Just 72 hours ago, our flamboyant prime minister Narendra Modi announced the discontinuation of currency notes with denomination of 500 and 1000. The move is aimed at curbing the menace of counterfeit currency that funds terrorism. New notes with 500 and 2000 denomination, and a possible 1000 denomination will be substantially fewer in circulation. The emotions displayed in WhatsApp groups ranged from panic and fear to victory and jubilation. Many declared the war on black money to be finally over, with GPS enabled nano-chips working as the metaphorical last nail on the coffin !
It took me over 24 hours to overcome the effects of Modi's emotional appeal and think logically about where will this really take us. I am summarising my thoughts, starting with what is black money and then inspecting whether it will be curbed in the absence of a technology to track the currency notes through satellites.
Black money, corruption, bribe, parallel economy, shadow economy, unaccounted income, unorganized sector, hidden economy, etc. are some of the words often used interchangeably. Black money is the name we Indians have given to money not reported to tax authorities. It stays out of calculation of national income (GDP). Graphic shows the black money is generated from a black transaction - purchase of goods or services in black. It could happen because the buyer doesn't want receipt in his / her name, say in case of benaami properties. It could also happen when seller doesn't want to give a receipt - usually to avoid taxes. Bribe paid to an official is a subset of black money, as it involves a transaction in which the seller is providing a service illegally or without authorization. Bribe is a form of corruption in which cash is exchanged, whereas corruption is not limited to cash benefits for self. Corruption expands the benefits beyond cash to friends and family of the corrupt. Thus, both corruption and bribes are black transactions; but not the only source of black money.
Every economy in the world carries with it some unreported income, quite often used for criminal activities. Luckily, most of Indian black money is not used for drugs, prostitution and gang wars.. but that's hardly a solace. Estimates for most developed economies put the amount of black money at about 10-20% of the respective GDP. Some of the developing countries from south Asia, Africa and South America have estimated size of 25-75% of GDP. In India, the latest official estimate is 30 years old. About half a dozen studies prior to that put the extent of black money at less than 10% of GDP of respective years. More recent estimates by journalists and opinion leaders have put the size at almost 100% of the economy. If one believes the unofficial estimates, the production, sales, per capital income and consumption in the country are roughly two times the official figures. Truth perhaps lies somewhere in between.
Economics tells us that marginal propensity to consume is always less than 1.0 In other words, generated income tends to get saved for future use. So no matter how lavishly one would like to live, someone earning black money would end up saving a part of it. There is a large market for it in India in the form of gold and real estate. Under current state of our record keeping and law enforcement, both gold and real estate provide ample opportunities for investing surplus black income with relative ease.
The problem statement for good governance, therefore, has three components - black money accumulated so far; black economy running at present; and stock of black money to be generated in future.
Let us begin by looking at the total accumulated black money since time immemorial. Reliable estimates are not available for this. Anecdotal evidence suggests that most of the wealth in India is black, barring perhaps the investment in to securities and bank savings. My belief is that the amount of black money is in multiples of GDP, but let us take the more conservative and published estimate of 1.0 times the GDP.
Accompanying graphic shows a comparison of amount of currency in circulation with the amount of GDP (which is also my conservative estimate of the amount of black wealth). Bulk of the black money is either in gold or in immovable properties. A large part of it is abroad, in fact according to one estimate nearly 1.0 times our GDP is stashed away in Swiss banks. A small fraction of black money is also kept as cash, we do not know exactly how much is stashed away in mattresses and other places, but it cannot be more than the total currency printed by RBI. This amount of currency in circulation is about 13% of our GDP, and some of the printed cash is getting used everyday - or was getting used till 8th November. So let's say about half of the printed cash was in circulation (which is how much other countries use) and the other half was being stored. By replacing the currency with new and improved bills, a fraction of the black wealth has been destroyed - unless the owners are smart enough to beat the system like they've done in the past. Being a large country, this fraction turns out to be huge - of the order of 8 lakh crores (8 trillion) INR. To put it into perspective, this is roughly half of all the taxes collected by the central government last year (including personal and corporate income taxes).
Would this be a deterrent to people accumulating black wealth? If we believe that the cash portion of black wealth was uniformly divided across all owners, then Tuesday's announcement was like a very bad week in the stock market. It wiped off 6% of total black wealth. Owners of black wealth are prepared to take much bigger shocks ! If we believe that the cash was unevenly distributed, depending on the nature of business, then picture changes just a little. Some businesses are efficient at conversion of black cash to other assets, and some are not. But eventually, most of the black money gets converted in to gold, real estate in India, or assets abroad. Only the inefficient owners would have ended up with liquid cash. They would have probably learnt a lesson and may change for good. The move could not have been a deterrent to efficient owners, who don't keep too much cash any way.
Thus, by and large, the fear of Tuesday night alone would not curb black money, corruption or bribes. I'm happy to see some fear, but the thick skinned have weathered this one quite well. In Hyderabad, the real estate lobby managed to get this out on front page today - https://goo.gl/S9Vbrz .. perhaps in a knee jerk reaction due to panic. I think businessmen in Gujarat, Mumbai, Kolkata and Delhi are doing far better keeping their heads cool.
Then, what are the other mechanisms that can curb the black economy running today and thereby reducing the generation of black money in future. Hopefully we should have an answer soon ! The motive with which government and RBI acted on 8th November was perhaps the fact that globally, poor and rich countries carry far less cash than us. We carry about 13% of GDP, whereas everybody else carries just 5%. But common citizens sometimes construe it as a raambaan ilaaj on corruption.
It took me over 24 hours to overcome the effects of Modi's emotional appeal and think logically about where will this really take us. I am summarising my thoughts, starting with what is black money and then inspecting whether it will be curbed in the absence of a technology to track the currency notes through satellites.
Black money, corruption, bribe, parallel economy, shadow economy, unaccounted income, unorganized sector, hidden economy, etc. are some of the words often used interchangeably. Black money is the name we Indians have given to money not reported to tax authorities. It stays out of calculation of national income (GDP). Graphic shows the black money is generated from a black transaction - purchase of goods or services in black. It could happen because the buyer doesn't want receipt in his / her name, say in case of benaami properties. It could also happen when seller doesn't want to give a receipt - usually to avoid taxes. Bribe paid to an official is a subset of black money, as it involves a transaction in which the seller is providing a service illegally or without authorization. Bribe is a form of corruption in which cash is exchanged, whereas corruption is not limited to cash benefits for self. Corruption expands the benefits beyond cash to friends and family of the corrupt. Thus, both corruption and bribes are black transactions; but not the only source of black money.
Economics tells us that marginal propensity to consume is always less than 1.0 In other words, generated income tends to get saved for future use. So no matter how lavishly one would like to live, someone earning black money would end up saving a part of it. There is a large market for it in India in the form of gold and real estate. Under current state of our record keeping and law enforcement, both gold and real estate provide ample opportunities for investing surplus black income with relative ease.
The problem statement for good governance, therefore, has three components - black money accumulated so far; black economy running at present; and stock of black money to be generated in future.
Let us begin by looking at the total accumulated black money since time immemorial. Reliable estimates are not available for this. Anecdotal evidence suggests that most of the wealth in India is black, barring perhaps the investment in to securities and bank savings. My belief is that the amount of black money is in multiples of GDP, but let us take the more conservative and published estimate of 1.0 times the GDP.
Accompanying graphic shows a comparison of amount of currency in circulation with the amount of GDP (which is also my conservative estimate of the amount of black wealth). Bulk of the black money is either in gold or in immovable properties. A large part of it is abroad, in fact according to one estimate nearly 1.0 times our GDP is stashed away in Swiss banks. A small fraction of black money is also kept as cash, we do not know exactly how much is stashed away in mattresses and other places, but it cannot be more than the total currency printed by RBI. This amount of currency in circulation is about 13% of our GDP, and some of the printed cash is getting used everyday - or was getting used till 8th November. So let's say about half of the printed cash was in circulation (which is how much other countries use) and the other half was being stored. By replacing the currency with new and improved bills, a fraction of the black wealth has been destroyed - unless the owners are smart enough to beat the system like they've done in the past. Being a large country, this fraction turns out to be huge - of the order of 8 lakh crores (8 trillion) INR. To put it into perspective, this is roughly half of all the taxes collected by the central government last year (including personal and corporate income taxes).
Would this be a deterrent to people accumulating black wealth? If we believe that the cash portion of black wealth was uniformly divided across all owners, then Tuesday's announcement was like a very bad week in the stock market. It wiped off 6% of total black wealth. Owners of black wealth are prepared to take much bigger shocks ! If we believe that the cash was unevenly distributed, depending on the nature of business, then picture changes just a little. Some businesses are efficient at conversion of black cash to other assets, and some are not. But eventually, most of the black money gets converted in to gold, real estate in India, or assets abroad. Only the inefficient owners would have ended up with liquid cash. They would have probably learnt a lesson and may change for good. The move could not have been a deterrent to efficient owners, who don't keep too much cash any way.
Thus, by and large, the fear of Tuesday night alone would not curb black money, corruption or bribes. I'm happy to see some fear, but the thick skinned have weathered this one quite well. In Hyderabad, the real estate lobby managed to get this out on front page today - https://goo.gl/S9Vbrz .. perhaps in a knee jerk reaction due to panic. I think businessmen in Gujarat, Mumbai, Kolkata and Delhi are doing far better keeping their heads cool.
Then, what are the other mechanisms that can curb the black economy running today and thereby reducing the generation of black money in future. Hopefully we should have an answer soon ! The motive with which government and RBI acted on 8th November was perhaps the fact that globally, poor and rich countries carry far less cash than us. We carry about 13% of GDP, whereas everybody else carries just 5%. But common citizens sometimes construe it as a raambaan ilaaj on corruption.
*****
Target audience for this piece is laymen (and women). Questions and comments are welcome to evolve our answer against black money !
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