Demonetisation: Has it Unearthed Black Money?

With the dust settling down on demonetization, several serious analysis have started appearing on whether it has served the purpose for which this major and unprecedented economic exercise was undertaken. As former RBI Governor Y V Reddy puts it, there has perhaps been no other policy decision that has affected the lives of a billion people directly and all at once. It is difficult to find a parallel in terms of the range of economic activities that have been hit by an economic policy decision. The end result seems to be none too encouraging.

Demonetisation led to a virtual denial of freedom of movement, drying up sources of livelihood and deprivation for no fault of theirs. Yet people did not revolt and went through the pain. This, according to Reddy is because of intense feeling of disgust with the state of affairs in recent years. What is baffling is: what is the disgust about – counterfeit currency, terrorist financing or black money? The 1.2 billion population did not protest but had enormous patience to withstand the pain because of their belief in Prime Minister Narendra Modi that he would deliver what he promises. Four months down the line, Reddy is of the view that there is a lurking fear that Demonetisation may turn out to be a non-event, except for bitter memories of pain.

There is general disillusion. It has turned out to be not a game-changer. Cleansing the system of the past ills requires fundamental changes in both government and governed and that has not happened. It is not only Y V Reddy, another top economist Kaushik Basu, World Bank chief economist and former chief economic advisor in Indian government is of the view Demonetisation has been a disaster. Indian Economy, which is on road to recovery, would have clocked 8 per cent growth now had it not been for the demonetization. Former Prime Minister Manmohan Singh, who himself is a renowned economist, has aptly summed up in Parliament that it is a monumental mistake. To Modi government’s assertion that in the long run demonetization would benefit the people, Singh quoted Lord Mynard Keynes to say that in the long run all of us are dead. In the liberalized World, it is left to market forces to deal with emerging economic situations. But some argue, state intervention is required because Markets fail but the counter to that is, yes, markets fail at times, but the state too fails many a times.

Also one important fact that has been overlooked in this whole exercise is the image of the Reserve Bank of India. The image has certainly been dented. Economist, C Rammanohar Reddy, formerly Editor of Economic and Political Weekly has recently come out with a book on Demonetisation and Black Money. He analyses in depth the damage that demonetization has done to the banking system and the economy. He is in agreement with several economists that the Indian economy has suffered significant damage. Also the outcome of this disruptive exercise and distress it brought to the people is unclear. Even Reserve Bank is yet to come out with any clear assessment of how much black money it has extinguished as a result of this unprecedented exercise. After analyzing the whole exercise in his 250 page book, which makes an interesting reading, he is of the view that whichever way one looked at, demonetisation was not a good one. As very little of black money is kept in cash, demonetization cannot destroy much of the unaccounted money.

Even if government wanted to track down unaccounted money, demonetization was not the way to go about. The fact that almost the entire stock of demonetized currency had entered the banking system showed the ease with such individuals and organizations could get better of the system. The belief that the tax compliance would improve has not happened so far. In fact, the immediate outcome is just opposite. More than demonetization, it would be worthwhile for government to appoint Lok Pal expeditiously, prohibit and punish benami transactions, stringent rule and punishment on bribery, early rollout of GST and transparency in government procurement. These are reforms in process but they are painfully slow. Importantly malpractices in financial sector are one area where not much headway has been made despite government putting in place stringent rules and regulations. Demonetisation was aimed at going after black money held as cash.

Gold and real estate are major areas where black money is generated and stashed and demonetization has not helped in significant way to curb it. Rammonohar Reddy notes that less was said about the illegal transactions that take place in the financial sector, which are recorded in the banking sector and yet escape the gaze of the income tax authorities. Over and under invoicing of trade, share price manipulations through shell companies, roundtripping of capital through participatory notes, flows to tax havens are some of the illegal transactions that take place in the financial sector. Reddy argues in the book that the generation of illicit income via such transactions conducted through banking sector may now be as much, if not more than what is created and held in the form of cash. Citing the example of disproportionate assets trial of former Tamil Nadu Chief Minister late J Jayalalithaa and her associate V K Sasikala, Reddy said 34 shell companies operating 50 bank accounts were used to illegally acquire or sell property and conduct other illicit transactions. This happened more than two decades ago.

The sophistication of illegal financial transactions that has since developed is mind boggling. Now a beginning has been made in cracking down on shell companies, but the task of dismantling illegal transactions in the financial sector is no simple challenge. Mere legislations will not help nor for that matter demonetization in curbing black money. The executive, legislature and judiciary have allowed black money to become a part and parcel of the Indian economy and society. Ending black money calls for a larger change in governance practices, attitudes and habits. This meant root and branch overhaul in the society is required to defeat black money. Electoral, political, judicial and administrative reforms besides systemic reforms needed to take place. Though there are several reports on these reforms are available, none seem to be getting implemented because it does not serve the political class. The entire electoral process has to undergo an overhaul and that seems to be not happening in India barring some tinkering. So Reddy feels, in sum that the demonetization has so far turned out to be a failure and if there is no significant follow up action, there could be longterm damage as well. (PTI)

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