LEADING economists in the country are divided over the so-called benefits of the Union government’s move to recall 500- and 1,000-rupee notes from circulation. There is scepticism over whether the move will result in the stated objectives of controlling the origin, proliferation and circulation of black money and counterfeit notes. Pronab Sen, the first Chief Statistician of India and former Chairman of the National Statistical Commission and Secretary to Ministry of Statistics and Implementation, spoke to Frontline on why he thinks it was an ill-advised move. Excerpts:
Black money, corruption and counterfeit notes—does the demonetisation under way address any of these issues? The government certainly seems to think so.
There are two forms of black money, the big ones—tax evasion and political and bureaucratic corruption. These are recurring activities, not something that happens once. Demonetisation does absolutely nothing to stop the generation of black money. It may postpone it a little bit. So, if I am a bureaucrat and if I were to take a bribe from you, I would say, ‘don’t give me money now, come back when you have the real cash and then we talk’. What happens is that the corruption gets delayed, and in the process, work may get delayed. So, what you could have gotten done today will take three weeks or a month to do. That’s about the only effect demonetisation will have on the annual generation of black money. Nothing else happens.
What demonetisation essentially does is that it puts a penalty on those who have made black money in the past and are holding it as cash. It is more a penalty rather than a preventive measure.
There are varying estimates of the extent of black money in the economy. The government seems to have some kind of an assessment on the basis of which it has carried out this “surgical strike”.
The basis, as far as I can understand, is the studies that have been carried out over the years; the latest one is the one by the National Institute of Public Finance and Policy. It is estimated at 22 per cent [of the GDP]. There are two kinds of things that happen. One is black money, which is being held in the form of cash because a person has not been able to convert it into some real asset. That is a transitory thing. The intention was there to convert it but the person did not have the time to do it. The second chunk is black money which is there in the productive economy. If you look at the informal financial sector—the moneylenders, chit funds, nidhis, hundis, etc.—some of the money is in fact black but these are funds that go into financing legitimate white activities. And my sense is that the latter is many times larger than the former. So, when you check black money, what ends up happening is freezing the flow of funds to the informal and the small-scale sector that depend on these moneylenders. Yes, the moneylenders get punished, but one has also blocked out an entire range of perfectly legitimate activities.
Much is being made of unaccounted wealth and wealth that is not being taxed, that it is not the honest who stand to be affected by the latest measures as much as those who have stashed away unaccounted wealth. To what extent is this understanding correct?
It depends on what one means by unaccounted wealth. The fact is, under our tax laws there are large chunks of the economy which are simply not meant to be taxed. If one looks at agriculture, both on the production and on the income side none of that [income] is taxed. That takes 18 per cent of your GDP right away from taxation; estimates of black money are around 22 per cent of the GDP. So we are left with only four per cent. But more important than that is that the money that we are talking about is also there in the informal sector, it is there in informal sector manufacturing and informal sector services. These are not taxable anyway. But now, suppose a person has built up savings of one to two lakh rupees over the years and put that in the bank. That will catch the attention of the tax guys. The person has to explain where he or she got the money from. The harassment potential is very large.
How reliable is the idea being circulated that a lot of cash is lying with people and that much of it is not accounted for? The high cash-to-GDP ratio may indicate that much of the cash in circulation has not been acquired by legitimate means. But there is evidence to show that corruption levels can be high in low cash-to-GDP ratio countries. Japan seems to have a high cash-to-GDP ratio.
The need for cash depends on the nature of the economy. If we are a country with a large informal sector, there will necessarily be a higher amount of cash. And this is true of most developing countries. In developed countries, where the size of the informal sector is small, the cash requirement is less. To my mind, the ratio of cash to GDP is a silly ratio to look at. The ratio that one should be looking at is the ratio of cash to informal economy GDP, in which case we are not high; we are very low. Japan is a complete outlier. That is because went through this huge period of very expansionary monetary policy to revive the economy. The central bank kept printing money. It is like the QE [quantitative easing] we are seeing in the E.U. and the U.S. If one had looked at the numbers prior to 2010, the cash-GDP ratios in these countries would have been much lower. What one is seeing is the effect of the QE in Japan, the U.S. and the E.U.
How viable is this as an economic policy decision? There is this short-term pain versus the long-term gain. Inflation is viewed as one such short-term pain. Freight movement has been affected and spending and purchasing power are constricted. It has been pointed out that the move has constricted employment as well.
I haven’t quite figured out what the long-term gain is. Everyone talks about it but I haven’t seen anyone articulate it. The short-term gain I can understand. Supposing freight movements get blocked, prices at the mandi level might drop. At the retail level, particularly in urban areas, prices will go up because of the shortage. Net-net, it is anyone’s guess.
The government seems to have sent a fear signal to the public to somehow come out with their ill-gotten money. Is this working?
How a fear signal works out needs to be seen. It may work out in different ways. It can send a signal to the corrupt person to plan on how to spend that money. It is a signal that says: don’t sit on the funds that you have, spend it. It makes matters just worse. It doesn’t make it better at all.
There is a view that the rural poor do not deal with high-denomination notes and that only luxury consumption stands to be affected because of demonetisation. Does this understanding hold good?
One of the things that perennially appals me is the complete lack of understanding of how systems works. Let us take one sector with large numbers of our poor, which is agriculture. Agriculture always works in large values of transactions at very limited times of the year. So, at harvest time farmers get a huge amount of money which is then supposed to carry them over for six months—they get it at one shot—and then at sowing time they borrow a huge amount of money to buy inputs. These are all lump sum, not a monthly flow or a weekly flow or small amounts. As an example, a one-hectare farm, which is the average in India, will produce some five tonnes of food grain. At the current market rates, five tonnes [roughly around 50 quintals] multiplied by a thousand comes to Rs.50,000. Now who is going to pay this person in small denominations? These are large transactions.
What kind of an impact is this going to have on the economy as a whole, given the fact there is constricted demand, low purchasing power, etc.?
I am not so worried about purchasing power. It is a short-term pain. Once the currency has been replaced, this problem will go away. The real problem is on the production side. If the farmer cannot buy seeds or pesticides or fertilizers and if the small manufacturer cannot buy raw materials, that will give long-term pain.
One of the things that the government seems to be encouraging people to do is move in the direction of a cashless economy. How realistic is that?
There are two dimensions. A cashless economy imposes a certain cost on each transaction. It is like a tax. So, when a credit card or a debit card is used or when a cheque is issued, a charge is levied by the financial institution. And this charge is levied on each transaction. And it is cumulative. The reason why people use cash is because the transactional costs are lower. If all of this were so easy, why would Europe and the U.S. have their majority retail transactions in cash? This question should be asked. In the U.S., it is more than half.
Do you think the government should have opted for a different course altogether? Has the message of controlling corruption and black money gone through to the sections concerned?
My problem is basically that at one shot the government pulled away 86 per cent of our currency. One of the big things they are trying to address is the problem of counterfeit notes. My understanding from what I have been reading from the papers is that all the counterfeit notes are 500-rupee notes. What would have happened if only 500-rupee notes had been withdrawn? The pain would have been much less. Maybe the “black” [money] guys would not have been penalised much; in penalising them and the counterfeit [people], a situation has been created where the poor have been badly affected, particularly the rural poor. A villager and an urbanite are being treated at par. I can use plastic money to buy vegetables, etc. The rural poor do not have the option of plastic money.
