Take note, the fault lies in the system

Updated - November 24, 2016 01:36 am IST

Published - November 24, 2016 12:02 am IST

It is absurd to suppose, and even more so to claim, that the black money problem will be solved once the transition phase is over.

It is absurd to suppose, and even more so to claim, that the black money problem will be solved once the transition phase is over.

This is not the first time demonetisation of high-denomination notes has been tried as a means to ‘eradicate’ black money. The present scheme differs from earlier ones in several important respects. It shows much more considered planning than earlier schemes. Significant sections of the public have welcomed it. At the same time, amid reports of widespread hardship experienced by people all over the country, the implementation of the scheme and even its basic design have attracted mounting public criticism.

Banks and financial institutions have been unable to cope with the task because of the huge rush of people, inadequate supply of new legal tender and small-denomination notes to banks’ branches and automated teller machines (ATM), further compounded by the non-functionality of ATMs in handling new notes. The inability to meet this demand is reflected in serpentine queues, inordinately long waits, and large numbers leaving frustrated and angry, and reported clashes, tension and occasional violence. The media has highlighted all this but focussed mainly on urban areas. The situation is much worse for the self-employed, small and micro enterprises in rural and poorly banked areas: the severe shortage of low-denomination notes needed for payment wages and meeting essential daily needs is causing severe economic hardship in the transition phase. The disruption in activity of the unorganised sectors is turning out to be increasingly widespread and serious.

Yardsticks of success

It is all too obvious that the logistical problems have been grossly underestimated. The reported inflow of demonetised notes into the banks is impressive but accounts for only one-third of the estimated stock of the earlier Rs.500 and Rs.1,000 notes. The success of the demonetisation exercise will be judged not just by how much of the remaining two-thirds flows into the financial institutions as a whole and not just scheduled banks by year end. We need to know the extent to which these increments come from existing depositors, how much from new ones with and without Permanent Account Numbers, and by the growth in the volume and value of cashless modes of settlement.

It is now necessary to focus on whether transparent mechanisms and procedures to collate and analyse the relevant data are in place. Equally important is to secure a firm commitment from the Reserve Bank of India and government that these data would be placed in the public domain within a reasonable time.

It is absurd to suppose, and even more so to claim, that the black money problem will be solved once the transition phase is over. The proportion of the stock of demonetised notes which return to the financial institutions by year end is a useful but inadequate index of the success of demonetisation. There are reports of the widespread use of ingenious ways to get around the restrictions: for example, the illegal transactions in gold, real estate and foreign exchange, disbursement of demonetised notes to party cadres, self-help groups and through Jan-Dhan accounts of the poor for depositing in banks.

Systematic monitoring of the increase in deposits with non-bank financial institutions is necessary. The findings from raids and inspections by the Income Tax Department, Enforcement Directorate and other government agencies will give some idea of the incidence of other illegal practices. But it is practically impossible to determine the extent to which these have been successfully used to convert demonetised notes into non-monetary assets and how much has been lost because of physical destruction of old currency or due to fall in asset prices. Nor can we rule out the possibility of hoarders of demonetised notes holding on to them in the hope that they can exert enough pressure on the political class to go easy on implementation, be lenient in enforcement of penalties or even allow conversion of old notes at a future date.

Post-transition challenges

The greater challenge is in the proposed follow-up action to identify and penalise those making fresh deposits during the transition period in excess of Rs.2.5 lakh. Their accounts are to be scrutinised to ascertain whether they are consistent with their declared incomes and assets. This raises serious difficulties, both conceptual and practical. The credibility of the process requires that the procedures of scrutiny and verification be spelt out clearly and made public. So far there is no indication that this and attendant legal issues have even received serious consideration of officialdom or independent experts. Whatever is decided has in any case to be implemented by and through the vast official tax bureaucracy. Not only is the magnitude of the task monumental, the tax administration is steeped in and used to extensive manipulation through individual and collective pressures and outright corruption. It is difficult to be optimistic about the prospect of the system overcoming its entrenched practices to become a credible enforcer of law and regulations.

In any case, demonetising high-denomination notes does not eradicate the accumulated wealth of the black economy which is held not just in currency but mostly in a variety of other assets such as real estate, gold and undeclared foreign accounts. A long-term solution to reducing, not to speak of eliminating, this black economy is not possible without addressing its root causes which lie in the way the economy and polity are structured and operate. The existing system offers enormous scope, opportunities and incentives for earning incomes and accumulating wealth through tax avoidance, the way markets for assets function, and direct and indirect exactions of the political class. It is idle to pretend that demonetisation even begins to address this systemic problem.

A. Vaidyanathan, an economist, is a former member of the Planning Commission and RBI board.

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