides and the chest thumping is over, please realise that the black money problem is far from over! We have just scratched the surface. But the reintroduction of higher denomination notes will only make the problem worse unless further measure to curb cash transactions are introduced.
So I would say to all those screaming that this will end black money that after all the noise subsides and the chest thumping is over, please realise that the black money problem is far from over! We have just scratched the surface. But the reintroduction of higher denomination notes will only make the problem worse unless further measure to curb cash transactions are introduced.
An important point to understand that cash is
fungible. It has no permanent label as black or white.
You withdraw cash from the bank and buy a durable
without a bill to avoid GST or pay a bribe for any approval you need, it become
black. The same recipient goes with that cash to a
supermarket or a restaurant and spends it and gets a bill, it become white. So not all cash is black and not all cash is
white!!!
So the solution is not attacking cash because it
will start the day the scheme ends as people as will about their old ways.
What's required is the incentives that drive
creation of black money need to be addressed. Attacking cash is like treating the symptom than the
underlying problem!
So was the midnight strike really necessary and
worth it?
Now let’s look at the dramatic way in which this decision
was announced. The move took many by surprise and the reactions in social media
has since moved from an initial euphoria to a state of chaos and panic that has
left crores of citizens on the streets queuing in front of banks and ATMs
looking for the right kind of cash (as lower denominations are only 14% of
stock in circulation trying to replace 44% of cash that needs to be replaced!).
To
top it, the new currency notes do not fit the ATM machines and it will take
more than a couple of weeks for ATMs to deliver the higher denomination notes
of Rs 500 and Rs 2,000! And the government says it has been planning for well
over six months!
In my opinion, the benefits of this surprise element
is being significantly overplayed by the Government. If the Government is
conducting inspections of gold traders and other places of suspected of conversion of cash, they could still adopt the same process of surveillance and could have given people a
reasonable notice to organise their lives. This would have
resulted in an orderly withdrawal of old notes and still snuff out the fake
currencies without the attendant chaos and hardships to a large section
of the population for a limited benefit!
The immediate withdrawal is unjustified as it results in hardships to 99% of the population to attack 1%
of hoarders. More so, when taken in the overall context
of the contribution of unaccounted cash to the black money problem as bulk of
it is held overseas in offshore assets or in real estate or in gold.
While people can be asked to make sacrifices for the
nation’s cause, this seemingly ill planned execution together with its limited
benefits does not quite fit that bill. The simultaneous introduction of the
higher denomination Rs 2,000 note blows a hole into that argument as it clearly
defeats the purpose of stamping out black money! All this exercise does, at
best, is to reset the base for a small part of the overall issue which could
have been managed better.
Here's some context
in simple layman terms of the current exercise:
If you earn Rs 100 per annum, how tickled would you be if I told
you that you will get a one-time bonus of Rs 2? Mighty thrilled?
And for that I have to inconvenience 99% of people to secure
that, and I am not even sure whether it will be Rs 2...That is the nature
of the current abrupt demonetisation. This could have been orderly without
having to cause chaos, panic and distress.
And BTW, there is
another Rs 50 that I know can be recovered without having to disturb the 99% of
the people. Ah, but that will involve upsetting some powerful business magnates.
We will leave that for another day...
A surgical strike is
a precision strike with precise intelligence. Not aimless shooting in the dark
in the hope of hitting some targets!
And creating an easy
path for future creation of black money cannot be part of such an objective
(re. Rs2,000 Note).
Hence, the Government’s claim that this action will stamp out black money is tenuous and a fantasy as the Rs 2,000 note will only accentuate the problem of black money creation. While the move is intended to catch the cash hoarders unaware, there are other effective administrative tools in the form of better surveillance, improving the analytics and intelligence network, and taking action against those who facilitate the fake currency trade from our side of the border.
Hence, the Government’s claim that this action will stamp out black money is tenuous and a fantasy as the Rs 2,000 note will only accentuate the problem of black money creation. While the move is intended to catch the cash hoarders unaware, there are other effective administrative tools in the form of better surveillance, improving the analytics and intelligence network, and taking action against those who facilitate the fake currency trade from our side of the border.
Conclusion
The monetisation move is to be welcomed as there
will be some benefit from this exercise but the justification for a sudden
withdrawal is questionable as the surveillance on exchange of notes could have ensured that even orderly withdrawal would succeed.
If the Government is seriously minded to tackle
black money menace, it has focus on the 96% of the problem and work with other G20
members on information sharing and take prompt action.
So far nothing much has been heard after the initial claim of 650 odd
names. Even the Supreme Court has now
stopped asking for updates! So the judiciary is also sleeping at the wheel.
I also question the associated hype and hyperbole,
which simply seems to exploit the financial and economic illiteracy that is
prevalent even amongst the educated middle class who haven’t comprehended the issue,
let alone the rural illiterate.
While there is some gain to the Government in the
form of a potential tax take or unclaimed balances which will help to reduce the
fiscal deficit, but to proclaim that this
is the end of corruption and black money is far-fetched.
This
move is neither going to deliver a death knell to corruption nor eradicate
black money! And the rhetoric doesn’t gel with the simultaneous introduction of
the higher denomination note!! The shock
and awe approach doesn’t quite justify the hardship inflicted on millions of
ordinary folks.
