DEMONETISATION AND BLACK MONEY

Demonetization of the notes of higher denomination has also been one of the recent step of the Government to unearth black-money.

Demonetisation is a radical monetary step in which a currency unit is declared as an invalid legal tender. This is usually done whenever there is a change in the national currency of a nation.

On November 8, 2016 Prime Minister announced that Rs 500 and Rs 1000 denomination notes will become invalid and all notes in lower denomination of Rs 100, Rs 50, Rs 20, Rs 10, Rs 5, Rs 2 and Re 1 and all coins will continue to be a valid legal tender.

He also added that new notes of Rs 2,000 and Rs 500 will be introduced. There was also no change effected in any other form of currency exchange like cheque, Demand draft (DD), payments made through credit cards and debit cards.

Why the government has banned Rs 500 and Rs 1000 notes particularly?

• Some 68% of all transactions in the country are cash-based, and the Reserve Bank of India has estimated that the banned currency notes formed over 86% of all currency in circulation.

• As per the data provided by the RBI, there are 16.5 billion (45% of currency stock in 2014-15) ‘500 rupee’ note and 6.7 billion (39% of currency stock in 2014-15) ‘1000 rupee’ notes are in circulation at present. It has been pointed out that any economic cost in printing these notes is likely to outweigh in terms of benefit it would bring to India and Indian economy.

• In India, the rationale behind banning Rs 500 and Rs 1000 notes is that unaccounted money used in corruption or any deals takes place in the form of high-value notes of Rs 500 and Rs 1000 bills. These higher denomination notes are often found to be used for funding terrorism and corruption.

• The Financial Action Task Force (FATF), a global body that monitors the criminal use of the international financial system has observed that high-value currency units are often used in money laundering schemes, racketeering, and drug and people trafficking.

• In addition, these notes constitute a huge percentage of money spent during general elections by political parties, candidates in India.

Impact of demonetisation on black money

• Better tax compliance: This move is likely to lead to better tax compliance, raise the Tax to GDP ratio and improved tax collection. This could lead to lower borrowing and better fiscal management. Also with lower cash transactions in the near term, inflation may see downtrend in the near term. Also with higher tax to GDP ratio, the government may also get enough headroom to reduce the income tax rates, which can lead to higher disposable income with people and can improve consumption demand in the medium to long term.

• Real Estate Check: Demonetisation is seen as a check on the real estate sector where prices get pushed up artificially, reducing the availability of affordable housing for the poor and the middle class. Claiming that removal of high denomination currency notes of Rs 1,000 and Rs 500 would lead to decline in real estate prices making affordable housing available to all.
At present, there is excessive use of cash in real estate sector due to large cash transactions in areas such as purchase of land and housing property. The real estate prices get pushed up artificially. This reduces the availability of affordable housing for the poor and middle class.
So now, greater over-the-board transaction will lead to a decline in real estate prices making affordable housing available to all.

• Parallel economy burst: The move is expected to curb the parallel economy as the owners of black money will not be in a position to deposit the money with them in the banks. It is likely to temporarily stall the circulation of large volume of counterfeit currency and prevent funding for anti-social activities like smuggling, terrorism, espionage etc.
The Income Tax department will be benefited with the move, as there will be more specific data gathered in the process which could help in catching the defaulters.

• Check Terror Funding: It will put a stop to the neighbouring countries drug cartels and terrorists of supplying high value currency into India.

• Check Fake notes: The move will also reduce the flow of fake currency in Indian markets as data shows that most of the counterfeit currency in circulation exists in high-denomination notes of Rs 500 and Rs 1000.
According to the Reserve Bank of India’s annual report published this year, more than 2.61 lakh counterfeit notes in the denomination of Rs 500 were detected by banks in the year 2015-2016 while another 1.43 lakh fake notes of Rs 1000 were detected. By value, counterfeit notes of Rs 500 and Rs 1000 accounted for more than 92% of all the fake currency detected by banks across the country.

• SOFT MONEY surge – Online transactions and other modes of payment: There is a massive surge in the online transactions and other modes of payment. E-wallets, digital transaction systems, e-banking, usage of plastic money are expected to see increase in demand. Eventually this should lead to strengthening of these systems and the concerned infrastructure.

Under the cash crunch situation in Banks, the role played by Automated Teller Machines (ATMs) in dispensing cash is hugely important and their success in disbursing the cash effectively is, to a great extent, going to decide the fate of the demonetisation scheme.
With the demonetisation move resulting in a drop in donations, some of the famous temples in Gujarat have started introducing e-wallets, ATMs with deposit facility and swipe machines to accept cashless donations.

Recent data

Number of Suspicious Transaction Reports filed by banks during 2016-17 has gone up from 61,361 in 2015-16 to 3,61,214; the increase during the same period for Financial Institutions is from 40,333 to 94,836 and for intermediaries registered with SEBI the increase is from 4,579 to 16,953.

Based on big data analytics, cash seizure by Income Tax Department has more than doubled in 2016-17 when compared to 2015-16; during search and seizure by the Department Rs.15,497 crore of undisclosed income has been admitted which is 38% higher than the undisclosed amount admitted during 2015-16; and undisclosed income detected during surveys in 2016-17 is Rs.13,716 crore which is 41% higher than the detection made in 2015-16.

Undisclosed income admitted and undisclosed income detected taken together amounts to Rs.29,213 crore; which is close to 18% of the amount involved in suspicious transactions. This process will gain momentum under ”Operation Clean Money” launched on January 31, 2017.

The exercise to remove the anonymity with currency has further yielded results in the form of
• 56 lakh new individual tax payers filing their returns till August 5, 2017 which was the last date for filing return for this category; last year this number was about 22 lakh;
• Self-Assessment Tax (voluntary payment by tax payers at the time of filing return) paid by non-corporate tax payers increasing by 34.25% during April 1 to August 5 in 2017 when compared to the same period in 2016.

With increase in tax base and bringing back undisclosed income into the formal economy, the amount of Advance Tax paid by non-corporate tax payers during the current year has also increased by about 42% during 1st April to 5th August.

Further actions were taken under the law to stop operation of bank accounts of these struck off companies. Actions are also being taken for freezing their bank accounts and debarring their directors from being on board of any company. In the initial analysis of bank accounts of such companies following information has come out which are worth mentioning:

• Of 2.97 lakh struck off companies, information pertaining to 28,088 companies involving 49,910 bank accounts show that these companies have deposited and withdrawn Rs.10,200 crore from 9th November 2016 till the date of strike off from RoC;

• Many of these companies are found to have more than 100 bank accounts – one company even reaching a figure of 2,134 accounts;
Simultaneously, Income Tax Department has taken action against more than 1150 shell companies which were used as conduits by over 22,000 beneficiaries to launder more than Rs.13,300 crore.

Post demonetization, SEBI has introduced a Graded Surveillance Measure in stock exchanges. This measure has been introduced in over 800 securities by the exchanges.
Inactive and suspended companies many a time are used as harbours of manipulative minds. In order to ensure that such suspicious companies do not languish in the exchanges, over 450 such companies have been delisted and demat accounts of their promoters have been frozen; they have also been barred to be directors of listed companies. Around 800 companies listed on erstwhile regional exchanges are not traceable and a process has been initiated to declare them as vanishing companies. Demonetization appears to have led to acceleration in the financialisation of savings.

Criticisms

The decision to demonetize Rs 500 and Rs 1000 notes is misconceived and will not address the problem of black money for the following reasons:

• Demonetisation will only affect those who conduct transactions in cash, are not a part of the formal banking system or have not converted their cash into assets.

• Black money is generated through evasion of taxes on income from lawful activities and money generated from illegal activities. In the absence of steps to curb the generation of black money, demonetization is a futile exercise, as it proved to be in 1978.

• As per the Indian Statistical Institute, Kolkata study done on behalf of the National Investigation Agency (NIA), Rs 400 crores worth of fake currency is in circulation in the Indian economy. This is only .028% of Rs 14,180 billion worth currency demonetised in Rs 500 and Rs 1000 notes.

• Two of the most vulnerable sectors that have traditionally been exploited for parking crime proceeds and black money is the property, and gems and jewellery market. These sectors have also been used for the temporary investment of terror funds. Unless transactions are made transparent and reflect real market value, black money and terror funds will continue to find their way into these businesses.

• FICN can potentially be reintroduced into India after a break by Pakistan. In order to sustain action, the following are suggested:
a. Enhance detection measures at public sector banks which have lagged behind some of the private banks over the years.

b. Establish a forensic cell which monitors each case of counterfeit currency to better understand the technology being applied to counterfeit notes. This must contribute to future measures to enhance security against counterfeiting.

c. The involvement of Pakistan established through a Special Court judgement in 2014 should be built upon to enhance international diplomatic pressure.

Conclusion

Demonetization provides an opportunity to encourage a shift to a digital economy. This is an essential requirement to not only reduce corruption but also create an electronic trail for transactions. This will help bring transparency into the financial transactions of individuals and organizations thereby constraining corruption, criminal proceeds, money laundering and the finance of terrorism, which are all linked given the common channels employed for transferring funds. While demonetization is likely to encourage it, incentives by the government for payment of bills can further encourage people to take up plastic and e-money options. This is also likely to be enhanced by the forces of market economy which are already offering money back options.

Demonetisation is an important step in the fight against the finance of terrorism. However, it should neither be the first nor the last, if the interlinked threats of corruption, crime and the finance of terrorism have to be controlled. These must also not be addressed simply within departmental and ministerial silos. Instead, an all-of government approach is imperative if each of these challenges is to be met.