https://scroll.in/article/849266/demonetisation-the-chronicle-of-a-failure-foretold
Demonetisation: The chronicle of a failure foretold
Because the exercise was doomed to fail in its primary objective of rooting out black money, the government kept changing its aims.
C Rammanohar ReddyPublished Yesterday · 08:00 am
AFP
We have travelled a long way from November 8, 2016, when Prime Minister Narendra Modi told us that the black money held in Rs 500 and Rs 1,000 currency notes would become “worthless pieces of paper”. Now, we are told by the finance ministry that the government expected all demonetised cash to come back to the banking system.
Demonetisation was doomed to fail in its main objective of rooting out black money. It was, therefore, necessary to keep inventing new narratives. When it became impossible to hide the fact that 98.6% of the demonetised currency had returned to banks, the original aim of destroying black money had to be turned on its head.
We now have an expanded formal set of objectives. The real aims, we were told earlier this week by Finance Minister Arun Jaitley, were to reduce the role of cash in the economy, expand the tax base, push digitalisation and increase formalisation of the economy – and in all these respects, demonetisation has had a positive effect.
But today we know enough to say the immediate effect of demonetisation on the economy was, in a word, disastrous. Economic activity was severely affected for three to four months, with its impact being felt most by those who could not afford a shock. The urban informal sector, the rural non-farm sector and agricultural markets were all put through the wringer. People at the bottom of the ladder could not find work and many of those who had employment were not paid wages on time. All this has been reflected in revised numbers on GDP growth in 2016-’17; future revisions will show a bigger decline in the months after demonetisation. The Economic Survey Volume II estimated a 30% jump in demand under the Mahatma Gandhi National Rural Employment Guarantee Scheme in six of the poorest states during November 2016-January 2017, an indication of rural distress.
If we turn to medium and long-term impacts of demonetisation, the balance is far from weighing in favour of the positive.
Ill-gotten gains
One, it is said that most of the demonetised currency coming into banks is a positive development because all this cash is now part of the legal economy. Data analytics can be used to identify the suspicious deposits.
This is not just an after-the-event justification, it is an argument made in hope.
Those who deposited their undeclared income in banks were able to launder their black money into white. Some of them have presumably declared these deposits as income for 2016-’17 and have paid tax on them. They have chosen this route rather than come clean under the second amnesty scheme of 2016-’17 because they are supremely confident that they can, as in the past, buy their way out of trouble.
Two questions then. Why should we presume that these players will keep their funds in the banking system and not pull them out later? Why should we presume that their ability to continue generating black money has been diminished in any way?
The finance ministry has gleaned information on large deposits made in banks. The Reserve Bank of India also says there was a six-fold increase in 2016-’17 in the number of “suspicious transactions” in banks. Since end January 2017, the Income Tax Department has been investigating these deposits. We are told that as of May 2016, Rs 17,526 crore in undisclosed income was detected under Operation Clean Money. This is under 4% of the very large deposits, totalling Rs 4.89 lakh crore, made in 1.5 lakh accounts in November-December 2016, if we assume that all these deposits were from unaccounted incomes. The danger of now putting the burden of making a success of demonetisation on the Income Tax Department is that if it is unable to come up with definite results on a large number of money launderers, the pressure to deliver may lead to harassment.
Two, growth in tax revenue and increase in the number of taxpayers is claimed to be another success of demonetisation. When those who did not declare their income previously now launder their money and pay taxes, there will of course be a bump in tax revenue collection. Whether this bump would be permanent, and to what extent, depends on continued full disclosure of income. This also holds true for increase in the number of taxpayers since November 2016; all of them must remain in the tax net even after they have completed their money laundering operations.
Shifting goalposts
Three, the finance ministry claims that with “full remonetisation having taken place”, the currency in circulation as of August 4, 2016 was only 83% of that on November 8, 2016. This, it is claimed, is a sign of the shift to an economy making do with less cash. There are many problems with the “India as a cash-intensive economy” argument. The one that matters here is that we do not quite know what this “full remonetisation” means. The Indian economy may be making do with less cash because the Reserve Bank has not pumped in more; it does not necessarily mean the economy is getting all the cash it needs.
Four, there is digitalisation, the poster boy, if one can call it that, of the entire exercise. There are many questions about the desirability, preparedness and acceptance of the push towards digitalisation, which comes with its own costs for users. Suffice to say that while volumes and values of digital transactions are appreciably higher now than last year, the growth has considerably moderated from the heady “Paytm days” of November-December 2016. It just shows that you cannot compel people to go with a transaction practice they are not yet familiar or comfortable with. In any case, did we need to use the sledgehammer of demonetisation to accelerate a process that had been going on since the early 2000s?
Five, “formalisation of the informal” is another mantra that began to be chanted midway through the demonetisation exercise. There are indeed name-plate/sub-contract companies that operate in the informal sector only to avoid the laws applicable to the formal sector. The Goods and Services Tax is likely to reduce such operations and, thereby, increase tax compliance. But it is surely a strange agenda to seek to formalise the informal sector in order to increase tax compliance. The larger part of the heterogeneous and low-productivity informal sector does not pay income tax because it falls below the tax threshold, and not because it evades taxation.
Selling a failure
In the end, there is a simple reason why demonetisation failed in its immediate objective of destroying illegal cash holdings. It was pointed out ad nauseam at the time that the larger part of black money is not kept in idle cash but invested in other assets. Since demonetisation was not going to weaken the power of the players in the black economy, it should have been anticipated that such players would succeed in turning their illegal cash into legal money. This, in a strange way, is what the government is now admitting when it says it expected most of the demonetised currency to enter the banking system.
The Modi government took a few steps to live up to its 2014 election promise to fight black money. It renegotiated agreements with Mauritius, Singapore and Cyprus to choke the round-tripping of illegal capital kept abroad. It operationalised the 1988 legislation on benami transactions that no previous government had wanted to do. It has now, after demonetisation, at least started making noises about shell companies.
However, an institutional structure to independently investigate corruption remains absent. The Lok Pal has not been established four years after the Congress-led government enacted the necessary legislation. The main sources of black money have also not been blocked. The 2012 White Paper on Black Money argued that generation of black money takes places largely within the formal financial sector and is not oiled by cash. Illegal funds are generated through trade-based money laundering, stock price manipulation, over or under-invoicing of trade – all these practices continue unhindered. The avenues for the use of black money too are still in place, most notably in elections. While the government has ignored the Election Commission’s recommendations to make election funding more transparent, there is the 2017 innovation of electoral bonds, which is going to increase opacity and encourage pay-offs in election financing. Real estate, traditionally one of the major generators and of black money, was badly affected after November 8, 2016. However, there are signs that “normalcy” is returning. The Economic Survey Volume II found proxy evidence that cash was returning to transactions in the real estate sector.
It has been argued that one of the political reasons for demonetisation was the need to cripple opposition parties ahead of the Uttar Pradesh Assembly election early this year. We do not have evidence of that. But the political pay-offs of demonetisation for the Modi government have been huge. A government that until November 2016 was being derided as “suit boot ki sarkar” was now able to claim that it was leading a war on the corrupt rich on behalf of the honest citizen. With this one act of demonetisation, the Modi government was able to occupy the moral high ground.
The people’s anger over corruption runs deep. They, therefore, bore the hardships of demonetisation in the hope that black money would be rooted out. But close to a year later, they are being sold a failure as success.
Demonetisation 2016 is behind us but we must remain apprehensive. If the BJP reaped political dividends from this poorly thought-out scheme, will another such scheme strike the country ahead of the 2019 parliamentary elections?
C Rammanohar Reddy, Scroll.in’s Readers’ Editor, is the author of Demonetisation and Black Money.
Demonetisation: The chronicle of a failure foretold
Because the exercise was doomed to fail in its primary objective of rooting out black money, the government kept changing its aims.
C Rammanohar ReddyPublished Yesterday · 08:00 am
AFP
We have travelled a long way from November 8, 2016, when Prime Minister Narendra Modi told us that the black money held in Rs 500 and Rs 1,000 currency notes would become “worthless pieces of paper”. Now, we are told by the finance ministry that the government expected all demonetised cash to come back to the banking system.
Demonetisation was doomed to fail in its main objective of rooting out black money. It was, therefore, necessary to keep inventing new narratives. When it became impossible to hide the fact that 98.6% of the demonetised currency had returned to banks, the original aim of destroying black money had to be turned on its head.
We now have an expanded formal set of objectives. The real aims, we were told earlier this week by Finance Minister Arun Jaitley, were to reduce the role of cash in the economy, expand the tax base, push digitalisation and increase formalisation of the economy – and in all these respects, demonetisation has had a positive effect.
But today we know enough to say the immediate effect of demonetisation on the economy was, in a word, disastrous. Economic activity was severely affected for three to four months, with its impact being felt most by those who could not afford a shock. The urban informal sector, the rural non-farm sector and agricultural markets were all put through the wringer. People at the bottom of the ladder could not find work and many of those who had employment were not paid wages on time. All this has been reflected in revised numbers on GDP growth in 2016-’17; future revisions will show a bigger decline in the months after demonetisation. The Economic Survey Volume II estimated a 30% jump in demand under the Mahatma Gandhi National Rural Employment Guarantee Scheme in six of the poorest states during November 2016-January 2017, an indication of rural distress.
If we turn to medium and long-term impacts of demonetisation, the balance is far from weighing in favour of the positive.
Ill-gotten gains
One, it is said that most of the demonetised currency coming into banks is a positive development because all this cash is now part of the legal economy. Data analytics can be used to identify the suspicious deposits.
This is not just an after-the-event justification, it is an argument made in hope.
Those who deposited their undeclared income in banks were able to launder their black money into white. Some of them have presumably declared these deposits as income for 2016-’17 and have paid tax on them. They have chosen this route rather than come clean under the second amnesty scheme of 2016-’17 because they are supremely confident that they can, as in the past, buy their way out of trouble.
Two questions then. Why should we presume that these players will keep their funds in the banking system and not pull them out later? Why should we presume that their ability to continue generating black money has been diminished in any way?
The finance ministry has gleaned information on large deposits made in banks. The Reserve Bank of India also says there was a six-fold increase in 2016-’17 in the number of “suspicious transactions” in banks. Since end January 2017, the Income Tax Department has been investigating these deposits. We are told that as of May 2016, Rs 17,526 crore in undisclosed income was detected under Operation Clean Money. This is under 4% of the very large deposits, totalling Rs 4.89 lakh crore, made in 1.5 lakh accounts in November-December 2016, if we assume that all these deposits were from unaccounted incomes. The danger of now putting the burden of making a success of demonetisation on the Income Tax Department is that if it is unable to come up with definite results on a large number of money launderers, the pressure to deliver may lead to harassment.
Two, growth in tax revenue and increase in the number of taxpayers is claimed to be another success of demonetisation. When those who did not declare their income previously now launder their money and pay taxes, there will of course be a bump in tax revenue collection. Whether this bump would be permanent, and to what extent, depends on continued full disclosure of income. This also holds true for increase in the number of taxpayers since November 2016; all of them must remain in the tax net even after they have completed their money laundering operations.
Shifting goalposts
Three, the finance ministry claims that with “full remonetisation having taken place”, the currency in circulation as of August 4, 2016 was only 83% of that on November 8, 2016. This, it is claimed, is a sign of the shift to an economy making do with less cash. There are many problems with the “India as a cash-intensive economy” argument. The one that matters here is that we do not quite know what this “full remonetisation” means. The Indian economy may be making do with less cash because the Reserve Bank has not pumped in more; it does not necessarily mean the economy is getting all the cash it needs.
Four, there is digitalisation, the poster boy, if one can call it that, of the entire exercise. There are many questions about the desirability, preparedness and acceptance of the push towards digitalisation, which comes with its own costs for users. Suffice to say that while volumes and values of digital transactions are appreciably higher now than last year, the growth has considerably moderated from the heady “Paytm days” of November-December 2016. It just shows that you cannot compel people to go with a transaction practice they are not yet familiar or comfortable with. In any case, did we need to use the sledgehammer of demonetisation to accelerate a process that had been going on since the early 2000s?
Five, “formalisation of the informal” is another mantra that began to be chanted midway through the demonetisation exercise. There are indeed name-plate/sub-contract companies that operate in the informal sector only to avoid the laws applicable to the formal sector. The Goods and Services Tax is likely to reduce such operations and, thereby, increase tax compliance. But it is surely a strange agenda to seek to formalise the informal sector in order to increase tax compliance. The larger part of the heterogeneous and low-productivity informal sector does not pay income tax because it falls below the tax threshold, and not because it evades taxation.
Selling a failure
In the end, there is a simple reason why demonetisation failed in its immediate objective of destroying illegal cash holdings. It was pointed out ad nauseam at the time that the larger part of black money is not kept in idle cash but invested in other assets. Since demonetisation was not going to weaken the power of the players in the black economy, it should have been anticipated that such players would succeed in turning their illegal cash into legal money. This, in a strange way, is what the government is now admitting when it says it expected most of the demonetised currency to enter the banking system.
The Modi government took a few steps to live up to its 2014 election promise to fight black money. It renegotiated agreements with Mauritius, Singapore and Cyprus to choke the round-tripping of illegal capital kept abroad. It operationalised the 1988 legislation on benami transactions that no previous government had wanted to do. It has now, after demonetisation, at least started making noises about shell companies.
However, an institutional structure to independently investigate corruption remains absent. The Lok Pal has not been established four years after the Congress-led government enacted the necessary legislation. The main sources of black money have also not been blocked. The 2012 White Paper on Black Money argued that generation of black money takes places largely within the formal financial sector and is not oiled by cash. Illegal funds are generated through trade-based money laundering, stock price manipulation, over or under-invoicing of trade – all these practices continue unhindered. The avenues for the use of black money too are still in place, most notably in elections. While the government has ignored the Election Commission’s recommendations to make election funding more transparent, there is the 2017 innovation of electoral bonds, which is going to increase opacity and encourage pay-offs in election financing. Real estate, traditionally one of the major generators and of black money, was badly affected after November 8, 2016. However, there are signs that “normalcy” is returning. The Economic Survey Volume II found proxy evidence that cash was returning to transactions in the real estate sector.
It has been argued that one of the political reasons for demonetisation was the need to cripple opposition parties ahead of the Uttar Pradesh Assembly election early this year. We do not have evidence of that. But the political pay-offs of demonetisation for the Modi government have been huge. A government that until November 2016 was being derided as “suit boot ki sarkar” was now able to claim that it was leading a war on the corrupt rich on behalf of the honest citizen. With this one act of demonetisation, the Modi government was able to occupy the moral high ground.
The people’s anger over corruption runs deep. They, therefore, bore the hardships of demonetisation in the hope that black money would be rooted out. But close to a year later, they are being sold a failure as success.
Demonetisation 2016 is behind us but we must remain apprehensive. If the BJP reaped political dividends from this poorly thought-out scheme, will another such scheme strike the country ahead of the 2019 parliamentary elections?
C Rammanohar Reddy, Scroll.in’s Readers’ Editor, is the author of Demonetisation and Black Money.
