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How can the ban on currency notes affect the Indian economy?

How can the ban on currency notes affect the Indian economy?

By Ankita Gandhi

The $2 trillion Indian economy, with a currency circulation of $246 billion, was hit by a sudden announcement on 8th November 2016. The government declared a ban on Rs. 500 and Rs. 1000 currency notes as legal tender. Previously, the people had been warned and asked to voluntarily declare their incomes. The declaration of income would result in a 40 percent increase in tax and most did not take the scheme seriously. Sweeping away 86 percent of the currency circulation overnight was indeed a great move, which will have massive repercussions on the current ‘stock’ of hoards of illegal money. However, it needs accompanying measures to actually curb the ‘flow’ of black money in the years to come.

What is ‘black money’?

Black money originates as unaccounted wealth churned into the economy through tax avoidance, evasion and corruption. For instance, even a salaried middle-class citizen who pays his/her taxes can contribute to the supply of black money in the market. For example, when one buys jewellery from Chandni Chowk in cash without a bill; or sends rupees to an agent in exchange for foreign currency; or pays bribes to get work done or avoid a challan.

black money

Sweeping away 86 percent of the currency circulation overnight will have massive repercussions on the current ‘stock’ of hoards of illegal money. Photo Courtesy: Wedio

In Delhi, where there are few manufacturing units, the principal economic activity trading.

There is another group of hoarders of black money – the unregistered or registered tax-evading traders running their family businesses with unaccounted for black money. In Delhi, where there are few manufacturing units, the principal economic activity is trading. There are traders in Asia’s biggest fruit and vegetable market (Azadpur Mandi), traders in Asia’s largest wholesale spice market and traders selling various Chinese products. Even agricultural landlords with huge amounts of land, earning tax-free agricultural income, deal in black money. When a self-employed person earning say one crore annually declares only Rs. 10 lakhs to the income tax department, the rest is in infused in the market as black money.

These various groups hoard black money in cash or kind such as accumulated gold assets and real estate properties.

Impact on the real estate sector

The most obvious implications of the move include the impact on the real estate market, the demand for gold and other high-end luxury goods. For instance, it was due to the circulation of black money that houses with circle rates and government appropriations amounting to Rs. 30-40 lakhs were sold for over a crore. Furthermore, the enforcement of the Benami Transactions (Prohibition) Amendment Act, 2016 from 1st November 2016 will further curb the use of black money in the real estate market.

Check on inflation

There is no doubt that in the short-term, consumerism will take a hit. However, in the long term, the unaccounted currency will not only add to the fiscal liabilities of the central bank, but also artificially raise the prices of various goods in the market. Thus, this would positively impact inflation. Urging people to deposit their old currency in exchange of new will legitimise the overall circulation. It will also put a check on fake currency. However, all the circulating currency will not be deposited in the banking system given the 200 percent fine on depositing unaccounted income.

Increase in tax revenues

With accounted for incomes and transactions, the government would earn greater direct and indirect tax revenues. Subsequently, this would result in lower fiscal deficits. For instance, only about one percent of our total population (12.5 million people) paid direct income taxes in 2013. Declaring one’s income through actual invoices would result in tax accountability. It may also bring into the employment registers informal contract workers who were earlier paid by cash. Linking their wages to the banking system would greatly increase financial inclusion and literacy. It would also make it possible to account for informality in employment.

A continuum of measures

While this is a welcome step, we need a continuum of measures to curtail the black money market. These include a controlled release of higher currency notes and lower indirect tax rates to dissuade tax avoidance and evasion. Moreover, it needs to be ensured that all transactions above a certain level (say Rs. 50,000) only occur through banking channels like cheques, demand drafts, online transfers. Incentives can be put into place such as reducing the transaction costs. We also must not forget the importance of educating the poor and financially illiterate who may not understand the implications of this ban. We must help and encourage them to embrace the change and feel accounted for in the system.

Ankita Gandhi has been a visiting research scholar, Universitat Autonoma de Barcelona,

Featured Image Credits: India Today

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