How Modi played his trump card

I was asked by a business acquaintance two days earlier if demonetisation was on the cards? I asked him what made him think so. To which he replied that was the bazar buzz. My considered opinion, which I told him, was that it was very unlikely and he could go on his planned pilgrimage for I felt the immediate costs would by far outweigh the long-term benefits.

When I heard the Prime Minister make the announcement on Tuesday night, I recalled an anecdote narrated by Paul Samuelson, the great economist and Nobel laureate. At the end of a talk on economic forecasting, when he was asked if he had forecast the Great Depression, he said: “Not a single economist in the star-studded Harvard economics faculty predicted it. Only the janitor of the building did!” Prof. Samuelson elaborated that the janitor, who used to perform a small service for the faculty by collecting salary cheques from them on Fridays for encashment for weekend spending, asked them to take out more or all as he felt the banks will not open the following Monday.” His advice went unheeded, and the next week the faculty had to borrow money from the janitor!

The moral here is that the street buzz is often closer to the truth. For several days I have been hearing about new Rs 2,000 notes and an incipient demonetisation. But I take pride in being rational, and hence have to wonder about why the event overtook us. For a start, as much as 86.4 per cent of the value of notes in circulation is in Rs 1,000 and Rs 500 denominations. The Rs 1,000 and Rs 500 notes account for seven per cent and 17.4 per cent respectively of the currency in circulation. These are significant numbers, and a sudden withdrawal will obviously make an economy offering little cheer even more anemic.

Most middle and upper income households are a little strung out due to this. My wife and I took stock on Wednesday morning and together we have Rs 600 in usable money. But we are mostly out of the cash economy, managing our economy on credit and debit cards. But the vast majority of ordinary citizens still function with cash. My driver just told me he has a few thousand rupees in Rs 500s and wanted some smaller notes. It is true the PM has assured us the old notes can now be exchanged for brand new notes by presenting them at the banks, where Aadhaar and PAN numbers will be noted to give the authorities a fix on the admitted owners of the cash. This is fair enough, and most of us have little to get bothered about, though the queues at the banks will be a bit tedious.

The most competent extra-governmental authorities on these matters like Baba Ramdev and Amit Shah have with predictable hyperbole compared this to the “surgical strikes” last month. The comparison might even be apt. For like the “surgical strikes” which were in reality a series of cross-border raids to depths of 0.5 and 1.5 km into Pakistani-occupied territory, this too is not without much depth. Like the Lashkar-e-Tayyaba leadership, the black money enemy lies deeper inland, and making a thrust here and there doesn’t amount to a surgical strike. Our nation’s leaders and the ruling elites understand the gravity and depth of the problem, but the baying hounds of public opinion too must be addressed. We are being fobbed off with a few bones.

The term “black money” is all-encompassing for income on which no taxes have been paid. This income may be from legitimate sources or patently illegal activities such as smuggling, counterfeiting, corruption and narcotics. The estimates of how much black money is generated each year vary widely. But a widely cited, still supposedly confidential study by the National Institute for Public Finance and Policy (NIPFP), commissioned by the government, estimated the black economy in 2013 to be equal to about 75 per cent of GDP.

The earlier NIPFP official study commissioned by the government in 1985 estimated it to be equal to about 21 per cent of GDP in 1984, or Rs 36,418 crores out of a then GDP of Rs 173,420 crores. In 2014, India’s GDP is estimated to be over $2.047 trillion, corresponding to $7.277 trillion PPP ($1= Rs 60). In 2014, the Government of India was expecting to collect taxes and duties amounting to Rs 13.64 lakh crores. This only means it is not collecting additional taxes and duties amounting to about 75 per cent of this, in other words about Rs 10.4 lakh crores. This is a huge sum, and any government will drown in salivation as it thinks about all the good it can do with that money.

We can then contemplate investment to GDP ratios higher than China’s. What this will do for GDP growth and the expansion of prosperity can well be imagined.

India has only 35 million taxpayers, of which 89 per cent declare incomes in the Rs 0-5 lakh slab. That means only 11 per cent declare incomes above Rs 5 lakhs a year, an absurd figure given that Indians purchased over 2.2 million new cars and SUVs last year, by all accounts a slow year.

Clearly most people who should be paying taxes are not. As the UPA government failed to address this, the people booted them out, with the expectation that a Narendra Modi government would restore what rightfully belongs to the public. The NDA used up almost 30 months frittering away good time. The public restiveness now evident and the economy’s protracted sluggishness have apparently persuaded them that a “surgical strike” was needed. So we are being thrown a few bones.

Last year Indians living in India illicitly exported $83 billion, making us the second largest stashers of money overseas after the Chinese. This money is out of the purview of this demonetisation. The government has so far demonstrated its inability to coerce or cajole the return of the estimated $500 billion stashed away in the last decade, as the economy expanded exponentially. Most of the other tax-evaded incomes are locked in property, jewellery and other assets. The value of money stashed away as cash is trivial by comparison. It’s mostly the likes of small businessmen, traders, artisans and peasant proprietors who keep hard-earned cash at home or buried underground. These will be the people you will meet later this week when you and I queue up at the banks to get our money back.

The rooting out of black money cannot be done by such pinpricks. That calls for the revamp of our system and real and deep reforms. Look at what Arun Jaitley and Co did to the GST law. We now have seven slabs and plenty of exemptions for the merry making band to sell discretion. We need a new start. For a good beginning we must make tax evasion a criminal offence, attracting a mandatory jail sentence. We need a layer of courts trying and swiftly dealing with economic offences. The government must put its money where its mouth is. Not the other way around, as is increasingly the case.