Demonetise and Develop

Indians have a fascination for black money. If they don’t generate it, they love to talk about it. And yet they share a major misconception about it — it is as if the money itself has a colour, either black or white. They would do well to heed what an Economics Professor of mine used to say “Money by itself is neither black nor white; it depends on the use to which it is put.” To give you an example, let us say you pay a hefty donation of Rupees ten lakhs to get your daughter a seat in a private medical college. You have raised this amount from your hard-earned life savings, from the gratuity and provident fund paid to you when you retired (and, therefore, indisputably white money). But when the college has to park this money, they will not take recourse to their normal banking channels: the funds will be routed through avenues that seek to evade the attention of the income-tax authorities. White money has, in a trice, been converted to black money, with a change of user.
Why does this transaction hit the normal economy? Well, for one, the government is denied its share of tax revenues, impacting public expenditure. The money could be invested in assets like land or gold, driving up their value and fuelling inflationary trends. Or it could be spirited out of the country through hawala channels, decreasing the money supply available for lubricating economic activity within the country. The real killer is the multiplier aspect of such behaviour — when such transactions outside the banking system become the norm, a huge parallel economy develops alongside the regular economy. Governments may then find that their interventions to stabilise inflation or currency rates are having little impact, since the demand for and the supply of money is operating outside the regular system.
How can governments tackle this problem? Lowering tax rates does not solve the problem: rates have come down over the past twenty years but the black money menace is more pronounced than ever. When there is an incentive to pay zero income tax, there are strong motivations to conduct transactions outside regular banking channels. So we have the spectacle of professionals accepting fees in cash and not declaring their incomes and land/building sale transactions being conducted in a black and white combination.
Two possible solutions suggest themselves: (a) Demonetise higher value currency notes to make cash transactions more cumbersome in terms of volume; (b) legally mandate that all transactions above a certain value, say, Rs. 10000 have to have an electronic footprint. On demonetisation, we have the example of countries like the USA, where the highest currency denomination in current use is 100 US dollars (higher denominations were not even printed after World War II). Unfortunately, we are headed the opposite way in India — we introduced 1000 rupee currency notes and are now contemplating 1000 rupee coins as well. It would seem that we are trying to make things as simple as possible for people who wish to despatch trunk loads of cash for illegal payments. If India were to demonetise all currencies of Rupees 100 and above, there would be a tenfold increase in the volume of cash that has to be carted around for cash transactions. This is where the second solution kicks in. Since all transactions above Rs. 10000 have to come through official channels (which are electronically monitored), cash withdrawals by an individual customer can be restricted to a certain value per month, say Rs. 25000. Barring minor payments for items like bus tickets and vegetable purchases, there is no need to rely on cash purchases at all.
Electronic payments would necessitate opening of electronic bank accounts for all citizens above eighteen years of age, an objective the Nachiket Mor Committee on Comprehensive Financial Services has already stressed in its recent report to the Reserve Bank of India. Issuing Aadhaar and/or PAN cards to all citizens would enable linkage of these cards to the account, to keep track of receipts and payments and ensure compliance with tax and other laws of India. The electronic footprint would also restrict cash withdrawals by an account holder to the amount specified above, to prevent huge cash volumes illegally exchanging hands. Who knows, this may well discourage payments at election time and speed money payments, till Indian jugaad comes up with some other ingenious solution. Payments above Rs. 10000 can be through bank transfers, internet transfers, cheques and/or mobile money.
There is another virtuous cycle that will come into operation once the above measures are introduced. We love to repeat ad nauseam that “of every rupee meant for a poor beneficiary, only 15 paise reaches her”. An obvious solution is the introduction of cash transfers. Instead of cash being paid, the amounts are directly credited to the account of the beneficiary. A combination of conditional and unconditional cash transfers can be employed. Where the amount is meant for daily use as in old-age pensions, there would be no restriction on the free use of the funds by the beneficiary. Where the funds are linked to fulfilment of a specific condition like the purchase of food grains, payment for health care or school vouchers, the amount would be electronically transferred from the beneficiary’s account to the institution/person providing the good/service when the good/service has been provided to the beneficiary. This should pose no technological problem to our IT geniuses, given that the National Securities Depository Limited (NSDL) is already handling such a large volume of capital market transactions. In fact, there is no reason why the same NSDL system cannot be fruitfully employed for this purpose as well.
We can talk about the scourge of black money and poor service delivery till the cows come home but unless we bring in reforms on the lines suggested above, I do not see any meaningful solution to these problems. The marriage of modern technology with existing systems can definitely create the conditions for sustained, inclusive growth and development.

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