With Demonetisation 2016 yet to deliver clear-cut benefits, what next?

One of the central arguments in this book is that whichever way one looks at it, Demonetisation 2016 was not a good idea. One, very little of black money is held in the form of cash, so demonetisation was not going to destroy much of the unaccounted wealth.

Two, even if the government did want to track down unaccounted cash, demonetisation itself was not the best way to go about it since it hurt the entire population while trying to ensnare a small number of holders of illicit cash. An alternative would have been to collect, analyse and follow up on information on large cash withdrawals from banks and thereby identify possible flows of unaccounted cash.

Three, if, in spite of all the risks and limited chances of success, the government still wanted to go ahead with demonetisation, then the manner in which Demonetisation 2016 was designed and implemented was neither the only option nor the best one. There were other less destructive options available.

In public discussion, “formalisation of the informal” emerged as a new rationale for Demonetisation 2016 after the event.

Demonetisation and then digitalisation of monetary transactions would compel, it was argued, the informal sector to be henceforth more tax compliant. It was also argued that the introduction of the Goods and Services Tax (GST) would only strengthen this process.

It is indeed well-known that in large sections of the informal sector – real estate, retail and wholesale trade, and professional services – payment of taxes is often not the norm. Demonetisation and digitalisation may drag these economic agents into the formal sector and lead to greater tax compliance. However, the fundamental problem with the “formalisation of the informal” argument is that the much larger informal sector that ekes out its livelihood on the margins does not avoid paying taxes, it just earns too little to fall into the tax bracket. Formalisation of production by the tiny enterprises in industry, road-side service establishments, and by small- and medium-sized farmers would not lead to a gain to society. It would, in fact, put an additional burden on these producers who are already struggling by earning low incomes.

Some weeks after demonetisation was announced and when it became clear that a large amount of the high denomination notes had already entered the banking system, digitalisation emerged as the main agenda from Demonetisation 2016. It remains the most important item on the agenda. The focus now is on how to accelerate the adoption of electronic payments at all levels – from households upwards. There remain many infrastructural and economic constraints to accelerating digitalisation. That, however, is not the issue with the emergence of digitalisation as an action programme after Demonetisation 2016.

The main issue is, did the economy have to be put through the demonetisation wringer in order to drive it towards digitalisation?

Digitalisation of payments is a process that has been underway in India for a decade and more. It has made considerable progress in transactions between companies in the organised sector and among those comfortable with electronic/on-line forms of payment. The larger population is, however, right now outside the scope of digital payments. Even with the Jan Dhan financial inclusion programme and the telecom revolution, major constraints in infrastructure and also issues relating to a lack of familiarity and unaffordability tell us that digitalisation cannot be hurried without running the risk of exclusion. Yet, the one major agenda that the government has been driving since Demonetisation 2016 has been digitalisation.

For some, it is not any concrete gain that matters, but the long-term “psychological shock” that Demonetisation 2016 will inflict on the behaviour of people. The holders of black money will have experienced such a major shock that they will, it is said, decide that tax compliance is a better strategy than running the risk of losing everything in the future.

But the immediate outcome seemed very much the opposite. That almost the entire stock of demonetised currency had entered the banking system showed the ease with which such individuals and organisations could get the better of the system. It also reflects the confidence they have of subsequently managing the system, in case there are to be investigations in the future.

The more likely psychological shock was a harmful one.

Some commentators pointed out that the upheaval caused by the removal of 86 per cent of the currency in circulation had unnerved ordinary people, the honest citizens. The trust they had reposed in the currency issued by the central bank and the government had been shaken. This is an unhealthy development in a modern economy.

Yet, the promise initially was of something else. Soon after demonetisation had been announced, in the intense debate that followed it was pointed out by many that this action by itself would do little to destroy black money and do even less to end the future generation of black money. The government in response said that demonetisation was neither the first nor the last measure to be taken to destroy black money. More steps were to follow in what was promised would be a larger war.

There was little of that kind to be seen in the next three months, save the limited measures on political party finance announced in the Union Budget for 2017–18. It appeared as if the promised action was not to follow.

There is, however, a great deal to be done if even a dent is to be made in India’s black economy.

Here is an illustrative list of just a few things calling for administrative/legislative action, which is drawn from a comprehensive unpublished note titled “Next Steps After Demonetisation” (1):

• Appointment of the Lok Pal: Three years after the enactment of the Lok Pal and Lok Ayukta Act of 2013, the Lok Pal in which so much hope had earlier been placed to identify and punish the corrupt is yet to be appointed.
• Rules prohibiting/punishing benami transactions: The Benami Transactions (Prohibition) Amendment Act, 2015 has been passed but the Act has not been notified and the rules have not been issued. The Act passed in 1988 had not been notified for 25 years. It was then amended, but it is yet to be operationalised.
• Tightening rules for punishment for bribery: The Prevention of Corruption (Amendment) Bill 2015 is yet to be passed. The bill proposes to tighten the rules in some respects, though it also weakens it in other areas.
• Citizens’ right to public services: The Right of Citizens for Time Bound Delivery of Goods and Services and Redressal of their Grievances Bill, 2011 lapsed in 2011 and has not been re-introduced. The bill mandated the preparation of charters with time-lines for provision of certain public services and the citizen’s right to complain against non-delivery. Another bill on the citizen’s broader right to public services has been languishing in the draft stage since 2009. This is the Public Services (Protection and Regulation) Bill 2009.
• Transparency in government procurement: The Public Procurement Bill 2012, which has been in the draft stage, mandates transparency in central government procurement. It could, if implemented properly, reduce corruption in procurement.

This is only a brief list. There is much more to do in a number of other areas. For instance, as argued in this book, the interface between politics and business, which is a major source of black money generation, is crying out for an effective elimination of conflict of interest.

There is also the issue of malpractices in financial sector transactions which are a major source of generation of black money. Indeed, while the government was going after black money held as cash, 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. Government committees have in the past highlighted the growth in transactions such as over/under invoicing of trade, share price manipulation through shell companies, round-tripping of capital through participatory notes, flows to tax havens, etc. It has been argued in this book that the generation of illicit income via such transactions conducted through the banking sector (with each transaction being large in value) may now be as much if not more than what is created and held in the form of cash.

A striking contemporary example of how undocumented money flows through the banking system is that which was brought out in the disproportionate assets trial of J Jayalalithaa, when she was Chief Minister of Tamil Nadu, and her associate VK Sasikala. Thirty-four shell companies operating 50 bank accounts were used to illegally acquire/sell property and conduct other illicit transactions. This happened more than two decades ago. It boggles the mind to imagine the sophistication of illegal financial transactions that has since developed. A beginning has been reported to have been made in cracking down on shell companies, but the task of dismantling illegal transactions in the financial sector is no simple challenge.

Doing away with black money goes beyond taking specific measures or enacting new pieces of legislation. All three arms of the state – the legislature, the executive and the judiciary – have allowed black money to become a part and parcel of the Indian economy and society. But the generation of black money is not just an outcome of the undermining of legislation by public institutions.

Ending black money calls for a larger change in governance, practices, attitudes and habits.

These are changes that must be made not merely in the arms of the state but also within larger society. It is now acceptable for business to operate the levers of political power to get things done. It is now acceptable for political parties and political agents to abuse their office for the smallest of gains to the biggest of pay-offs. It is now acceptable for professional associations to condone violations of the norms of professional behaviour. It is now acceptable for the more powerful of citizens to proudly state that they flout rules, possess wealth beyond their means, and evade payment of taxes. It matters nothing that they flaunt ill-gotten wealth.

Root and branch overhaul in the society is then required to defeat black money.

If in the end Demonetisation 2016 turns out to have been a failure and if there is no follow up action on black money, there is likely to be long-term damage. The colossal distress that Demonetisation 2016 caused will make it impossible for any future government to embark on a more serious war on black money. The government will be wary if there is even a small risk of pain being inflicted once again on the entire population. No society will be able to go through this suffering once again. The black economy will then remain in place.

(1) V Bhaskar, 2016, “Next Steps After Demonetisation” December, mimeo.

Excerpted with permission from Demonetisation And Black Money, C Rammanohar Reddy, Orient Blackswan.