In India, black money makes for bad policy

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Kaushik Basu

ON Nov 8, the Indian government announced an immediate ban on two major bills that account for the vast majority of all currency in circulation. Indians would have until the end of the year to change those notes for other bills, including newly minted ones. On Wednesday, the govt released via a smartphone app called “Narendra Modi,” named after the prime minister, the results of a survey purporting to show 90pc support for its so-called demonetisation policy.
The poll was rightly criticised. In the two weeks after the measure was announced, millions of Indians stricken with small panic rushed out to banks; ATMs and tellers soon ran dry. Some 98pc of all transactions in India, measured by volume, are conducted in cash. Demonetisation was ostensibly implemented to combat corruption, terrorism financing and inflation. But it was poorly designed, with scant attention paid to the laws of the market, and it is likely to fail. So far its effects have been disastrous for the middle- and lower-middle classes, as well as the poor. And the worst may be yet to come.
The govt’s demonetisation dragnet will no doubt catch some illicit cash. Some people will turn in their black money and pay a penalty; others will destroy part of their illegal stashes in order not to draw attention to their businesses. But the overall benefits will be small and fleeting. One reason is that the bulk of black money in India isn’t money at all: It’s held in gold and silver, real estate and overseas bank accounts. Another is that even if demonetisation can flush out the black money that is held in cash, with no improvement in catching and punishing tax evaders, people with ill-gotten gains will simply start saving in the new bills currently being issued.
When the government announced demonetisation, it also justified the measure as a way to curb terrorism financing that relies on counterfeit rupee notes, as well as to dampen inflation. Both these justifications are flawed. Catching fake notes already in circulation neither helps trap the terrorists who minted them nor prevents more such money from being injected into the economy. There also is no evidence that black money actually is more inflationary than white money; nor in theory should it be. Black money is just money held by people instead of the government.
It’s an excessive money supply that tends to create inflation; whether that money is white or black makes little difference. Demonetisation may have been well-intentioned, but it was a major mistake. The government should reverse it. It could at least declare that 500 rupee notes, which many poorer people frequently use, are legal again. And if the government really does want to limit the amount of black money in circulation, it would do better to move India toward becoming a more cashless society. About 53 percent of adult Indians have a bank account, but many signed up at the government’s initiative and so quite a few of the accounts are dormant.
On the other hand, more than one billion people in India have a cellphone, and this could be tapped to encourage more active banking, in the form of mobile banking. India’s push to issue a unique ID number to all Indians based on their biometric information is a major step in the right direction. More than one billion people have already been registered, according to the government, potentially enabling them to use an app to collect pensions, for example. Tackling corruption also goes beyond currency, cash or even banking. It requires changing institutions and mind-sets, and carefully crafting policies that acknowledge the complexity of economic and social life. The government could start by increasing penalties for tax evasion and amending India’s outdated anti-graft laws.
In a country like India, where the illegal economy is so intimately intertwined with the mainstream economy, one inept government intervention against shadow activities can do a lot of harm to the vast majority, who are just trying to make a legitimate living. The writer, professor of economics at Cornell University, was chief economic adviser to the Indian government in 2009-12 and chief economist of the World Bank in 2012-6.
— Courtesy: The New York Times