| BIG STORY BLACK MONEY SWACHH BHARAT DEMONETISING HIGH VALUE CURRENCY WILL DEALA BODY BLOW TO THE SHADOW ECONOMY—AND EVERYTHING CONNECTED TO IT | ByM.G. Arun with Shweta Punj, Uday Mahurkar and Kaushik Deka | he announcement was as dra matic and unexpected as the T military's ‘surgical strike’ in late September, AU8,17 pm on November 8, Prime Minister Narendra Modi unleashed a massive attack on India’s shadow economy, leaving black money holders with less than four hours to deal with their stash of cash. Currency notes of Rs 500 and Rs 1,000 denominations, he said, would cease to be legal tender from mi- night that day. He had reasons to do so, The black money ‘menace has been gnawing atthe roots of India's ‘economy, sowing the seeds of corruption in many sectors, stoking inflation, and driving up real est- ate prices. US-based Global Financial Integrity, policy advocacy non-profit, in a report, ‘liit Financial Flows from Developing Countries 2004- 2013", estimates black money outflows from India at $505 billion (nearly Rs 33.3 lakh crore) between 2004 and 2013. Back in 2007, a World Bank estimate pogged India’s shadow economy at 23,7 por cont ofthe GDP. ‘This move has been in the works for some ‘ime. On June 27. during his Mann Ki Baat radio address, Modi hinted his gov- ernment would take strong steps iftax evaders did not disclose their income vol- untarily. On September 2, during a TV interview. ho said, “Don't blame me if take tough decisions after September 30.” Modi stuck to his warning, and timed it to precision. As his administration neared the halfway mark of is five-year tenure, Modi needed a big-bang announcement to coun~ twr the oppositions oft-repeated barbs on the black money issue. And so. just ahead of the big election battle in UP, he launched his war. Even the usually abrasive Janata Dal-United UD-U) seomed appreciative of the move, “The PM has fulfilled bis poll promise with this step. We wel+ come i,” says party spokesperson K.C. Tyagi, ‘Tho Congress has taken an opposing view fon the decision, and ehoson to focus its tique of the move on the adverse impact itis widely feared it will have on the common man, Former finance minister P. Chidambaram raised the point that in 1978 the Janta govern- ment under Morarji Desai had also domonetisod high denomination notes but the action had failed to achieve its,BIG STORY | BLACK MONEY “objectives. Lawyer-activist Prashant Bhushan said that while the deci- sion was welcome, a great deal of black money was in the form of par- ticipatory notes (a kind of nancial instrument for overseas investors), or residing in banks and in tax havens. ‘Not much has been done on that acc- ‘ount, he said, adding that the decision to demonetise and replace Rs 500 and Rs 1,000 bank notes would burt casual and migrant labour, as woll as those who do not have bank accounts. India’s unbanked population (peo ple without bank accounts) stood at 233 million, according to a 2015 PricewaterhouseCoopers report. On the other hand, supporters point out that this isa logical second million bank accounts created under the Pradhan Mantri Jan Dhan Yojana. Also, it was planned well in advance: six months ago, officials at tho Resorve Bank of India (RBN wore directed to print more currency notes inthe Rs 100 denomination, and later instructed to create now notes in Rs 500 and Rs 2,000 denominations. CAMPAIGN FINANCE Officially, this decision has heen, presented as a body blow to terror- ist groups, especially crass-bor ‘ones, all of whom depend on illicit currency to finance their activities in this country. A great deal of pressure will also be felt in political eirele According to Delhi-based political ‘watch NGO Association of Democratic Reforms (ADR), 93.8 per cent of the income reported by the Congress, and 91.3 per cent of the BJP comes from unlisted sources. However, the two parties that will likely face immedi- ate consequences are the SP and BSP, the two main rivals in Uttar Pradesh’s ‘upcoming elections. While a BSP spokesperson rofused to comment ‘on the matter, UP CM AKhilesh Yaday ‘was circumspect, asking the Centre to ensure that the move did not result in harassment of the common man. He also wanted camps set up in rural areas with poor access to banks to ‘enable people to exchange their old curreney notes. However, while polili- cal leaders may feign indifference, ‘or oven, as Mamata Banerjee did HIT. HARD How sectors with high cash transactions will be impacted REAL JEWELLERY ESTATE, SIZE OF THE RsG5lakhcrore Rs 3lakhcrore ECONOMY (2014) (2018), netucing gems % OF GDP n 67 HOW MUCH 30% 70-80% ‘BLACK'(%) >> ofatransaction D> —_oftransactions inthe early hours of Novembor 8, vent her rage online—"WITHDRAW ‘THIS DRACONIAN DECISION” she sereamed on Twitter—the Fact remains that campaign finance has long had a cosy relationship with the ash economy, ‘Under Election Commission (EC) guidelines. political parties are not required to account for contribu ions loss than Rs 20,000. This allows for some creative accounting: for example, despite the many photogr- aphs of BSP supremo Mayawati being garlanded with wroaths of cash, off- tial declarations say her party got no cash donations during the 2014 Lok Sabha elections. “Parties are taking advantage ofthe opacity in the expen diture statements to collect and spend funds in cash,” sald an ADR roport on campaign finance, Other statis- tics give weight to this view: of the 37 regional parties contesting polls botwoen 2004 and 2014, 19 claimed to have spent more than they had col- loctod—in 2014, the Shiromani Akali Dal (SAD) collected Rs 17.8 erore but spent Rs 18.5 crore, and in 2011, the would end, tax evasion (an-June 2012) IMPACT Blackeomponent | Converting black money inproperty buying into goldwillbe cubed controled ‘Trinamool Congress collected Rs 12.7 crore, but spent Rs 18.4 crore. ‘SWEEPING IT CLEAN ‘The idea to demonetise high denomi- nation notes was first mooted around January this year, months bofore the idea atthe time was to announce it as part of the budget, but the ground- ‘work necessary for such an ambitious chang Doth time and plan- ning. As Sabyasachi Kar. associate professor atthe Institute of Economic Growth, Delhi. explains. “The first stop has boon takon, and it was done excellently It was a perfect surprise, asiit should have heen,” In hindsight, there were a number ‘of stops that led to it. For instance, the RBI began tapering the supply of Rs 1,000 notes as far back as a yoar ‘ago, releasing only 977 million notes ‘against a projected 1,900 million. In the first weok of November, it also ran pilot project to test the financial sec- lor's ability to quickly replace legal tender, instructing banks to operate ten per cont of ATMs with only Rs 100CONSUMER HOSPITALITY BETTING GOODS +A Rs 83,127 crore Rs 2.38 lakh crore Rs lakh crore (2016) (2013) (2012) 25 2 Noestimate Over 50% of the Indian consumer market Noestimate » 100% revenue's unreported ‘Transactions withtheend /-Mid-sizedestablish- Without unaccounted customers areincash,most | mentsaskcustomers cash, match-fixing will cofwhichgounaccounted | topaypartofthebillin not be possible for.Fake product makers | _cash.|tmakes part of dodge taxes, which cannot the transaction untrace- bedone any more able. That willgo notes. Another major step was to push the Jan Dhan bank accounts. Those there wore also other indica- tions, such as the voluntary disclosu scheme for black money, which led to Rs 65,000 crore becoming ‘clean’ HOPE FOR THE ECONOMY Abig question, however, remains: what will be the economic after- ‘math ofthis decision? While there is no single answer, there are several possible consequences. As citizens and institutions queue up at banks toreplace their legal tender, deposit ‘growth could improve. Since rural houscholds will have to open bank ‘accounts to deposit ald notes, gov- ‘ernment schemes for financial inchi- sion may soe botter results, Since black money plays a significant role in property purchases. negative con- ‘sequences are likely forthe already down real estate market. Since some black money will become legitimate via currency exchanges, the govern- ment’ tax revenue collections will {got a boost, As Nomura, a brokerage house, wrote in a research note, "We bolieve the move generally bodes well for the inflation outlook since black money was associated with high infla- tion, However, iti likely to hurt near term consumption demand. wr Arun Jaitley said demonetisa- ‘tion “Would lead to an increase in direct and indirect tax collection Bank deposits will increase, and there will be significant fiscal advantage for states and the Centre”. According to estimates within the government, Rs 14.9 lakh crore of high denomination notes are in circulation and nearly 30 per cent of these are in black or unac- counted for. The government hopes to arn tax rovenue to the tune of Rs 3-4 lakh crore, which can alter the fiscal picture considerably. But a sceptical Mumbai-based economist Iaments: “It sounds too good to be true. Consumption will take a hit as that much purchasing power goes out of the system.” However, Jaitley reit- crated that the docision would change consumption patterns, as more and more people shift from physical cash F: his part, Union finance minis- 1 electronic transactions. “This isa brilliant move and proba- bly the best way to got black money out of the system,” says Doopak Parokh, chairman of IDFC, India’s largest home loans company. However, he also noted thatthe administrative cost ‘would be significant and would impact the economy in the short run. Ashima Goyal, a professor atthe Indira Gandhi Institute of Development Research AUGIDR), Delhi, said the move would have a one-time effect. “But it will not stop future black money genera tion unless transparency is brought in black monoy sources such as roal ‘estate and political funding, and big data is used more effectively to det tify ax avoiders.” she added MANAGING THE SHAKE-UP ‘Over the next fow weeks, India's financial systems will likely see a ‘groat doal of strain, Tho total value of ‘currency in circulation is estimated at Rs 17 lakh croro, of which 80 per cent is in high-value denominations. Banks will have to replace about Rs 13.6 lakh crore of currency, a potential logistical nightmare. The long queues in front of ATMs on Tuesday evening, immediately after Modi’s announce- ment, were a sign of what's in stor Online trade could also be affoc- ted. Sreedhar Prasad, partner, e-com- ‘moree and start-ups, KPMG India, said there are currently over 3 mile lion orders in the pipelines of online retailers using their ‘cash on delivery’ payment option. “Unless an immedi- ate ‘e-wwallet pay on delivery’ model is devised.” he says. "many of the orders may get cancelled, or clog the logistics notwork, Many customers may still be hesitant to adopt e-wallots in such a short span of time.” Ajit Ranade, chief economist with the Aditya Birla Group, says that ‘while this will inconvenience the gen- ‘ral public for a few days, the biggest {impact wil be felt in sectors where black money has a significant pros~ ‘such as real estate, construc tion and education. “There will be some trouble for the economy: but not too long-lasting,” he said. “Our denominations are too large. They should ideally be 0.25 per cent of perTHE PAPER TRAIL ACURRENCY RECKONER | By Damayanti Datta | Irene ‘Twocompanis, with printing presses across the country, workunder the Rl to produce cur rates and coins. Thereis the Bharatiya Reserve Bank Note Mucran Private Ltd (BRBNMPL),with ‘wo printing presses.n Mysorein Kamataka, and Salbonin Benga. minting 6 bllon note pieces pe year at each. Then there isthe Security Printing and Mnting Corporation ofIncia Lic (SPMCIL), formed ater the corpratsation of four presses, four mints and one paper mil earlier Under the finance ministry Both are now involved inbringing out the new curency notes, HISTORY REPEAT: ue 1970s Rs 500:47% Rs 1,000: 37% WRs50 ands 100: Around 11% ‘Other: Around 5% CIRCULATION RESERVE BANK OF INDIA See tome Somer rere amet) Bim = 090000 New Design Security Thread Portrait New Cancers, Aeagaleteaawth Watermark rmagentawithangsl —inseptonforsecuriy. —_lightan-shade ‘yaan (Rs 2,000); and Ikcanbeseenasa ‘Gandhi, with multi SonegreywithRedFert conthuousinewhen ——_drectoalnesin (ss00)atthevack—heldagainstlht thewedew PUNO See s1.000 Rs500 Rs2,670 | Rs3,159 Rs2,450 | Rs2,530 (BranmPL) | (SPMCIL) (BRaNMPL) | (SPNCIL) India has a habit of scrapping high-value bank notes 1978 Rs 1,000, RsS.000.and NN, Wanchoo committee ‘Under Moraji Desai govern 10000 notes are Singestsdemoneisaton ‘ment, ho High Denomination taken out (under RBLgow ‘§ _fseaterackmoneyt | Bank Notes (Demonetisaton) mor €D. Deshmukh) Srurshearcerstegelrdet ‘et, 878, makes'1000,5000 7 lustbeforelndependence \e high denominations ‘and 10,000 rupee notesillegalRand 12% Cash to GDP ratio in india (QDP: $2.3 trlion. Wirt average s about 496 Rs 18 lakh crore Total value of notes andcoins in circulationininda 86% ofthe totalcurreny in cireulaton va vuedatRs 149 lakh eoreisnow useless 15-25% ‘of @DPisblackmoney according to some.Othersbelve tis more than 0 percentafthe economy Rs 15,000-20,000 crore Estimated costointroduction of newseres of notes Rs 2,770 crore Costof printing Rs 500 and Rs 1.000 notesin 201615 eno $1.2 billion Blackmoney Indians heldin Swiss banks atthe end of 2015 according to Swiss Central Bank, SNB Rs 2.7 lakh crore Total daly banking transaction in India, of which 80 per contisin cash Other Features See-through Register Afleralband when seen agaist the Latent Image Jrnumeas isle only when the not isheld orion aye level Microlettering Value and tin fie pit Intaglio Printing Oras print whichcan be fet touch Fluorescent ‘Number panels infuorescentrk and optical fixes seen when exposed Wight Variable Ink Numerals pritedincelourshtingink that charges trom greento bli when nots tied Sms Borg aseitr Reet 7008 ‘capita income, which is Rs 250." In the United States, for instance, the highest denomination note is the $100 Dill. Aditi Nayar, a senior economist at ratings firm ICRA, said the intermit- tent disruption of activity in some sec+ tors may result in economic growth boing somewhat lower than expected, REAL(I)TY BITES n Wednesday, stock markets. woighed down by the govornment’s announcement, as well as Donald ‘Trump's vietory in the US presiden- tial elections, crashed 1.689 points in ‘morning trad, Although the BSE had recovered most ofthat loss by the end of the day, it was still 338 points down from the previous close. The biggest losers were real estate shares, with the BSE Realty index slumping 14 por cont, This was not unexpected, and is seen by many as a necessary cost of loaning up this sector of the econo my. "The banning of higher currency notes is a major move which will help curb unaccounted-for cash in the real estate sector,” says Anuj Puri chairman and country head of real estate consultancy JLL India. Strict ‘measures have long been required for greater transparency, to givo the Indian real estate sector more croc ibility and make it more attractive for foreign investors, he adds. ‘Tho Indian real estato soctor has historically been unregulated and ‘unorganised. a haven for black money Nonetheless, the sector is also an eco- nomic powerhouse, attracting $10.5 Dillion in FDI between 2005 and 2014. Itis slated to grow to $676 billion by 2025, five times its size in 2014, according to KPMG. Without a tho- rough clean-up, litle of this real estate ‘boom will make its way to the Indian exchequer. Putit this way: ideally ris- valty pricos should load to more ‘government revenue in the form of stamp duty and taxes on capital gains. What happens instead isan increase in ax ovasion, by under-reporting of property prices. In effect, tax is only paid on the reported price—the ‘of= cial’ sale price—which is usually far lower than the actual amount chang. ing hands, The balance is paid in cash which is neither reported nor taxed. BIG STORY | BLACK MONEY However, the government’ decision, coming close on the heels ofthe Real Estate (Regulation and Development) ‘Act (RERAY, is expected to significantly ccurtal such practices. twill ereate a level playing field among al stake= holders. Coupted with legislation like RERA, GST and the Benami Act, this will further increase transparency in the sector.” says Shishir Baijl. CMD of Knight Frank (india) OTHER BLACK PEARLS India is one of the leading gold mar- kets in the world. This market is also a significant contributor to the shadow economy—black money hold- fers are known to invest in bullion and jewellery to protect thetr ill-gotten agains from inflationary depreciation Rampant cash sales in the gold and jewellery trade give buyers a route to convert black money into gold and jewollory, while offoring sollors the ‘option of keeping unaccounted wealth by underreporting the sale price. Stories on the market grapevine sug- {ost that traders in cortain pockets in ‘Mumbai have converted their black ‘money into gold by paying a premium. Underlining this. gold prices rose over ‘two per cont the day after the prime minister's announcement, According to a Ficei study, another generator of black money’is the mar- kot for countorfoited branded brands Since the products being sold are fake, counterfeiters neither rogise tor themselves nor their sales. This rosulls in tax evasion of excise duty fon manufacture and jab work, service tax on sorvieos such as transporters, and VAT on sale of products. One of the expected results of the govern- ‘ments policies is thet those suetors will be forced to shift their actvitios into the legal sphere. thus strengthen- ing India’s economy. “Ifthe economy picks up as a result ofthis clean-up, then t should strengthen the rupee.” says Jamal Mecklai, 2 consultant Modi has ondoavoured to strike ‘at the root of the black money men- ‘aco and silonee his erties to an extent. But his biggest challenge will be to ensure that the ship of state recovers quickly from these sudden shifis in policy direction, .GUEST COLUMN 3 THIS PURIFICATION WILL BE PAINFUL Good intentions pursued with good rationale make for good public [ASHOK. DESAI like ths in my life, 1 do not mean the ean- collation of 500 and so notes, L vebsite of the Reserve Bank of India crashed. Instead, there was a message: “Error 521 Ray ID: 2fftc1321ce83192 + 2016-11-09 13.5412. That is hardly worth a complaint, for the prime minister himself gave a protty clear explanation, And he gave us in detail the arrangements th ‘government had made for exchange ing banned notes for unbanned ones. Alone had to do was to choase one of the exchange counters—in cremato- ra, milk booths. rail ticket booths and sso on—and queue up with one’s sacks of notes. ‘Truo, it was an unwarranted ‘waste of time; but while one stood for hours, one only had to share the PM's view that one was participating in a ‘makayajna—I guoss it moans groat roligious ceremony— this celebration of intogrity and credibility. And justin cease one wondered why the PM of a secular country had organised these thousands of yajnas, the answer is lear—his government has brought a new moral dimension to the running of this country. This is not is first stop of this ‘kind. Barlier this year; the finance minister had asked black-moneyed people to confess, pay up 45 por cont ‘of the money they admitted to have ‘evaded taxes on, and earn the gov cermment’s forgiveness. While the PM has boon bnt on physically cloaning, Bharat, the nance ministor has been ‘engaged in cleaning it financially. ‘Andi he thinks he has suecoeded; in ‘July, he said that there had beon a Sslavable dip in money parked abroad. wish he would give some evidence, not so much because his word cannot bo trusted, but because statistics of| money parked abroad are extremely scarce and unreliable, There's @ good roason why tax havens havo a tation for socrotiveness. ‘The impact of the PM's ban on. two notes is pretty clear: The Rs 500 and Rs 1,000 notes constitute over four-ifths of currency notes in circu lation in terms of value. So those who tse them will be seriously inconv nioncod, procisoly what the govern- ‘ment intended. It believes tax evaders use these notes, and will be seriously inconvenienced. So will be the small fellows who use t transactions; the vegot and pavement traders will have a tough time. They too should know they are participating in a yaina Presumably. the government rec- ons that apart from the common people, those who make black money transactions in stacks of notes will also suffer. The bad businessmen can hire small people, give them wads of notes and ask thom to stand in the quoues: but the government presumably ‘thinks they have such huge stocks of notes that they won't he able to get ‘most of their black money converted. Is this right? No one knows, and the government has not issued any data to show that tis. This is a general prob- Jem with the policy measures ofthis government—that it does not publicly If notes are risky, how about the govern- ment’s other paper, e bonds? How about its word? Can it be trusted? policy, something this government hasn't figured out demonstrate its rationality. My guess {that iit had any evidence, it would see the advantage of publicising it; the evidence till now is that it proceeds ‘without sufficient evidence Good intentions pursued with a poor rationale: Ist a good combina tion? Some obviously think so; but a Dotter combination can be conceived of, namely good intentions pursue with 2 good rationale. I myself believe this is essential in public policy: the {govornment isso big, its actions affoct so many citizons, and they are so powerless against it, that itis essor tial to make policy robust and failure- proof. Itis not enough to ask whether ‘a policy would do some good itis far ‘more important to be careful that it does not do harm, Thoso who make poliey today ovi- dently do not think so; we just have to ‘accept and endure the new approach, to policy, that as long as some evildo- ors aro inconvonioneed to an unce ain extent, collateral damage to Innocents is quite all right. Apart from the morality of such a view, ‘one should also consider the likely {impact on India’s reputation. Also, currency notes have been for gon= eral, unrestricted use ever since their invontion; by demonetising thom, the government has given the message that it can do so again. Henceforth, it would be unwise for people to hold on to currency notes—not just for black- ‘moneywallahs, but for ordinary peo- ple too. And ifnotes are risky, how about the government's other paper, like bonds? How about its word? Can ithe trusted? T would have thought twice before I gave the people an ‘ceasion to ask the question, The author is a former chief economic ‘advisor to the Government of IndiaBIG STORY | BLACK MONEY TAKING OUT PAKISTAN’S TERROR MINTS The phaseout will nix Pakistan's low-intensity economic war, taking out Rs 400 crore worth of fake notes ervorism is a fright- ening threat, so ‘many have lost their lives because of it... Enemies from across the border are running their operations using fake currency notes,” Prime Minister Narendra Modi said in his November 8 address. The threat of terrorism held out by the PM as one of the reasons for his phasoout of 500 and 1,000 rupee notes goes deeper than just terrorists using Fake Indian ‘Currency Notes (FICN}, Ibis part of a larger stratagom, a low-intensity ‘war against the Indian economy by Pakistan's deep state. This strategy ‘gathered pace over the past decade, and counterfoit notes began flooding the Indian market, Counterfeiting currency isa favoured tactic of economic w: Under ‘Oporation Bornhard’, Nazi Gormany printed and distributed fake pound sterling notes to under rine the British currency, More recently, impoverished North Korea thas taken to printing fake US dol- lar notes and fake Chinese yuan. In June 2009, the National Investigation Agency (NIA) uncovered what is only the second attempt after Hitler's Germany by one nation to print another nation’s currency. The NIA rovoaled a nationwide network injecting fake Indian cure ry notes into the economy. It gat the notes forensically analysed and dis- covered they wore manufactured in regular currency-making machines ‘owned by a soverign government. It dlidn't take the NIA long to establish ing across the border, in Pakistan, ‘The notes were printed in two high security printing presses set up in Malir cantonment near Karachi. The presses used the same paper and inks used by high value Indian notes and even replicated RBI security fea- tures like threads and watermarks. “Tho FICN wore also boing print- fd to strike at the credibility of the Indian currency,” a top police official says, The value of FICN, though. is ‘minuscule when compared wit the billions of rupoos of black money in circulation. The Indian Statistical Institute, Kolkata, in a report in June this year estimated, that Rs 400 crore ‘was in circulation, It ak ‘THE FAKE BUNDLES: 708704 2015 2016 (O Personsarrested BS FINseizedinRslakh has created “a self-sustaining crimi- nal network in South and Southeast Asia for infusing FICN into India via Nepal, Bangladesh, Thailand Malaysia, Sir Lanka and the UAE, MoS for home Haribhai Parathibhai Chaudhary said in the Rajya Sabha last December. The fake notes also found their way into the diaspora in Southeast Asia where they severely damaged the rupee's credibility. “Overnight, we found moneychang- cers refusing to aceopt Indian curt ney notes,” says a police official Botwoon 2012 and 2015, the gov- ernment seized counterfeit currency worth Rs 147 crore, a vast majority oft in 500 and 1.000 rupee denomi= nations, The NIA 2009 chargesheot saw the “wilful circulation of such curreney notes printed abroad and smuggled into the country to sabo- tage India’s economic security as tan- tamount toa terrorist act” In January 2013, the Unlawful Activities (Prevention) Act, 1967, ‘was modified to include FICN as an instrument of waging economic war- fare against India. The November 8 phaseout of the 500 and 1,000 rupee notes, however is the single biggest ‘move in recent yoars to strike at fake currency. It disrupts the produc- tion of FICN in Pakistan, and makes redundant existing stocks of fake currency with a vast network of te ror funders—the hawala traders and ‘money launderers. “The phaseout of those notes is @ double whammay for Pakistan,” says Colonel Vivek Chadha of the Institute of Defence Studies and Analyses, Delhi. “It limits the impact of counterfeit notes on tho ‘economy and curtails terror funding through FICN circulation in India.” ty Sandeep Unithan