One of the government’s most dominant justifications for last year’s demonetisation was that it would lead to a decline in black money, or unaccounted cash. The Income Tax Department’s high profile display of the crackdown on black money over the past few months has served to reinforce and fuel this expectation.
However, business owners and informal financial service providers in Vijayawada and other parts of Andhra Pradesh, who were interviewed in July, reveal that the lasting legacy of demonetisation is not the disappearance of black money, but rather a substantial change in the way unaccounted cash circulates – in other words, black money’s circulation dynamics have changed. Another outcome, albeit unintended, is the emergence of a new set of beneficiaries of the changed dynamics in the circulation of black money.
In the context of the financial sector, the term “informal” refers to all categories of unregistered, private players, including those in illegal but socially acceptable businesses such selling coal stolen from freight trains, or even smuggled gold. Black money has not disappeared because this informal sector caters to a segment that is not serviced by banks for a variety of reasons, including the lack of clear titles, compliance issues or because they are businesses that operate in the grey areas of the law, or are outright illegal.
How unaccounted cash circulates
But how exactly have black money’s circulation dynamics changed since November 8, when demonetisation was announced overnight?
Business owners and informal financial service providers say that earlier, the line differentiating black and white money was quite porous. It was common for unaccounted cash to enter and exit the formal banking system at varying intervals depending on the needs of its holders. However, now the interaction and intersection points between the two have changed. The crackdown and raids by Income Tax authorities in the aftermath of demonetisation scared informal service providers, who mostly operate in the black economy, forcing them to lie low. Business owners indicate that they are now more cautious in their banking transactions, indicating that the frequent interactions between the black and white economy has more or less come to a standstill or been vastly reduced. In other words, the black and white economy have become two parallel tracks – which intersect far fewer times than they did earlier, if at all.
The question of trust
Another major change among informal daily financiers post demonetisation is the increased discretion in lending. Familiarity and reliability of customers – always important – are now more essential. This is because of the increased fear among such financiers that a defaulting customer can lodge a complaint with the police and tax authorities about their businesses and cause them great damage.
At the same time, borrowers who are both familiar and reliable can unlock the supply spigot of finance more liberally than they could at any time in the past.
And there are people looking to borrow money from the informal system. For one, demonetisation created a rare situation where large numbers of high net worth individuals, who have black money, are scouting for people who will lend them white money. This is because, in the larger cities of Andhra Pradesh, people holding black money cannot deposit large amounts in the banks because they cannot explain their source, while, on the other hand, people with money in the bank are not interested in withdrawing it, as re-depositing cash in their accounts could draw the scrutiny of the tax authorities.
Thus, the first clear beneficiaries of the crackdown on black money post demonetisation are those who can lend white money to those who possess black money but cannot deposit it in the bank as they cannot show a source for it.
One builder in Andhra Pradesh, negotiating a development agreement, pointed out that with the improvement in the availability of cash post demonetisation it is not difficult for a reliable customer to borrow Rs 4 crores to Rs 5 crores in a very short duration – often less than an hour. In case familiarity and reliability criteria are met, larger amounts of cash can be arranged within a day or two, the builder said.
The unintended beneficiaries
Post demonetisation, the black economy has also been grappling with a rare problem of parking excess cash. Increased scrutiny by tax authorities is further aggravating this problem of plenty.
This is where informal chit fund organisers – the second set of unintended beneficiaries of the crackdown on black money – come in.
Chit funds, which are also called Rotating Savings and Credit Associations, are a kind of savings schemes in India where members contribute as instalments a pre-determined sum every month for a fixed number of months, and bid for the money collected every month at a discount to face value. The monthly sum collected is called the pot.
Take for instance, a group of 20 people contributing Rs 10,000 each for 20 months. Every month, the pot in this group will be Rs 2,00,000 (20 instalments x Rs 10,000). Each of the 20 people, called subscribers, who are part of this group, will be able to bid for this sum. The person willing to forgo the biggest chunk is the one who gets the pot, after the cut (also called the discount) is deducted from the pot. For instance, in the chit group mentioned above, if a person who needs the money urgently is willing to take a hit of Rs 20,000 (the discount) on the monthly pot of Rs 2,00,000, that person is given Rs 1,80,000 and the balance Rs 20,000 (now called the dividend) is distributed equally among all subscribers, who get Rs 1,000 each. The process is repeated for the next 19 months. But each time the person who got the pot earlier cannot bid, and the discount/dividend varies depending on how much the winning bidder agrees to forgo.
The last decade saw an interesting trend of informalisation of formal chit fund companies in Andhra Pradesh. A large number of registered chit fund companies shut down their registered chit fund groups, and the same promoters started informal chit fund groups consisting of cherry picked customers considered to be reliable, and those who had a record of paying the monthly instalment on time. Since these reliable customers already had a business relationship with the chit fund promoters, trust is never an issue.
But what do chit funds have to do with black money?
In Vijayawada, the past three to four months has seen a large demand for these informal chits due to their ability to absorb black money while maintaining anonymity, as well as the lack of a trail that can be tracked by tax authorities. A large part of the demand is from professionals and businesses that continue to generate black money and need a safe place to park it.
Informal chit fund organisers have been quick to take advantage of this increasing demand by either doubling the size of the chit instalment or by increasing the number of chit groups without changing the tenure. For instance, in the previously quoted example, the monthly instalment will increase, from Rs 10,000 per month to Rs 20,000 per month. The pot will also double correspondingly, from Rs 2,00,000 a month to Rs 4,00,000.
Interviews with chit fund operators in Vijayawada in July indicate that the number of chit groups with monthly instalments of Rs 50,000 (in a group of 20 subscribers for 20 months where the monthly pot is Rs 10 lakh) has witnessed a sharp increase. Compare this to the past, when the standard size of an informal chit instalment was Rs 5,000 per month for 20 months, and the pot was only Rs 1,00,000.
Informal chit fund groups usually set a minimum amount (the discount) that a person wanting to collect the pot must forgo. This minimum amount is fixed in such a way that the dividend earned by all subscribers over the life of the chit fund will be more than the returns they will get on an equivalent investment in bank deposits.
Another interesting trend seen in Andhra Pradesh post demonetisation is that a large number of these groups have started reducing the minimum guaranteed return. The increase in the demand to join chit funds by people who need to put their black money somewhere has led to its organisers reducing this minimum guaranteed return though most chit funds still continue to offer returns higher than term deposits in banks. In the changed circumstances, as parking black money in these chit funds is more important for those who have black money, returns are given lower priority.
S Ananth is an independent researcher currently based in Vijayawada, Andhra Pradesh.
