The Good, Bad And Ugly Of Modi's "Surgical Strike" On Black Money

Black money, by its very nature, is hard to estimate accurately; therefore the gains from demonetization of Rs 500 and Rs 1000 notes are also difficult to quantify. Thinking about the following ten questions will enable us to have a clearer account of what this will (or not) achieve. 

India has more cash (12% of money supply) than other countries (3% in UK and 10% in the US), but it remains a small part of the total. 

1. Of the stock of black money in India, do we know all the forms it is held in? We know some of it is held in Indian Rupees (INR), some in foreign currency, property and gold and jewellery. Is this an exhaustive list? Relatedly, of the known forms of holding "black money", do we have an estimate of how much is held as rupees versus foreign currency?

2. Of the four forms listed above - Indian rupees, foreign currency, gold and jewellery and property - INR are most likely to lose value over time (for example, due to inflation). The remaining three are known to appreciate in value, so why would anyone keep the bulk of their black money in Indian rupees? According to this report, cash is the least preferred form of holding 'black money'.

3. Earlier this year, this report made an argument in favour of phasing out the Rs 1000 note. According to RBI data cited in The Wire, 39% of cash in circulation is in the form of Rs 1000 notes, whereas another 50% is in the form of Rs 500 notes. Would not the demonetization of Rs 1,000 notes alone have achieved almost as much, with much less inconvenience?

4. Of the current stock of black money, much is hoarded as Indian rupees. Post-demonetization, there are reports of cash-hoarders buying gold and jewellery, leading to a big increase in the price of gold. Doesn't the demonetization move provide a windfall profit to those who invested their black money in gold?

5. If the government believes that black money is held predominantly in the form of notes of large denomination (Rs 500 and Rs 1,000), why introduce a new note of a higher denomination (Rs 2,000 note)? This question has been raised repeatedly, but there have been only lame answers (on NDTV India's Muqabala, one commentator said that the largest denomination in any country should be such that one can buy a pair of shoes!). 

6. Earlier, the BJP had said that much of the black money was stored abroad, but the so-called "surgical strike on black money" is only on domestic black money held as Indian rupees. Does this mean that the government has given up on black money held abroad?

7. If this is aimed at undermining terror financing, we need to know to what extend it was thus financed, especially by counterfeit currency. Estimates cited in Business World, suggest fake currency was 0.002% of Rs 1,000 notes, and 0.009% of Rs 500 notes.

8. Looking ahead, if this is a push towards a cashless economy, is the necessary regulatory framework, the legal safeguards for those who go cashless (hidden costs, data protection and privacy) in place? We need greater awareness about the concurrent safeguards. Note also that cashless is possibly regressive as poor people are likely to have frequent but small value transactions (so commissions as a percentage to total may be higher).

9. Has the government formulated a plan to leverage this for longer term gains by expanding the income tax base? Of all the cash that gets deposited into bank accounts over the coming weeks, how will the government determine what is black or undeclared, and what is not? Raghuram Rajan and Mohan Guruswamy have also suggested that focusing on a wider tax base is likely to be a more rewarding, longer term, solution.

10. Finally, is someone calculating the costs of the demonetization? For instance, if we queue for an hour to withdraw Rs 4,000, we're actually getting Rs 3,900, if we value one hour of our time at Rs 100 per hour. Various legal economic activities (especially cash-intensive, as this has pointed out) have been hit - some for a day, others may be longer (vegetable trade, farmers who are unable to buy inputs required for sowing). Breakdown of POS (Point-of-Sale) and ATM machines, rumour-mongering and hoarding, price rise due to shortages and other disruptions have been reported from metros. In the final analysis, these costs need to be factored in.

The demonetization of Rs 500 and Rs 1,000 notes will end up being a "surgical strike" on one form of black money: cash held as Rs 500 and Rs 1,000 notes, but not gold, property, US dollars, etc. Even of their cash holdings in 500 and 1000-rupee notes, people find ways of saving them. Only the current "stock" is hit, as an economist from the Delhi School of Economics said, "the scheme looks back, not ahead." It won't block future opportunities, is unlikely to hit black money held in other forms (property, forex, gold or sent abroad).

Its most significant effect may be psychological (e.g., fear of such move against gold in the future), but the direction and size of those effects are harder to quantify. In the end, since we don't know the breakup between the various forms of black money (India vs. abroad, INR vs. USD vs. gold etc.), it is difficult to say whether this will be a net gain.

(Reetika Khera teaches at IIT Delhi)

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