Off the black mark

Demonetisation won’t hurt ‘kala dhan’ — it will only damage economic growth.

Written by Ajay Chhibber | Published:November 28, 2016 12:04 am
demonetisation, Rs 500, Rs 1000, black money, Pm Modi on black money, currency notes, demonetised currency notes, news, latest news, India news, national news It might have been better to go after real estate transactions, the movie industry, gold, weddings, election financing and benami transactions.

The Modi government’s hit on black money may go down as one of India’s biggest economic blunders — or greatest achievements. Whether one agrees with the move or not, its implementation has been bungled and the collateral damage is likely to be heavy. Where did this idea originate? Surely the PM’s key economic advisors would not have recommended it.

Demonetisation is usually associated with decrepit economies and hyperinflation, such as Zimbabwe recently and Argentina in the past. The Argentine government demonetised several times in the last century; it even changed its currency’s name from peso to austral, then back to the peso — each time, it further reduced confidence in the currency. Myanmar, Ghana, the former Soviet Union, Nigeria and Zaire also demonetised, leading to devastating economic consequences. In all cases, often done by military dictatorships, demonetisation eroded confidence in the currency. It is therefore surprising that a reform-minded, popular, democratically elected prime minister has resorted to demonetisation. Even Arthakranti, the Pune NGO from where the idea ostensibly emanated, is distancing itself from a ham-handed plan to withdraw 85 per cent of the country’s currency overnight.

There is likely to be a one-time stock effect on those who held black wealth or kala dhan in cash. But much of it sits in gold, real estate or is offshore. Estimates of kala dhan vary; the most commonly accepted is around 25 per cent of GDP. Demonetisation only affects black money — not kala dhan. Estimates from previous raids show cash is 5-6 per cent of kala dhan. Cash is easily transactable but because it’s bulky, it’s hard to hoard too much kala dhan in cash. So, about 1-1.5 per cent of GDP is held in black money. If the government nets half of it through demonetisation, it’s around 0.5-0.75 per cent of GDP. This still leaves the bulk of kala dhan untouched. The flow of resources into kala dhan is unlikely to be affected by demonetisation. In fact, over time, even less will be held in cash, more in gold, real estate or shifted offshore.

The collateral damage from this move could be huge, economically and politically. The poor are already suffering, especially those without easy access to banks, post offices, even information on what to do. More long-lasting damage could be to trade in sectors where much business is conducted in cash — especially the informal sector and rural areas comprising about 40 per cent of GDP. The non-bank financial sector, on which many SMEs rely for short-term finance, has also been hit. As a result, the effect on economic growth in 2016-17 could be as high as one per cent of GDP — which will neutralise the one-time gain from demonetisation.

It is claimed India’s cash to GDP ratio, at around 11-12 per cent of GDP, is too high. But comparisons are made with countries at much higher levels of development, with much smaller, rural, un-banked populations. China has a cash to GDP ratio of around 9.5 per cent of GDP, Germany at 8 per cent of GDP and the US at around 7.5 per cent of GDP. There appears no correlation between corruption and the cash to GDP deposit ratio. Nigeria, widely regarded as one of the most corrupt countries, has a cash to GDP ratio of only 3 per cent of GDP as faith in the currency has eroded.

To weed out black money, more comprehensive reform is needed. It might have been better to go after real estate transactions, the movie industry, gold, weddings, election financing and benami transactions. Without tackling the reasons for black wealth, just demonetising won’t address corruption or eliminate the black economy. The Modi government should focus on achieving genuine economic recovery and ensuring job creation. More poorly conceptualised, badly implemented and moralistic policy prescriptions will take us back to the Hindu growth rate of 3-4 per cent of the 1970s and 1980s. We thought we were done with that.

The writer is distinguished visiting professor at the National Institute of Public Finance and Policy, (NIPFP) and former DG, independent evaluation office, government of India.

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  1. V
    Vaid
    Nov 28, 2016 at 8:37 am
    It is the same cash which is being used to buy those ets is it not?lt;br/gt;A has cash and buys gold from B. Now B has that cash and so on.lt;br/gt;So, let us first eliminate the cash and put a break in the propogation of black money. Then we will go after the other ets.
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      Prashant
      Nov 28, 2016 at 10:29 am
      Luks like u lost heavily during this firefighting against Black.money menace
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        Prashant
        Nov 28, 2016 at 10:27 am
        Sr plz don't fool innocent IE readers,,, recently during raid in house of an Police SI in Bihar,,,90lakh cash was recovered,,,how???,,as per your logic black money is in Form.of Gold,flats etc,,,,This is not just one example,,there r several cases like this,,,,,Nd moreover this is first step 2wards black money menace
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          Prashant
          Nov 28, 2016 at 10:32 am
          जो नामुमकिन को मुमकिन करदे,,,उस पंछी का नाम "नरेंद्र दामोदरदास मोदी" है,,,,,,,,you were on Post of DG ,,,,,,, recently a DG rank officer in delhi Committed suicide bcs of corruption,,,,,,though he blamed CBI for this,,,but during raid ,,crores of cash was unearthed from his house
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            Hemant Kumar
            Nov 28, 2016 at 4:49 am
            Mr. Modi has rightly said that those who are underestimating the effectiveness of demonetization are unhappy because sufficient time was not given to them to make their black money white.
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              prakash gotimukul
              Nov 28, 2016 at 7:02 am
              People can keep ranting, but India is changing and a revolution is coming. People and political parties have to forget how u handle business. Gone will be the days when people deal with PETI, KHOKA, rokda etc. It is either a bank transfer, cheque or e money, credit card.................physicl cash is pe. Already naxalites, criminals, real estate agents, builders, terrorists, hawala operators are feeling the heat. Of course no body is day dreaming that this is one golden bullet. This is just a beginning and PM knows. Either change or burn your fingers........
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                Anonymous
                Nov 28, 2016 at 4:41 pm
                The author should note that Narendra Modi has a track record as Gujarat CM and and if we go by that we may actually be on course for double digit growth rate not the kitchen gossip version in the article.
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                  Harjit
                  Nov 27, 2016 at 11:29 pm
                  It is already hurting the weakest in our country. The richest and the CMs of UP, Bihar, Orissa, Telagana and Andhra Pradesh have no impact at all. On one hand BJP politicians Reddy spending Rs.500 crore on wedding of his daughter and another NDA politicians claiming to have Bullet proof bathroom while over hundred innocents from bottom of our society died of either heart attack or suicide or without treatment due to lack of money.
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                  1. J
                    Jim
                    Nov 28, 2016 at 6:38 am
                    Ignorant rant. There is cultural shift towards less cash society by force. Many more ppl in tax ambitlt;br/gt;lt;br/gt;There is a general lack of good quality data in Indian economicslt;br/gt;lt;br/gt;And then this ignoramus umes that informal sector means all poor people. How wrong he is. There are many crore pati farmers and traders. Indian traders are naturally dispensed to moan and show losses and hide profits
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                    1. J
                      Jim
                      Nov 28, 2016 at 12:17 pm
                      This sarkari babu has come out from under the rock to tell us this drivel
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                        Jagjit
                        Nov 28, 2016 at 8:02 pm
                        India will soon be put in same category as Sri Lanka, Bangladesh with set back from demonetisation which is causing immense pain to small scale enterprises and conumers who have nothing to spent, may lead to economic collapse soon.
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                          Karan
                          Nov 28, 2016 at 12:57 pm
                          👍
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                            Khan
                            Nov 28, 2016 at 7:45 am
                            Exactly to the point. The black-money mostly is with politicians and industrialists.lt;br/gt;The BJP is making the people suffer for its friends to flourish by taking loans from banks. PM says long term gains ( for who? ) the person who loaned billions of Rupees and escaped from just below your nose.lt;br/gt;lt;br/gt;How come persons deposit becomes illegal. I cannot withdraw my own money from my own account..!!.. After this do u think anybody will believe in banking systems which can make you suffer any given time without any notice like is going now. Ridiculous.
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                              ND
                              Nov 28, 2016 at 3:42 pm
                              Even if black money is .5 to .75 pct of GDP it will add up to lot because this amount is per year. People are aware that in real estate the cash is about 50% or more Now since there is less of black money stored in cash the real estate price will go down at least for some time. Too bad the professor seem ideology driven not logic/fact driven.
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                                SubbuI
                                Nov 28, 2016 at 6:49 am
                                ,MADYA PRADESH BJP BOUGHT PRIME REAL ESTARE WORTH 8000 CRORES ( ie IN HALF THE MARKET RATE) in LAST FORTNIGHT OF OCT 16.PROOF RELEASED IN NATONAL HERALD -28/12/16
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                                  SubbuI
                                  Nov 28, 2016 at 6:32 am
                                  RAGHU RAM RAJAN WAS SACKED BY NALAYAK DICTATOR NMODI AS HE WAS AGAINST THI FOOLISH AND UNTMELY DEMONETESATION.
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                                    SubbuI
                                    Nov 28, 2016 at 6:36 am
                                    URGIT BAI PATEL THE CO BROTHER OF ELDER AMBANI IS AN NRI AND WAS APPOINTED AS GOVERNOR FOR THE DEMONETASATION PURGE BY THE DICTATOR MODI.THIS HAS TAKEN OUR ECONOMY BACK TO PRE 1991
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                                      SubbuI
                                      Nov 28, 2016 at 12:20 pm
                                      THE BELOW SAYING WILL FIT SUPER VILLAIN NALAYAK DICTATOR NMODI WELLON HIS DEMONETESATION JUMLAlt;br/gt;NAACH NA JAANE- AANGAN THEDA!lt;br/gt;MOOV NA SUNDAR AAINA THODA!lt;br/gt;IN ONE EGOIST AND UNDER PREPARED ACT HE TURNED THE CLOCK OF NATIONAL ( RURAL) ECONOMY BACK BY 10 YEARS
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                                        SubbuI
                                        Nov 28, 2016 at 6:29 am
                                        DEMONETESATION BY NALAYAK PRIME ,INISTER IS TOTAL FAILURE.IT HAS TAKEN INDIAN ECNOMIC CONDITION TURNING TO DOOM AND GOING BACK TO PRE 1991 STATUS WITH IN 6 MONTHS.
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                                          SubbuI
                                          Nov 28, 2016 at 6:45 am
                                          BJP AND FRIEND MADE A COOL 150000 CRORES WITH IN 10 DAYS IN REAL ESTATE AND LAUNDERING.LET THE BAKTHS DENY IT.PROOF WILL BE GIVEN
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                                            K SHESHU
                                            Nov 28, 2016 at 2:18 pm
                                            This will only increase ' kaala' economy where the real ' 'black' money is shifted into dark rooms if foreign banks
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