Let’s agree: demonetisation of Rs 500 and Rs 1,000 notes will be disruptive in the short term. It may be three months before business and retail transactions return to normal.
However, the question is this: is it worth spending thousands of crores in printing new currency and forcing banks to focus on handling so much cash instead of fixing their balance sheets, all for an inconclusive attack on black money?
The answer is a yes, but.
Yes, it is good to take a swipe at the hoards of black money held in currency notes (though the bulk of it must be held in real estate and gold). It is worth imposing a cost on crooks. But, this alone will not be enough. You must target other things and cash in general. You must force Indians to think less cash, more digital money.
This morning’s newspapers were stuffed with front-page ads from Freecharge, PayTM, Ola Money, Snapdeal, Uber, and Big Bazaar, among others, exhorting customers to substitute cash with other forms of payment, including e-wallets, mobile money, credit cards and electronic money transfers.
This is exactly what needs to be done.
Another Times of India report says that the Tirupati temple, India’s richest, is now setting up debit and credit card swiping machines. Even God can do with less cash.
While government ads talk about fighting black money, fake currency and terror funding, it is private businesses that are focusing on shifting focus from hard cash to virtual money.
The whole demonetisation exercise would be sub-optimal if it is seen merely as an attack on black money, and not physical money itself.
There are two broad issues here.
First, smaller value transactions need to be digitised.
Second, the stock of illegal cash generated by evading tax must be both diminished and prevented from accumulating further.
The first challenge needs political will and systematic efforts at financial literacy and promotion of digital money. This needs not only private sector effort but direct government intervention to popularise digital and mobile payments.
But this is exactly what government seems unable to do. After opening more than 250 million Jan Dhan accounts, more than a quarter of them have either zero balances or are operated infrequently.
When an initiative is top-down, the people pushing it (bankers in this case) will game the system. They will open the accounts and say “mission accomplished” when the real mission should be about having active accounts and not dormant ones. Top-down schemes need a strong push for usage, and this can’t be done without a long-term campaign of financial literacy that will explain how to open and maintain bank accounts, how to pay and receive money using mobile phones, and how to use debit cards, among other things. Putting a little amount of cash in these accounts (not Re 1, but something more substantial) will work wonders. The pump must be primed before it will be used.
Given the huge commercial interest in mobile money, as evidenced by today’s ads in various newspapers, this literacy programme can be done through a public-private partnership, with a marketing professional at the top.
In dealing with the other issue, reducing the hoard of black money and tapering down the generation of future flows, several steps need to be taken.
The most important one is real estate reform – and states must partner this initiative. The bulk of the black money is held in real estate, for this is where crooked politicians, builders, and businessmen are invested. A simple way to demolish black money in real estate is to reduce stamp duties dramatically, allow the vertical building to bring down prices of land, invest in infrastructure and mass transport, and create transparent and time-bound methods of giving building permissions.
If floor-space indices are boosted dramatically, real estate prices will fall, and benami owners will be forced to accept losses on their black money. As prices fall, more genuine buyers will be encouraged to buy property and the realty industry will revive, especially if transaction costs, including stamp duties, are rationalised.
The way to “drain the swamp” — to use Donald Trump’s apt term — is to make the real estate market function like a real market, by opening up supplies. Realtors and their hidden benefactors make money by bottling up land availability, not by allowing the land markets to function. Once real estate stops being a one-way bet to enormous gains, black money will have nowhere to hide.
As for gold, its price is artificially high in India precisely because the government wants to discourage its imports. If gold can come in and go freely, with minimal restrictions and duties, Indian prices will equate with global ones, and black money holders will take note. Indians will still buy gold, but the metal will stop looking overly attractive to black money holders.
You cannot demonetise gold the way you did with currency notes. But when the gold market operates for real, it will no longer give buyers a guaranteed gain in future. Gold prices can go up or down.
Another important area to focus on is state funding of elections. The demonetisation of Rs 500 and Rs 1,000 notes will impact the funding of the forthcoming round of elections, including Uttar Pradesh, but future elections will surely draw more black money as everyone adjusts to the new notes. The only way to end this need for black money is to fund elections through the state. It is a small price to pay for the elimination of dirty money.
Narendra Modi should thus take this opportunity to go the whole hog. He must attack cash, both when used for ordinary transactions and when used to hide illegal wealth from the taxman. Right now, a lot of the hoard is held in brick and mortar, not just cash.
Updated Date: Nov 10, 2016 15:30 PM