Controlling Black via Demonetization of High Denomination Currency
Arun Kumar
Retd. Prof of Economics, JNU
The PM’s announcement that high denomination currency notes will soon
be worthless paper caught everyone unawares. Even the government
departments did not know of it and would have to prepare for its
implementation after the TV announcement. It is an attack against the
black economy no doubt but questions will be asked about how effective
it would be and at what cost to the economy? There will be an
immediate impact and also over time as many unforeseen consequences
emerge. It is so complex that analysts in the government or outside
will be discovering new aspects of it for some time.
Do we have any experience of such a move in the past from which we
can learn? In 1978, the Rs 5,000 and Rs 10,000 currency notes were
demonetized. Of the Rs 165 crores of such notes that had been issued,
Rs 135 crores were returned with little impact on the black economy.
Not only that, the black economy continued to grow after that. The
move did not touch the lives of the average citizens. The economy was
small and the income of the average citizen was tiny compared to now.
People carried mostly Rs.10 notes and hardly any Rs 100 notes. So,
trade was not affected. So, it did not touch the lives of the average
person. There were no queues at the banks.
The high denomination notes now constitute around 80% of the Rs. 16
lakh crore currency in circulation. Most of this is with business and
not individuals. Even if it is held mostly by the well off with black
incomes, say, the top 3% of the population, it would not amount to
more than Rs.3 lakh per person and if businesses hold most of it then
the average amount may not be more than Rs 1 lakh per person. Only a
part of this would be black money saved out of the black incomes which
cannot be accounted for. These are averages but some may hold crores
in black money. But, black savings in cash may not be more than a few
lakh crores.
Of the current size of the black economy of about Rs.90 lakh crores
this may be only a few per cent. But clever rich and businessmen will
find ways to circumvent the new regulations and convert a part of
their black into white. The black economy in India is not parallel but
intertwined with the white economy. So, just as in 1978, a very tiny
part of the black economy would be demolished. The real worry ought to
be that the mechanisms of generation of black incomes in different
sectors would be unaffected by this move and black income generation
would continue as before.
At what cost to the economy? Household, business and industry would be
adversely affected as transactions would become difficult in the
coming months. Large part of the economy does not use plastic money or
cheques. Small businesses will be hit hard and that is the BJP’s core
constituency. There would be long queues at banks and a black market
may emerge in the currency notes for exchange and for smaller currency
notes. There would be premium for gold and foreign currency – this was
the case in the 1980s with the Bearer Bonds. Jan Dhan accounts are
likely to be used for converting black into white. Havala may become
more active. Demand for discretionary items would drop sharply in the
coming months. But sales in Malls and from e-commerce based on plastic
money may rise. However, in the net, dislocation of trade and commerce
is likely leading to a hit for industry which has hardly been growing
recently.
Our poorly performing and leaky bureaucracy would be unable to handle
such a complex operation at such a short notice. Remember the wheat
trade nationalization in early 1970s which had to be reversed in a few
months time because of the havoc it created. But the present move
cannot now be reversed even if it fails. The government has taken a
big risk. Why? Recent steps to control it via the foreign money bill
and the Income Declaration Schemes failed. It wants to show that it is
serious about the black economy after its promises during the 2014
election. In conclusion, it is unclear that the likely impact on the
black economy would justify the costs that the economy would have to
pay.
Author of `The Black Economy in India’, Penguin (India)
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Peace Is Doable
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