Narendra Modi wants to crack down on “black money”. Will it actually work?

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Offline Repon

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India: Narendra Modi’s bonfire of the rupees
A debate rages over the effect of the prime minister’s crackdown on ‘black’ money
by: Amy Kazmin

India, at the start of this year, began requiring retailers that received more than Rs200,000 ($3,000) in cash from a customer to report details of the sale — and the buyer’s taxpayer identification number — to tax officials. The impact on Ethos Watches, a luxury watch retail chain with 45 stores, was immediate: sales plunged 60 per cent. Before the new rule, 45 per cent of the company’s sales were of Swiss timepieces worth more than Rs200,000 — often bought with suitcases full of notes.
“People are no longer able to make cash purchases of expensive products without the risk that they will be called by the income tax department inquiring where they got so much cash from,” Yasho Saboo, Ethos’s owner, told the Financial Times a few months after the new regulation took effect.
Strict monitoring of large cash payments was the opening salvo in Prime Minister Narendra Modi’s campaign to crack down on “black money” — cash earned through illegal activities, or earned legally but never declared to tax officials. The campaign hit its apogee last week, with New Delhi’s surprise ban on the use of Rs500 and Rs1,000 notes — a radical action intended to catch black money hoarders.

The scrapped currency — together worth more than $220bn, or 86 per cent of India’s circulating cash — is no longer legal tender and the notes are not supposed to be used for any transactions, except buying fuel at state petrol pumps or in government hospitals. Until December 30, the notes, worth $7.50 and $15 respectively, can be deposited in bank accounts or exchanged in small quantities over the counter for new currency. But income tax officials will be alerted to any deposit of more than Rs250,000, a sign of the widening campaign against corruption and tax evasion.

The cash ban, which Mr Modi had kept secret until it was announced on November 8, has shocked India just as it was beginning its frenetic high-spending wedding season. Markets are deserted, except for banks and automatic teller machines deluged by desperate Indians on a quest for cash. “I know the forces up against me,” Mr Modi said in a speech this week. “They may not let me live. They may ruin me because their loot of 70 years is in trouble.”
As the Indian government struggles to overcome logistical bottlenecks that have impeded distribution of the new currency, debate is raging over just how effective the draconian measure will be in combating black money. There are also questions about its impact on the wider economy. In India, circulating cash is 14 per cent of GDP, compared with less than 5 per cent in other large economies. Nearly 80 per cent of consumer transactions are in cash. Many of those have now come to a halt.

The stealth decision to abruptly cancel and replace most of India’s currency is a radical economic experiment, and political gamble, with few precedents. Some western economists such as Kenneth Rogoff, professor of public policy and economics at Harvard University, have advocated the gradual phasing out of high-value notes to combat crime in advanced economies, which tend to be far less cash dependent. The European Central Bank is slowly withdrawing the €500 note over concerns that it facilitates illegal activity and tax evasion.
But, until now, large-scale overnight demonetisation and currency replacement exercises have only occurred in countries in the midst of state or economic collapse — such as in Germany after the second world war, or the former Soviet Union — or in the throes of hyperinflation. Such disruption has never been inflicted on a country that was ticking along nicely like India, where GDP grew at an annual rate of 7.1 per cent from April to June this year.

“No country has done this kind of shock therapy,” says Jahangir Aziz, global emerging markets analyst at JPMorgan. “We don’t have any precedents of doing anything of this sort. We are flying by the seat of our pants.”

Swapan Dasgupta, a member of India’s upper house of parliament, says the move is intended as a radical shake-up of Indian society, where corruption and tax evasion, by businesses and affluent individuals, is a way of life. It is a big risk for Mr Modi, whose supporters include wholesale and retail traders, known for their non-transparent cash dealings.
“It’s motivated by a philosophy which is that if you want India to be a meaningful player on the world economic stage, you’ve got to take tough measures,” says Mr Dasgupta, who has close ties to Mr Modi’s ruling Bharatiya Janata party. “Otherwise you can plod on.”

India’s tax to GDP ratio is just 16.6 per cent, some 5.4 percentage points less than comparable countries, the government estimates. Just 5.5 per cent of Indian earners pay income taxes, while nearly 85 per cent of the economy is outside the tax net. Mr Modi’s hope appears to be the cash crunch will force many businesses to start using banks or digital payments, so their income can be monitored.

“It really is shock treatment, declaring total war on a particular way of conducting business,” says Mr Dasgupta. “But it’s a huge political risk. The traders are your biggest political base and you’ve really hit the traders the most. They don’t consider it black money. They’ve been doing it like this for generations.”

‘The clever find ways around it’

Indians’ attachment to cash — and tendency to conceal their income — dates back to the socialist era of Indira Gandhi in the 1970s, when income tax rates rose to nearly 98 per cent and government officials had extensive control over business. Income tax rates have fallen sharply since. But property purchases are still taxed heavily, giving buyers and sellers a shared incentive to understate property values. Officials retain vast discretionary powers, often used to amass illicit wealth.
“There is not a soul in India who has not paid black money,” says Surjit Bhalla, senior India analyst for the New York-based Observatory Group, an economic consultancy. Mr Bhalla admits he caved in to pressure in the 1990s to pay Rs300,000 to a Delhi city official who withheld permission for him to build a house for two years. “We have created an environment in which everybody is forced to be corrupt,” he says.

India has demonetised to try to flush out black money once before. In 1978, New Delhi scrapped what were then truly high value notes — denominations of Rs1,000, Rs5,000 and Rs10,000, which then accounted for 2 per cent of the country’s entire cash supply — and gave holders a week to exchange them. Recently, anti-corruption campaigners embraced the idea that India needed another round of such medicine.

Yet Raghuram Rajan, the recently departed governor of the Reserve Bank of India, was sceptical about the effectiveness of demonetisation as a means of purging black money from the economy. Most illicit wealth in India is believed to be held in property and gold, not the sacks of cash depicted in Bollywood films. “My sense is the clever find ways around it,” Mr Rajan said two years ago. “They find ways to divide up their hoard into many smaller pieces … It is not that easy to flush out black money.”

It is unclear who convinced Mr Modi to take the gambit. Influential yoga guru Baba Ramdev has tried to claim credit. But others suggest the real champion was Anil Bokil, an accountant who founded an obscure Pune-based non-profit, ArthaKranti. His group has gained influence in rightwing circles with its vision of radically restructuring India’s economy, including abolishing banknotes larger than Rs50 and scrapping income tax.

This summer, Mr Bokil reportedly had an audience with Mr Modi that lasted nearly two hours. “In India, if you lobby hard enough with the prime minister’s office and say, ‘I have no vested interest,’ you get a few minutes to present your idea,” said Saurabh Mukherjea, chief executive of Ambit Capital, a Mumbai brokerage. “There was no real debate on the subject and no conventional economist mooted the idea — certainly not on the scale in which it’s been done.”

Economists agree that the sudden cash crunch will be a painful blow to the economy initially. Analysts estimate that the ban on the notes will shave about 1 per cent from GDP growth in the current financial year, which ends in March. “This is a large, negative sudden shock and the impact on real activity is going to be large and negative in the short run,” said Mr Aziz.

According to Deutsche Bank, fast-moving consumer goods sales have dropped 30 per cent in some regions, while consumer durables in small towns are at a standstill. Much of India’s trucking fleet, which relies on cash for tolls and taxes, is stranded on the highways. “All kinds of cash-based businesses are all gumming up,” says Rajiv Lall, chief executive of IDFC Bank.

Property prices have also been hard hit, with implications for the employment-intensive construction sector. In the longer term, it is seen as good news for aspiring homebuyers. “On average, you are likely to see a 50 per cent correction in residential real estate prices,” says Ambit’s Mr Mukherjea.

Long-term benefits

The full impact of the negative shock will depend on how fast the government can roll out the replacement cash. So far, the process has been agonisingly slow, as each ATM needs physical recalibration to handle the new notes, which are slightly smaller in size than the old ones. “You need to solve, as quickly as possible, the challenge of introducing new currency into the market,” Mr Lall says.
Despite the difficulties, many economists, and even ordinary Indians, believe Mr Modi’s shock therapy will yield long-term benefits. Higher levels of bank deposits can facilitate lower interest rates and greater lending, while traditional businesses will be under pressure to find alternatives to cash and come under the tax net. “There is an economic argument that if you get black money into the formal economy it does improve public finances,” says Rajeev Malik, senior economist at CLSA.

No one knows how much cancelled cash will return to the banks, and how much will be purged from the system. Cynics claim many working-class Indians who have been queueing at banks to exchange up to Rs4,500 are “mules”, being paid by the wealthy to launder their money. Others with excess, illicit cash are looking to friends and family to help get their money into the banking system — and offering a handsome price. Experts say the note ban will do little to stop new black money.

Mahesh Rewaria, who sells phone accessories from a tiny stall, says his sales fell 60 per cent after the ban and have yet to fully recover. Yet he supports Mr Modi’s move. “It’s only those who were not paying taxes and stealing from the government that have to worry. I am included in that,” he says. “I would have always wanted to pay my taxes fairly, but then I would think why should I, when other people are so corrupt.”
Politics: Cash policy could hit Modi’s rivals in the purse
Many Indians are dismayed that Prime Minister Narendra Modi’s ban on Rs500 and Rs1,000 notes hit at the start of the annual wedding season — a moment when families spend significant amounts of their savings on elaborate nuptial celebrations.
But analysts believe Mr Modi was thinking more about the political season ahead of crucial elections in Uttar Pradesh, India’s largest state, in the first few months of next year.
With 80 parliamentary seats, Uttar Pradesh is critical for Mr Modi’s re-election prospects in 2019, and he is eager for his Bharatiya Janata party to win control of the state administration, which would offer him strong advantages in the national election.
With his move, he has reinforced his image as a strong, decisive leader, willing to take bold decisions in a country typically inclined to incremental change. It may have had an added benefit: the cash crackdown is thought to have inflicted significant financial damage on his political rivals, some of whom could have felt a hit to their own cash stashes just as they are gearing up for the campaign.
“The BJP’s monetisation scheme is politically monopolistic in intent as it aims to wipe out the cash reserves of other parties,” wrote Sushil Aaron of The Hindustan Times.
But Mr Modi’s gamble risks backfiring. Many rural Indians store their hard-earned savings, such as they possess, in cash in high denomination notes at their homes. Now, they face the challenge of trying to deposit that money into distant banks — or see it turned into worthless pieces of paper. Rural dwellers depend even more on cash than city residents. It remains to be seen whether they will share in Mr Modi’s enthusiasm for purging black money.
« Last Edit: November 18, 2016, 09:39:44 AM by Repon »
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Offline sourav000000

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may be for this reason some products price also increase in Bangladesh which normally comes from India. A few months back I bought one Fastrack Watch  and the same model now price increased by 1 or 1.2% and the seller said that is because of the Rupee rate.