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Current Affairs For 2017- (November 2016)

Cover Story Decoding Demonetization: Short Term Pain or Long Term Gain? INTRODUCTION

The images on television are troubling. Harassed people are queuing for hours. An

elderly man, obviously quite sick, crying helplessly. The hospital wouldn’t admit him for the required surgery nor would the chemist sell him the drugs he needed. A lady crying,

her husband had just died because no hospital would admit him. The small retailers

have witnessed a drop in their sale. The daily wage workers are finding it difficult to get

work. Frustration is widespread, patience is running thin, and there are worrying reports

about incidents of violence, fortunately still isolated.

Former prime minister Manmohan Singh has called the decision of GoI a case of

organised loot and legalised plunder of the country. Dr Singh called it a monumental

mismanagement. “Even those who say that this measure will cause distress, in the short

run, and it will be in the interest of the country in the long run reminds me of John

Keynes' words, "In the long run we are all dead"," Singh said. The Opposition parties

witnessed one day all India strike against the decision. Mamta Banerjee and Arvind

Kejriwal had put on a rally in Azad Nagar Mandi, Delhi criticising government’s move.

Now the question is - what has happened in the country all of sudden that we see such

chaos in all streams- political, social and economic? Why is that every corner of the


street is engaged in debates and deliberations? This is because the Government

decision of 8/11 has affected every person in the country. This is because the common

mennotes of Rs 500 and Rs 1000 had ceased to be legal tender. It has lost it buying

capacity and has become worthless. This is the third time in Indian history that the

government has used demonetisation tool.

In tune with Joseph Schumpeter’s theory of “creative destruction”, disruptive

technologies and events are now considered to be good things, the forces that drive

competitive capitalism. The demonetization shock is certainly disruptive. 86% of the

money in circulation has been extinguished at a moment’s notice. It had to be done

suddenly, without warning. Otherwise, its whole purpose would have been defeated. But

is it good for Indian capitalism? We will analyse this in later part of this cover story.

WHAT IS DEMONETISATION?

Demonetisation is a radical monetary step in which a currency unit’s status as a legal tender is declared invalid. Legal tender is any official medium of payment recognised

by law that can be used to extinguish a public or private debt, or meet a financial

obligation. The national currency is legal tender in practically every country. A

creditor is obligated to accept legal tender toward repayment of a debt.

The process of demonetization involves either introducing new notes or coins of the

same currency or completely replacing the old currency with new currency.

WHY IS A CURRENCY DEMONETISED

Historically, ‘demonetisations’ or radical recalls/replacements/redenominations of currencies by governments have been in response to hyperinflations. We know of

many such cases of outright withdrawal of notes from circulation being resorted to,

when normal means to suck up excess liquidity in the system have failed. The

underlying purpose has always been to control runaway inflation and the

accompanying loss of faith in the domestic currency, both among investors and the

larger public.

The best example here is of Germany under the Weimar Republic, which, on

November 20, 1923, introduced a new currency — the rentenmark — and declared

all old reichsmark notes to be no longer legal tender. This happened as domestic

prices, already 14 times their 1913 levels in mid-1921 and 1,475 times towards end-


1922, had skyrocketed to 1,422,900,000,000 times by November 1923. As the

currency lost value by the minute, people rushed to spend their wages the very

moment they received them, fuelling further inflation and necessitating more printing

of notes to pay 250 billion reichsmarks for a kilo of butter or 15 billion for a short ride

on a Berlin streetcar. The only way to deal with this situation was demonetisation:

purging the system of all existing notes and launching a new currency backed by

solid assets — in this case, land belonging to the state. With credibility restored,

inflation fell and the run on the currency, too, ended.

We could similarly cite Boris Yeltsin’s Russia, which, on January 1, 1998,

redenominated its currency, with a ‘new’ rouble being made equal to 1,000 ‘old’ roubles.

North Korea, under its erstwhile Supreme Leader Kim Jong-il, did the same on

November 30, 2009, by creating a ‘new’ won equivalent to 100 ‘old’ wons. The intended goal again was to address rampant inflation and restore credibility in the

local currencies that had even become unwieldy for conducting transactions.

But in contemporary times, demonetisation has been used for several other reasons

which include to combat inflation, to combat corruption, to eliminate counterfeit

currency, and to discourage a cash system.

INTERNATIONAL EXPERIENCE OF DEMONETISATION

• The Coinage Act of 1873 demonetized silver in favor of adopting the gold standard

as the legal tender of the United States. The withdrawal of silver from the economy

resulted in a contraction of the money supply, which subsequently led to a 5-year

economic depression in the country. In response to the dire situation and pressure

from silver miners and farmers, the Bland-Allison Act remonetized silver as legal

tender in 1878.

• In 1982, Ghana rolled out the decision to demonetise their 50 cedi currency notes in

order to monitor money laundering and corruption. The change was not welcomed,

creating chaos across the country and finally resulted in a move back to physical

assets and foreign currency.

• Nigeria’s economy collapsed after the 1984 demonetisation move that did not go as

planned. The military government of then President Muhammadu Buhari introduced

different coloured notes to invalidate their old currency in order to fight black money.


• Around 80% of Myanmar’s currency was demonetised in 1987 by the military to curb

black money, but the move resulted in a lot of protests and the country witnessed

several killings.

• Under the governance of Mikhail Gorbachev in 1991, the then Soviet Union

demonetised the higher denominations of ruble bills, the 50s and 100s. The move

did not go well and resulted in takeover of Mikhail’s leadership within eight months of

the plan

• Another example of demonetization occurred when the nations of the European

Monetary Union adopted the euro in 2002. In order to switch to the euro, authorities

first fixed exchange rates for the varied national currencies into euros. When the

euro was introduced, the old national currencies were demonetized. However, the

old currencies remained convertible into euros for a while so that a smooth transition

through demonetization would be assured.

• North Korea faced demonetisation of their currency in 2010 to check hyperinflation.

But the move led to major economy breakdown with people left to starve for basics.

• In 2015, the Zimbabwean government demonetized the Zimbabwean dollar as a

way to combat the country’s hyperinflation that was recorded at 231,000,000%. The

3-month process involved expunging the Zimbabwean dollar from the country’s

financial system and solidifying the US dollar, Botswana pula, and South African

rand as the country’s legal tender in a bid to stabilize the economy.

The above mentioned experiences in several countries point to the fact that

demonetisation move has been unsuccessful and disastrous for most of the countries.

INDIAN EXPERIENCE OF DEMONETISATION

First Demonetisation (January 12, 1946)

Soon after World War II, while the government was giving attention to ways and

means of averting the expected slump, thought was also given to check black market

operations and tax evasion, which were known to have occurred on a considerable

scale. Following the action in several foreign countries, including France, Belgium

and the UK, the Government of India decided on demonetisation of high-

denomination notes.

According to a note, it appear the Reserve Bank of India (RBI) authorities were not

enthusiastic about demonetisation. The RBI Governor said the finance member had

given him the impression that the scheme would be launched only when there were


signs of the onset of an inflationary spiral. The Governor saw no special signs of

such a situation. It appeared to him that the main object of the scheme was to get

hold of the tax-evader.

The government came out with two Ordinances on January 12, 1946, which was

declared a holiday. The first Ordinance asked banks to furnish info about currency

holdings of various denominations (Rs 100, Rs 500, Rs 1,000 and Rs 10,000). The

second was to tell people that denominations of Rs 500 and above were declared

illegal; Rs 100 was spared. People were given 10 days for exchange, later extended

for 20 days more.

Second Demonetisation (January 16, 1978)

R Janakiraman, a senior official in the chief accountant’s office in RBI, got a phone call on January 14, 1978, summoning him to Delhi. On reaching Delhi, he was asked

to write the demonetisation Ordinance within 24 hours. He used the previous

Ordinance as a guide. On January 16, 1978, All India Radio, in its 9 am news

bulletin, announced that an Ordinance had been promulgated.

The Ordinance provided that all banks and government treasuries would be closed

on January 17, 1978, for transaction of “all business except the preparation and presentation or the receipt of returns" that were needed to be completed in the

context of demonetisation. For purposes of the Negotiable Instruments Act 1881, 17

Jan’ 1978 was deemed to be a public holiday notified under the Act. People got three days to exchange high-denomination notes.

Then Finance Minister H M Patel, in his Budget speech on February 28, 1978, said:

“The demonetisation of high-denomination banknotes was a step primarily aimed at

controlling illegal transactions."

Governor I G Patel was not in favour of this exercise. Patel recalled in his book,

Glimpses of Indian Economic Policy: An Insider’s View, that he told Patel “such an exercise seldom produces striking results. Most people who accept illegal

gratification or are otherwise the recipients of black money do not keep their ill-gotten

earnings in the form of currency for long. The idea that black money or wealth is held

in the form of notes tucked away in suitcases or pillow cases is naïve. And in any

case, even those who are caught napping — or waiting — will have the chance to

convert the notes through paid agents as some provision has to be made to convert

at par notes tendered in small amounts for which explanations cannot be reasonably

sought".


Third Demonetisation (8 November 2016)

In Nov 2016, the Indian government decided to demonetize the 500- and 1000-

rupee notes, the two biggest denomination notes. These notes accounted for 86% of

the country’s cash supply.

The government’s goal was to eradicate counterfeit currency, fight tax evasion,

eliminate black money gotten from money laundering and terrorist financing

activities, and promote a cashless economy. By making the larger denomination

notes worthless, individuals and entities with huge sums of black money gotten from

parallel cash systems were forced to convert the money at a bank which is by law

required to acquire tax information from the entity.

If the entity could not provide proof of making any tax payments on the cash, a tax

penalty of 200% of the tax owed was imposed.

IMPACT OF DEMONETISATION

What are likely to be its immediate, medium and longer term consequences? The

diagram below shows the impact of demonetisation in short-to-long term. The diagram

shows that while the short term impact will lead to reduction in growth rate and inflation

due to slump in demand, the long term impact will increase consumption demand,

especially of housing and gold, due to lower interest rates- thus boosting the economy.


Let us now see in detail the likely impact on economy, working class, and various

sectors.

Fiscal Impact

Likely Increase In Fiscal deficit: Turning to broader macroeconomic implications,

let’s first look at the fiscal impact. Of the large deposits flowing into banks every day,

if a significant component turns out to be tax-evaded income, it will generate an

incremental flow of direct-tax revenue and penalties. On the other hand, we are likely

to see significantly reduced economic activity during the next few months, and that

will reduce the flow of indirect-tax revenue. Clearly, no hard estimates of the net

effect are possible at present. But it seems that total tax revenue will be well below

budget projections, leading to an increase in the fiscal deficit.

Falling Rupee: Foreign institutional investors have sold more than $2.5 billion of

Indian equity and debt holdings so far this month, compared with the about $1.5

billion they offloaded through October. With the demonetisation move infusing a

surge of liquidity into the banking system, domestic interest rates are expected to

decline, making the rupee less attractive to investors seeking to benefit from an

interest rate arbitrage.

Monetary Impact

On the monetary side, a very interesting phenomenon is playing out. On the one

hand, 86% of currency in circulation by value has been extinguished in one shot,

delivering a huge negative monetary shock. On the other hand, there is a massive

increase in bank deposits.

Essentially, a part of the money supply that was taken out of the banking circuit has

been brought back into it, i.e., from the black economy to the white economy. The

large growth of bank deposits will enable the enhanced flow of bank credit.

The first positive impact of demonetisation on banks will be an improvement in their

CASA (current account savings accounts) ratio. As liquidity improves and cost of

funding drops, many banks will lower their lending rates, as Axis Bank has already

done. Over time this will reflect in an improved credit-to-deposit ratio of banks.

Second, as cash circulating within the economy drops, consumption may be hit,

which may get reflected in lower inflation. GDP growth may also falter for a few

quarters. Experts expect the central bank to cut the repo rate by 50 basis points over

the next six months. Banks hold a lot of government securities on their books. When

interest rates fall, banks will enjoy capital gains on the mark-to-market portion of their

G-Sec portfolios.


Impact on Working Class

The largest adversely affected group, numerically, is the working class. Farmers,

fishermen, vegetable sellers, small shopkeepers without card readers or Paytm, taxi

drivers, truckers, etc., have all been affected with loss of livelihood which may be

irretrievable in some cases, for example, loss of daily wages for casual labour, or

lower sales for vegetable vendors.

The entire working class adds up to about 400 million persons. Most of them are

unlikely to have any tax-evaded income because their annual incomes would be

below the income-tax-exemption threshold. They and their families are bearing pain

for the sins of others.

Casual workers are at the bottom of the working-class hierarchy. About 33 % of all

employed persons are casual labourers (estimated at 15 crore). Suddenly, they

found themselves without work because those who employed them could not find the

money to pay wages. Further their incomes are the lowest and the least secured.

They spend the money as they earn it. Those paid in old Rs 500 or Rs1,000 notes

would have had to lose a day’s wage to queue up at banks to convert their money. If

the cash ran out, they would have had to lose another day’s wage. Meanwhile, they

would have had no money to buy food, medicines or other essentials.

Next, there are the medium-skilled blue- and white-collar workers in the

unorganized sector and contract workers in the organized sector. Finally, there are

the regular organized-sector workers, the most skilled and the best paid. All of

these wage/salary recipients would have received their wages shortly before the

demonetization. They too would have had to miss work and queue up at banks or

ATMs to convert their money. Without conversion, they would have had no usable

money for food, medical expenses and other essentials.

Impact On Self-employed Professionals: This group is adversely affected. For

example, doctors, lawyers, accountants. The incidence of tax-evaded income is high

among this group, many of whom are high net-worth individuals. The large non-

monetary component of their wealth would be unaffected, but the monetary

component will be extinguished to the extent that demonetization forces the

unloading of hoarded black money.

Impact on Industry

The next major group adversely affected is the small-medium enterprises in

services and industry, especially wholesale and retail traders. Cash transactions

are an integral part of their daily operations, especially for traders. Their range of


goods includes everything from raw materials to intermediate inputs to food items

and other consumer goods. Numerically, this class is not as large as the working

class, but their impact on economic activity is very large. Their businesses have

been severely disrupted. Wholesale markets shut down. Weekly fairs stopped. Retail

outlets reported a calamitous fall in sales. Industrial hubs such as Tiruppur, Surat,

Ichalkaranji etc ground to a halt because there was no money to pay wages to the

workers and no money to pay for ancillary and support services like transport.

Impact On Real-estate Industry: The disruptions here is likely to be quite severe

and long lasting. This sector is the destination where large proportions of black-

money flows are converted into real assets, and black-money transactions are all-

pervasive. The sector has already been in the doldrums for the past couple of years

and transactions are likely to remain frozen for quite a while. In the short run, it will

also disrupt downstream income flows in the form of wages to construction labour,

purchases of cement and other construction materials, including steel, paint, glass,

etc. This will have downstream effects on both employment and income.

Sectors such as hotels, restaurants, catering, the fashion garments industry, etc.,

which were often paid for in cash from black income, will also be affected.

Impact on Agriculture

Disruptions in harvesting of the Kharif crop and sowing of the rabi crop could also

hurt. MFIs and NBFCs that lend to these businesses and also primarily deal in cash

for last mile connectivity could see delays in repayments and even defaults. Some

have already declared moratoriums on repayments.

For some inexplicable reason, cooperative banks were not allowed to exchange the

notes. Millions of farmers could not deposit or withdraw money and, in the sowing

season, there was no money to buy seeds or fertilisers or hire labour.

PUBLIC OPINION ON DEMONETISATION

Deliberations and discussions are the bedrock of democracy. Every time some

revolutionary changes took place in Indian democracy, public are up with their own

opinion. Realising the public swing on social media, the Government conducted an

opinion poll to know the mood of country on demonetisation. The result has been mostly

in its favour as is evident from the picture below:


DEFENDING THE MOVE

Government’s Defence: Government has defended its move citing the benefits as

shown below in picture.

Reshaping Public Attitude Towards Cashless Economy

o The Government’s demonetization is remarkable because it hasn’t been undertaken in response to any hyperinflation or loss of confidence in the rupee.


The rupee has actually been quite strong, both in terms of its internal as well as

external value. Annual consumer price inflation was just 4.2% in October, while

the rupee has held steady at Rs 66-68 against the dollar for the last one year

and more.

o Thus, the recent demonetisation move does not follow the conventional logic of

a currency ‘stabilisation’ measure. It has, instead, been projected as a

‘structural reform’, targeted at reshaping public attitudes towards currency with

a view to move towards a cashless economy. That, by itself, is a laudable goal.

In India, most economic transactions take place in cash outside recorded

market channels and hence go largely untaxed.

o This — apart from fostering a parallel ‘black’ economy with obvious security implications — prevents the government from investing sufficiently in public

goods to pursue long-term growth and equity objectives. Demonetisation, if

anything, sends out a clear message that cash is no longer cool and should,

perhaps, also be seen with the other planned big reform — of instituting a

nationwide goods and services tax regime, which is also ultimately aimed at

raising the country’s abysmally low tax-GDP ratio.

No Disaster For MSMEs: A major concern has been that all those in the informal

sector who have legitimate business, though carried out in cash, will be

undeservedly hurt. Some may be hurt mortally and result in their permanent closure

resulting in job losses and the slowdown of GDP growth. This is surely not the truth.

All medium, small and even micro production enterprises (production MSMEs as

opposed to wholesale or retail traders) surely have some access to formal credit

sources. This must be true of MSME export units that are reported to account for 45

% of India’s total merchandise exports. The majority of MSMEs deal only partially in cash. Anticipating the onset of GST, many had started to move away from cash

transactions as these would not receive any tax credit. Therefore to argue that

demonetisation spells doom and disaster for MSMEs is sheer exaggeration.

Farmers Not Completely Vulnerable: Farmers, it is asserted, are in deep distress

and dying. This again seems to be hyperbole. Farmers can sell their kharif harvest of

sugarcane to mills with receivables being directly credited to their bank accounts as

always. Any amount of paddy can be sold to the FCI at the government-declared

minimum support price (MSP). Agro-inputs are normally available at 30-60 day credit

to virtually all farmers. Rabi sowing is, therefore, reportedly on track, opposition

parties’ grandstanding notwithstanding.


CRITICISING THE MOVE

Hardship To People: Attacking the Prime Minister on his request of giving him 50

days to cleanse the nation, different political parties have raised the trouble faced by

the common man and the death of 60-65 people standing in long queues outside

banks and ATMs. The pain and suffering will continue because it will take months to

print 2,200 crore notes of the new series to replace the old series and because of the

limitations of bank staff and the ATMs (yet to be recalibrated). Dr Manmohan Singh

said, “I would like to know from the PM, the names of any countries where people

have deposited their money in the bank, but aren't allowed to withdraw their money.”

Slowing Down Of Economy: The economy was already in slowdown mode and

starved of investments, forcing even RBI to significantly loosen its monetary policy

stance of late. Demonetization would willy-nilly lead to unprecedented monetary

tightening, with nearly Rs 15 lakh crore worth of currency being withdrawn overnight

from circulation. This untimely, and probably unintended, ‘stabilisation’ has the potential to convert a slowdown into a full-blown recession. This scheme will hurt

agricultural growth, will hurt small industry and will hurt all those people who are in

the informal sector of the economy, causing poor economic growth. The GDP of the

country can decline by about 2 %, yet an underestimate by some economists.

o Moody’s Investors Service also flagged concerns regarding the wide-reaching

economic impact of demonetisation, saying that it will “significantly disrupt economic activity” and result in weak consumption and GDP growth in the near term. Corporates will see economic activity decline, with lower sales

volumes and cash flows and those directly exposed to retail sales will be

most affected, the report said.

o CARE Ratings has said the overall GDP growth would be affected by 0.3-0.5

% with the services sector expected to be affected the most, mainly on

account of losses in trade, hotel, transport among others due to the volume of

cash transactions involved in these economic activities. SMEs in industry will

have a major problem in adjusting production schedules as both payments

and receipts flow in cash given their structures, the CARE rating report said.

Claim Of Surgical Strike On Black Money Not Well Accepted: Experts argue that

the move will not unearthen all black money. The reasons being--

o It targets the stock, not the flow variable.


o Gold, real estate, and foreign exchange reserve not targeted. A recently

published study says that the cash component of black money recovered in

raids accounted for only 6 % of the total amount received,

o People are routing their black money to- NBFCs which are not under scrutiny;

Jan Dhan Accounts; and Poor person account to bypass deposit limits.

o Further it will not plug generation of black money. It does not affect the

continuous flow of black income and the corruption/tax evasion which

generates it, which in many ways is the core of the corruption problem.

Sectors which are prone to use unaccounted money (wholesale trade,

construction, jewellery, higher education, election funding etc) will continue to

demand unaccounted money and, therefore, ways will be found to supply

unaccounted money.

Poorly Implemented Move: The critics point to the fact that the implementation has

been badly botched and certainly could have been better. They raise some critical

questions to justify their points.

o Was the relatively short window of 50 days necessary and could it not be

extended?

o It has been reported that given the capacity constraints at the two printing

presses, it will take until May 2017 to replace all notes. Could the domestic

security printing press capacity constraint not be overcome by placing orders

on foreign printers to produce Rs 100 and Rs 50 notes? Printing additional


quantities of these denominations would not have breached secrecy and

could have augmented the much needed currency supplies?

o Given the scale and time constraint, could government departments and

treasuries not be used as points for dispensing and exchanging currency to

overcome the shortage of ATMs that are still being re-calibrated.

o Building up a larger stock of new notes in advance would certainly have

avoided some of the inconvenience and the associated cash shortage. The

belated provisions made for weddings could have been anticipated.

o The ministry of agriculture’s request regarding an exemption for farmers

purchasing seeds and other inputs during the sowing season, in order to

avoid disruption in sowing, should also have been addressed promptly, rather

than after several days.

o The flexibility provided after problems surfaced is to be welcomed but it could

be increased even further. For example, old notes are allowed to be used in

public-sector hospitals but not private hospitals, and farmers are allowed to

use them for purchase of seeds from public-sector agencies but not private

agencies. Perhaps the most important flexibility is to allow cooperative banks

to accept old notes.

o Black wealth held in cash can also be laundered by purchase of gold and

hawala transactions. Some of this has already happened as evidenced by the

sharp rise in gold prices and also the hawala rate for the dollar. Inevitably,

higher gold prices will encourage smuggling and divert foreign exchange that

would otherwise have flowed through legal channels to finance gold

smuggling. This is bound to put pressure on the rupee.

o Since the notes will be valueless after 30 December, holders of undeclarable

cash will be willing to offer 30-40% commission, or even more as the deadline

approaches to offload the cash. Intermediaries will organize large numbers of

individuals who can take smaller “explainable” amounts of cash to the banks

for deposit. Since farm income is free of tax, large numbers of people

claiming to be farmers, could make deposits in banks, technically even

exceeding Rs2.5 lakh with impunity.


WAY FORWARD

Demonetization has brought a sense of justice among honest tax payers and this would

be further strengthened if money recovered is used by the government in an efficient

and leak-proof manner for infrastructure and social schemes, says Stakeholders’ Empowerment Services (SES).

In a report titled Demonetisation — India’s BLEXIT, SES termed the move‘one-stroke’ revenge by the government on behalf of honest tax payers. However, the current step

alone would not end corruption and creation of new black money. “It has ended the black

money held in form of cash for once but the government will have to take further steps to

stop corruption in the future. The leakage of unaccounted money into the black system

must end.

SES was of the view that the government was in the best position to bring in reforms to

cleanse the system. It recommended eight key steps that may cause short-term pain,

but result in long-term dividends.

1. Mandatory digitisation of all land and property records linked to PAN/ Aadhaar

numbers.

2. Tax on agricultural income based on farm holding, leaving small and marginal

farmer untouched and unaffected.

3. Small and marginal farmers be provided one-time state assistance to rid their

personal debts taken from local money lenders at exorbitant rates. The money so

given as assistance must be recorded as interest-free loan from the government

payable only in case the land is sold by these farmers. This will ensure that while

the economic status of farmers will improve, the money will not be misused. The

land shall not be allowed to be mortgaged to anyone except banks for crop loan

only.

4. Plastic money should be encouraged. A charge may be introduced for cash

withdrawal beyond a limit. For example, any cash withdrawal beyond Rs 10,000

per month for an individual or business entities according to the class of entity, a

certain percentage of the turnover may be allowed to be withdrawn free of cost and

thereafter rates should be increased in steps. Provision may be made for small

businesses and in their case, the charge may be based on net withdrawal.

5. Cash transaction fee must be introduced. At present, many business

establishments display a sign that credit card payment will be charged extra.

Instead, a cash transaction levy must be introduced and they must come to the

central government to recover the cost of currency management.


6. To encourage credit / debit card payments, the settlement cycle must be

reduced from monthly to fortnightly on mandatory basis; otherwise, it will give rise

to unhealthy competition.

7. Capital gains tax on traded security should be calculated by the tax department

by linking PAN and demat account. The assessee should be required to only file

for exemption, if any, from the tax assessed.

8. Last but not the least, funding to political parties should come under the purview

of Right to Information and income tax authorities. Such funding needs to be

disclosed to the tax department and matched with the spending in various election

campaigning. The ruling party as well as the Opposition should ensure that nobody

is excluded from scrutiny. The Government should raise election spending limits,

mandate that donations to political parties be only by cheque and that the accounts

of political parties can be independently audited. And, eventually, the country

should move towards state funding of elections.

Few More Suggestions To Control Generation Of Black Income

1. Reducing discretion in both the Central and state governments and increasing

transparency and accountability especially where the financial amounts involved

are large. The biggest area of discretion relates to land and land use.

2. Reforming the system of tax administration, including reorganizing,

strengthening and modernizing the Central Board of Excise and Customs/Central

Board of Direct Taxes. Lowering tax rates and simplifying the tax system to

improve compliance. The GST to be introduced shortly was an ideal opportunity,

but the proposal finally approved by the GST council has far too many rates and

exemptions. Even if this cannot be changed at this stage, the council could at least

announce a review of the multiplicity of rates with a view to converging on two

rates plus a sin tax. It could also announce an intention to include alcohol—a major

source of evasion and black money—and also real estate in the GST by 2020.

3. Lowering the corporate tax rate to 25% at one go with exemptions eliminated in

the next budget. Any negative effect on the fiscal deficit can be justified given the

need for a fiscal stimulus.

4. Persuading states to drastically lower the stamp duty for real estate sales as

high rates of stamp duty are a major incentive to perpetuate real estate

transactions in black money.


5. Pursuing some high-profile corruption cases to a successful conclusion to send

a message to both business and the bureaucracy that corruption will not be

tolerated.

6. Transactions in high denomination notes make it easier to evade taxes and

detection by law enforcement agencies. Hence over the next two years, the

government should withdraw all Rs 500, 1000, and 2000 notes.

CONCLUSION

The ethical and social aspects of this dramatic demonetization move are of utmost

importance. The measure represents the draining of a cesspool, created over seven

decades. Demonetisation will surely reverse, to some extent, the brazen flaunting of ill-

gotten wealth. It may induce India to turn away from the Latin American model of

state, with its extreme inequities and rampaging drug mafias, and hopefully, turn it

towards the more equitable and honest East Asian model.

We know that black money (currency) is only a small part of the black economy. The

aggregate black economy is estimated at over 30 % of the formal economy. Even if

black money constitutes 10 % of this amount, it represents a cash hoard of nearly Rs 5.5

lakh crore. To try and immobilise that amount or even a substantial part would convey a

strong anti-corruption signal.

Nevertheless demonetisation can only be a part of a comprehensive strategy to tackle

corruption and generation of black income, and it is likely to impose substantial pain

because of the adverse effect on GDP and low-end employment. The more important

part of the fight against corruption involves the other set of measures listed above.

Progress on these would make a real contribution to reducing the long- term gain of

reducing the generation of black income over time.

cover story decoding demonetization: short term pain … · cover story decoding demonetization:...

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