Crackdown on Cash: The Hype and the Reality

“Finance is like blood in the system and when you drain that much of blood, obviously there will be problems”
Crackdown on Cash: The Hype and the Reality

Having promised during the 2014 election campaign to bring back black money worth lakhs of crores supposedly stashed abroad, the NDA government has been under pressure to do something dramatic. The government has implemented a major change in the economic environment by demonetising the high value currency notes – of Rs 500 and Rs 1000 denomination. These ceased to be legal tender from the midnight of 8th of November 2016. People have been given up to December 30, 2016 to exchange the notes held by them. 

The proposal by the government involves the elimination of these existing notes from circulation and a gradual replacement with a new set of notes. In the short term, it is intended that the cash in circulation would be substantially squeezed since there are limits placed on the amount that individuals can withdraw. In the months to come, this squeeze may be relaxed somewhat. The reasons offered for demonetisation are two-fold: one, to control counterfeit notes that could be contributing to terrorism (Now if there is counterfeit currency, by the way, there is nothing to guarantee that the new currency also would not be counterfeited), in other words a national security concern and second, to undermine or eliminate the "black economy". These highly loaded legal tender notes constitute the bulk of the currency used for transactions in the Indian economy. It constitutes about 86 percent of the currency in circulation. The total currency in circulation as of October 28, 2016 was Rs 17.77 lakh crores. On November 9, 2016 currency in circulation suddenly declined to 14 percent of the currency of the previous day.   

Capturing the black economy by giving a shock therapy in an economy in the form of demonetisation of highest currency notes in the economy has raised many questions. Whatever else you say of this step, you cannot accuse the government of timidity. It is not easy to predict its effects, since the details of implementation are not entirely clear and there are hardly any similar experiments to draw lessons from. Except In 1978, India denotified the 1,000 rupee note, and nothing much happened. A black market sprang up. People who had these notes took a loss while selling off these notes to people who could claim these as legitimate income. At the time, those notes were 0.6 per cent of the cash in circulation. Things are more daunting this time as 85 per cent of the cash in circulation is in the old Rs 500 and Rs 1,000 notes. Before making a few general observations, one needs to understand the concept of black money which has created some misconceptions, and this decision suggests that the misconception also affects the highest levels of the government. That we think of black money as basically a whole stash of currency notes which are put in suitcases or put in pillow cases or put in trunks or put underground etc. That the whole notion of black money is a stash of currency notes which is completely wrong. In fact, if that was the case then the problem of black money wouldn't be serious, which it is, because black money really itself is a misnomer. It is not a term which is very properly, appropriately used. But basically when we talk of black money, we refer to a whole range of activities. Those activities are either illegal or those activities are undeclared, because those who get profits out of those activities don't want to pay taxes. Therefore, really, it is a set of activities very much like the activities which are known, declared and which constitute the GDP. 

Likewise there are a whole lot of other activities going on in the economy which are undeclared. Now those other activities are undeclared partly because they may refer to illegal activities like drug running or arms smuggling or gold smuggling or whatever. They may be undeclared in order to avoid taxes; they may be undeclared like illegal mining because you are actually exceeding whatever you are supposed to mine. So for a variety of reasons there are a whole lot of activities that are undeclared, and those activities really constitute the black activities. So when one think of black money, it is not a stock, it is actually a flow variable. There is a continuous set of activities that are generating incomes that are employing people but on the other hand that employment and that income is undeclared, is unrecorded in the official statistics or in government's reckoning. 

Now having defined the notion of black money, one can observe that the scheme may be a success in putting some black money out of circulation, which will create some redistribution of purchasing power, but the question is towards whom? The biggest lament centering on the underground economy is that it deprives the government of revenues that could have been spent to improve schools, hospitals, roads and power supply. Why India is one of the lowest taxed among the major economies of the world? There are many reasons for this. There has been no serious attempt to expand the tax base, especially to bring large farmers into the net, no doubt in part due to vote bank considerations. According to M Govinda Rao, (who was a member of Manmohan Singh's Economic Advisory Council), the immediate short-run impact of the demonetisation drive will help curb inflation and shore up the fiscal deficit but India can kiss goodbye to the GDP growth target of 8%. "Finance is like blood in the system and when you drain that much of blood, obviously there will be problems." Rao's observations are also that the rural economy will suffer more than the urban economy, the less developed regions will take a bigger hit than developed regions and poor people will suffer more than honest rich people. 

Whole absurdity of a cashless economy is really going to affect large numbers of very poor people as seen in long queues outside banks waiting for their turn. Deaths have figured in double digits so far. Kaushik Basu, the former chief economist for the World Bank, says the "collateral damage" is likely to outstrip its benefits. Surely sudden tightening money supply will negatively impact production in the quarter Oct-Dec 2016. The disruption in transactions could also hit the emerging growth of consumer demand. 

The crackdown overall may catch or eliminate some of the black money created in the past, but it has nothing new to prevent the accumulation of black money in future.

(Sajad Hussain Rather is a Research Scholar in the Department of Economics in AMU, Aligarh)

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