India bites the bullet: Drastic measure to curb black money
The World Bank in July, 2010 estimated the size of India’s shadow economy at 20.7% of the GDP in 1999 and rising to 23.2% in 2007. The parallel shadow economy corrodes and eats into the vitals of the country’s economy. It generates inflation which adversely affects the poor and the middle classes more than others. It deprives Government of its legitimate revenues which could have been otherwise used for welfare and development activities.
Reasons for the drastic step
The Government had taken the drastic step to
- Curb financing of terrorism through the proceeds of Fake Indian Currency Notes (FICN)
- Use of fake notes for subversive activities such as espionage, smuggling of arms, drugs and other contrabands into India,
- Eliminate Black Money which casts a long shadow of parallel economy on India’s real economy.
The Government cancelled the legal tender character of the High Denomination bank notes of Rs.500 and Rs.1000 denominations issued by RBI till now. This came into effect from the midnight of 8th November, 2016.
Fake Indian Currency Notes in circulation in these denominations are comparatively larger as compared to those in other denominations. For a common person, the fake notes look similar to genuine notes. Fake notes facilitate financing of terrorism and drug trafficking.
High denomination notes are used for storage of unaccounted wealth. In addition high denomination notes facilitate generation of black money. This may be evident from the fact that while the total number of bank notes in circulation rose by 40% between 2011 and 2016, the increase in number of notes of Rs.500/- denomination was 76% and for Rs.1,000/- denomination was 109% during this period.
The Government as advised by the Reserve Bank of India will issue new Two thousand rupee notes and new notes of Five hundred rupees for circulation. Notes of one hundred, fifty, twenty, ten, five, two and one rupee will remain legal tender and will remain unaffected by the decision. A detailed process of exchange of demonetized notes from banks has also been announced.
Measures for disclosure of Black Money
The Government had passed a law in 2015 on disclosure of foreign bank accounts. In August 2016 strict rules were put in place to curtail benami transactions. During the same period a scheme to declare black money was introduced. In addition the Prime Minister had raised the issue of black money seeking click here safe haven in different global forum. The efforts have borne fruit. Over the past two and a half years, more than Rs. 1.25 lakh crore (Rs 1.25 trillion0 of black money has been brought into the open.
Impact of demonetization
In one swift decision the Government has flushed out the huge cache of black money and also fake notes from the system. The immediate impact will affect smooth trade and business in the country. There may even be shortage of legal tenders till banks push in the new currency notes into the system. The injection of liquidity into the system to keep retail continue at a robust rate is a challenge to the system.
Over the longer term real estate prices in India, notorious for undervaluing and transacting in cash will come down with the cash element flushed out. Coupled with judicious taxation policy the Government can bring the real estate sector at par with advanced global economies. Price of real estate will also come down to represent the real economy with the black economy now erased.
The political parties and their leaders, notorious for encouraging creation and circulation of black money will be the biggest losers. This will cleanse not only the economy but the administrative process also. Indian economy will come stronger on the transparency parameter than it was earlier.
Gold is another commodity where Indians hide their ill-gotten wealth. The strike on black money and expected tightening up of the retail trade will ensure less demand for gold. Since India is a major importer of gold India’s import bill will come down.
The transparency will boost real economy. Pressure on inflation will come down. Hoarding and black marketing of commodities will be checked. This will raise collection of tax by the exchequer. The higher revenue collected will induce better rating of India since the debt to GDP percentage will come down.
Deepak Talwar, Principal of DTA Consulting said, “The rupee will remain stable or strengthen in the exchange market. With less pressure on inflation the interest rates are expected to come down. On the whole demonetization move will help the Indian economy though a lot will depend on the efficiency of the local and national administration.”