Problems with the tall claims made about demonetisation

There is an abundance of claims by the government both about the virtues of demonetisation as well as the duration of the “inconvenience” people have to go through. Here is my attempt to debunk some of them.

To begin with, there is a slight problem. The objectives of the demonetisation have not been officially and explicitly listed anywhere, it appears, so one must draw them based on the Prime Minister’s speech and whatever various people have said would be a “good” result from the demonetisation. These include fighting black money, fake currency notes, reducing corruption, bringing most of the money in the country into the banking system, generating more taxes and improving economy. Other non-stated objectives, widely pointed out of course, would be the ongoing bank bailout using private funds of citizens (recapitalizing, it is called in polite circles) and strangling the financial resources and thus limiting power while contesting elections for political opponents.

Let us look at these one by one.

Fighting black money

There seems to be no consensus on how much black money exactly is in the form of currency notes. An estimated 6% of all illegitimate income recovered has been in the form of currency, which does not appear to be a lot in comparison with the losses to the economy from the shock of the demonetisation. How much has been recovered is unclear. There are several reported instances of notes being confiscated. However how much of it is black money and how much is (or gets explained away as) legitimate income remains to be seen. There are reports of the news of the demonetisation already been leaked to the wealthy well in time and is supported by increased sales of gold before the demonetisation being announced. Additionally, as economists are repeatedly cautioning, black money is a result of the nature of the transaction rather than a quality of the money, so the same notes can be black money or white depending on the legality of the transaction and whether it is declared in taxes.

Supporters of the government, in their attempts to silence all criticism of demonetisation have increasingly taken to demonising cash transactions or the possession of cash itself as black money, which is a dangerous perspective in a country where 95% of the transactions happen in cash. They might as well call India a black money country. This view is incorrect and obfuscates facts. However, there is no shortage of reports of the old notes themselves being traded for a lesser value creating an overnight black market ranging from a single note to crores being laundered through agents. Between the advance warning and the laundering a large amount of the already small percentage of black money is likely to have safely returned to its owners without changing color.

A small percentage of people may declare their money and choose to pay tax on it, but this is not likely to be a large amount given that amounts over 2.5 lakh will be flagged for Income Tax, and those that cannot be explained as legitimate income are likely to incur a 200% fine in addition to the tax on the deposit (though there currently does not appear to be a provision under the law), essentially leaving only 10% with the owner of the money. Another percentage of the black money is likely to be confiscated from suspicious deposits in banks and through raids. Given that the Income Tax Department will have to show that this money is not legitimate income, the percentage of money likely to be confiscated will be small compared with all deposits flagged, if for no reason then for the sheer number of accounts that will be flagged requiring manpower to investigate and process. No doubt mass mailing of notices will happen and is already reported to have started.

However, there appear to be plenty of ways for people to launder money, including big and connected agents close to the government, false sales of gold, purchase of gold, backdated fixed deposits in banks, interest free loans, advance salaries for several months to employees and more. The government itself offered the victims of the Kanpur train tragedy compensation in the old and illegal notes. It is anyone’s guess whether these amounts were originally withdrawn as legal notes and swapped with illegal ones before giving the victims, since the notes not being legal tender cannot be legally paid out by the government after demonetisation.

But the biggest blow to claims of black money being hindered by #demonetisation is the abundance of people named as having offshore accounts, notorious for having black money, cronies who have benefited from disproportionate favors from Modi led governments (state before center) and of course the noble denizens of the black money rich Bollywood. If all these people support demonetisation, they are clearly not worried about their black money being in trouble.

Fighting fake currency notes

The new notes introduced have no additional security features. Existing notes are already counterfeited, so it does not seem like demonetisation will prevent fake currency to any large degree. In fact, within days of the new notes being released, there were instances of photocopies of the notes being used to defraud people, including, in one instance by school children. The garish color and relatively flimsy paper of the new 2000 rupee notes make even real notes appear to be dubious in comparison with regular currency notes. How soon or late counterfeiters start producing fake notes is anyone’s guess, but there is absolutely nothing to indicate that it won’t happen. We certainly seem to have failed in intercepting their distribution, or fake notes would not be a reason to demonetise.

The hasty nature of the demonetisation causing the panic and overburdening the banks has not allowed banks to adequately examine deposits to catch and refuse fake notes, so existing fake notes are likely to have been knowingly or unknowingly legitimized with government approved real currency through deposits and exchanges.

Reducing corruption

This seems to be mostly fiction, as even in this short duration, a bribe of four lakhs was paid using the new 2,000 rupee notes, that at the time of being caught had not even been released for a week. Reducing corruption cannot be achieved by changing currency. It would require better law enforcement and deterrents. The government machinery being one of the biggest causes of corruption in the country on every level, the government making a claim of reducing corruption with the simple changing of notes sounds mostly like the fox claiming to provide security for the poultry. Indeed in recent days, we have seen allegations backed by documents that implicate the Prime Minister himself in receiving over 55 crores from the Sahara group when he was the Chief Minister of Gujarat.

Another set of serious allegations come from several quarters, notably a BJP MLA himself, indicating that businessmen close to the ruling party had advance notice of the demonetisation and had already cleared their black money. A third allegation is that people close to the president of BJP, Amit Shah himself are exchanging large sums of black money for a fat commission. This is by Yatin Oza, a former BJP MLA who also claims to have videos backing his accusation as well as makes some realistic challenges about the richest people not featuring among those with large deposits of money into banks. Large quantities of 2,000 rupee notes seen with various people support these accusations, as no one can legally get a bundle of 2,000 rupee notes at this point due to limitations on withdrawal. None of these allegations have so far been denied by the Prime Minster or Amit Shah.

While the country lines up for access to its own cash, a large number of loans by high profile defaulters have been written off. A green fine worth 200 crore levied on Adani has been waived. BJP MLA from Rohtak has publicly reassured black money owners that they need not worry and that Haryana Chief Minister Khattar and Modi were with them. And all this is just within the last few days without needing any extensive searches through history. It is unclear why corruption would reduce under a leadership like this.

Routing most money through the banking system

How much money remains in the banking system is a matter of debate once the cash demonetised is fully replaced. Opinions are split on this. Right now people have no choice, since they aren’t allowed to withdraw much cash, and banks are often even failing to provide the allowed limits of cash given the severe cash crunch that is likely to last for 4 – 6 months by most estimates. When they do have choice, it is quite possible that a lot of the cash will be withdrawn right back out. Also, given the availability of the 2,000 rupee notes and their relatively low utility for transactions, the only purpose they could realistically be used in any quantity appears to be hoarding. Even while limited cash withdrawals are allowed, there have been several instances of bundles of 2,000 rupees being seen with people including office bearers of the BJP as well as being used to pay bribes. The instances described in the black money laundering also would remain outside the banking system. So it is entirely possible that while the country struggles for cash, a lot of the illegitimate money may still remain out of the system, merely converted to new notes.

In the meanwhile, there seems to be some evidence for the misuse of Jan Dhan accounts (and indeed it could be done with other accounts too) for parking funds. So money entering the banking system may not necessarily be in a manner desired. My suspicion is also that if there are corrupt bank employees, money could be deposited into the bank accounts of people who aren’t even aware that their account is being used for laundering. Such money could probably be recovered by forging signatures on withdrawal slips or misuse of debit cards if the person whose account is misused is known to the launderer and trusts them. There seems to be evidence of this happening as well. Such money would fly right out of the banking system once scrutiny was reduced and if caught, would implicate a complete innocent.

The large number of Jan Dhan accounts lying unused and thus likely to not be monitored by owners are particularly a concern, as they have been suspected to be misused for hawala transations in the past.

Improving collection of taxes

While there will be increased collection of taxes, there are easier ways of doing this with far less loss to the economy. Namely tax reforms, reducing corruption in the tax system and robust enforcement. As of now, about 1% of India’s population pays taxes. Given the widespread poverty even with an absurdly low poverty line, how much this number can be realistically expected to rise is anyone’s guess. The economic stagnation will also result in fewer taxes being collected because of lost jobs, wages, business losses and devalued goods, even if more people temporarily seem to be on the radar.

Recapitalizing banks

Banks will be recapitalized, loans will be easier to get, interest rates will be lowered… are the expected outcomes from demonetisation. I am no expert on these matters, but given the kind of slowdown the economy is seeing, there will also be reduced deposits, transactions, people digging into savings and businesses collapsing, taking their loans down the drain with them. There is speculation that low interest loans will encourage rebuilding of the economy. No economist of note seems optimistic that it will outstrip the shrinking already set into motion. At best it is put as a possibility in the long run, all things going well. All things don’t appear to be going well, given that it will be months before there is any liquidity worth mentioning for businesses. What advantage will evolve in the long run remains to be seen.

Preventing terror financing

This seems to be a popular reason on TV as well as supporters of the government. Modi himself referred to it in his speech. However, going by evidence so far, it does not make sense. Manohar Parrikar hurried to claimsuccess as a halt in stone pelting incidents in Kashmir after demonetisation. This echoes a popular belief within the ranks of the BJP leadership and supporters – that the stone pelting incidents in Kashmir are not spontaneous protests, but well organized and funded with black money. However, this couldn’t be farther from the truth. Apart from demonetisation having triggered stone pelting on banks in other parts of the country, the stone pelting in Kashmir had actually reduced by October – as per the J&K Home department data (BJP itself is a part of the J&K government) – well before demonetisation and there have been incidents of stone pelting after the demonetisation as well, though congruent with the slower frequency. Furthermore, Kashmir actually saw the least disruption to daily life and order as a result of demonetisation in the country – this is attributed to the penetration of banking to even remote parts of Kashmir as compared with the rest of the country.

Furthermore, the most counterfeited currency in the world is the dollar and it is also the one most likely to be used by international terrorists for financing, yet demonetisation has not seemed to be a feasible deterrent to any such use if it happens. In comparison, Indian currency has far more limited use – within India and Nepal alone and is even less likely to be used. Several people have pointed out that there is no reason why terrorists wouldn’t use online banking and electronic transfers, given that they could be accomplished with fake identities, and being caught for taxes is unlikely to bother those willing to brave the consequences of being caught for terrorism (there may be the potential to dispute this using some jokes on taxes here).

Attack on finances of other political parties

One would expect to see a lot more agitation among political parties if their finances were truly disrupted. And it would have been possible for the BJP to disrupt them quite thoroughly if it had chosen to implement transparency in political funding as well. However, BJP has not done that – quite likely as a result of it being the party with the largest amounts of unaccounted funding in the country at present. Consequently, the other parties are merely opposing the BJP for politics as well as the sheer disastrous nature of the demonetisation. There seem to be no indications of alarm for their own well being.

There have been no instances of black money being found with rival parties or politicans so far. In fact, so far the few instances of large amounts of cash being found as currency notes have all been from the BJP itself. The reason for this likely is that political parties being allowed to accept funds in cash as well as not provide details for donations under 20,000 rupees, it is a routine practice for parties to even show larger amounts of black money as several donations of smaller amounts. Far from being cornered, rival parties would likely be able to comfortably change old notes for new ones, including the potential of laundering black money to white for politicians belonging to the party.

It is unclear what advantage, if any the demonetisation will end up giving BJP in comparison with rivals when measured against the tremendous inconvenience, losses and worse caused to voters.

This post will be updated with links to all the claims and quotes in a couple of days when I get some time. Till then, you could probably google the references up if you need them.

Vidyut

Vidyut is a blogger on issues of National interest. Staunch advocate of rights, learning and freedoms. @Vidyut

3 thoughts on “Problems with the tall claims made about demonetisation

  1. Looking to the bigger picture we could expect telcos including RELIANCE to promote mega scale the e-wallet to the 18th century indians and make big bucks, while subtracting the band width which could have been used more productively

  2. Very perceptive and well-written article, Vidyut. The man who everyone looked towards to help develop India, has now done the opposite with one extremely poor decision. To cure a disease, he has killed the patient. The Indian economy is now in very real danger of going into a cascading downward spiral, and the Indian government seems to be completely oblivious to it.

    I would have done the exact opposite with the currency. I would have promoted Indian rupees as a product in itself, and extolled its virtues as a store of value, and money that could be used to buy anything, anywhere, even outside India. That would have greatly helped development. Instead, you’ve now got a situation where people are going to view Indian rupees with a great deal of skepticism.

    This doesn’t really affect me personally, because I live in Canada. However, it is distressing to see that the old janam-bhumi still keeps taking one step forward and three back, and just can’t seem to get it’s act together. Good luck to you all.

  3. “Reducing corruption cannot be achieved by changing currency. It would require better law enforcement and deterrents.”

    Vidyut, that’s not correct. Enforcement and deterrents have a role, but they come in much later, after the core incentives have been fixed.

    “Black money and corruption are symptoms of our system. Unless we repair the system, nothing will change; black money will return with a vengeance. So long as our politicians are necessarily corrupt due to our electoral system, and bureaucrats are necessarily unaccountable (and often corrupt) – as detailed in SBP’s manifesto – black money cannot be rooted out.” – see http://swarnabharat.in/blog/read/swarna-bharat-party-says-that-demonetisation-has-been-implemented-badly-and-will-do-nothing-to-address-the-causes-of-corruption-and-black-money

    Further, see: http://swarnabharat.in/blog/read/swarna-bharat-partys-president-asks-mr-modi-why-he-is-doing-nothing-to-eliminate-the-causes-of-corruption

    First, we all know that candidates in elections spend crores of rupees of black money, both to bid for a party ticket (tickets are auctioned by the major parties at prices of Rs.4 crores or more) and for campaigning. Why then, would any elected politician not be corrupt? Those who get elected seek to recover their costs, with compound interest. We have a democracy only in name. Honest and competent people are blocked by the system. We therefore only get corrupt people as our Ministers.

    The solution is to minimise candidates’ losses during elections. SBP has a proven solution for this. All candidates must be reimbursed an amount, say, Rs.20 per valid vote cast. This will allow honest candidates a chance to contest elections since they will be able to recover at least some of their costs.

    Second, India’s bureaucracy was created for colonial masters. It is designed not to be accountable to the people of India and has become a major cause of corruption. SBP has a solution for this. Senior officials should be appointed on hire-and-fire contracts that ensure total alignment with performance. Such contracts should dispense with any unnecessary red tape that dilutes accountability. Officials must lose their jobs (not just be transferred) for non-performance. All India Services, which have choked the life of the country at every level, must go.

    There is much more, and details are provided in SBP’s manifesto.

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