Of “Shaky” Demonetisation Statistics, Arun Jaitley and Black Money

We don’t live in a perfect world. And given this, governments like to showcase the positive impact of the decisions they make, all the time. Sometimes, they get very desperate in the process.

Take the case of the economic impact of demonetisation. Most data now coming out clearly shows that the decision did not have a positive impact on the Indian economy. It might have helped the Bhartiya Janata Party to win the Uttar Pradesh assembly elections, but that doesn’t necessarily make it a right decision on the economic front.

Nevertheless, the Modi government would like us to believe that demonetisation has helped the country on the economic front. Early last week the finance minister Arun Jaitley said that “more than 91 lakh people were added to the tax base due the result of the actions taken by the income tax department.”

It was later clarified that 91 lakh people were added to the tax base in 2016-2017(i.e. between April 1, 2016 and March 31, 2017). As per Jaitley’s statement 91 lakh individuals were added to the tax base post demonetisation, which is incorrect.

Meenakshi Goswami, Income Tax Commissioner and the official spokesperson of the Central Board for Direct Taxes (CBDT), told NDTV later in the week that91 lakh was the total number of new taxpayers enrolled in the financial year 2016-2017.”

Now this makes things interesting. On the face of it, the addition of 91 lakh individuals to the income tax base sounds like a huge number. But when we are talking about any increase or decrease, a number should never be viewed in isolation.

The trouble is that we don’t have long term data on this front because of a change in the definition of “tax base” and “new tax payer added during the year”. The annual report of the ministry of finance for 2015-2016 points out that new taxpayers “added during the year 2014-15 is 76,04,154”. This basically means that 76 lakh new taxpayers were added during 2014-2015. I couldn’t find any data for 2015-2016. Now compare the 91 lakh additions in 2016-2017 to 76 lakh additions in 2014-2015, and suddenly the number doesn’t seem too high, given that no demonetisation was carried out in 2014-2015.

Even if the government doesn’t do anything, taxpayers get added every year, especially when the minimum tax slab continues to remain the same. In 2014-2015, the minimum tax slab was Rs 2,50,000, which is where it continues to be. This basically means that inflation alone would have ensured that more people came into the tax bracket and thus increased the tax base.

Over and above this, as the economy grows and people earn more, more people come into the tax bracket.

Once we take these factors into account, the addition of 91 lakh taxpayers suddenly doesn’t sound much, especially taking into account the disruption that demonetisation caused through the length and the breadth of the country.

Further, Sushil Chandra, chairman of CBDT said that between November 2016 and March 2017, the search actions of the income tax department revealed an undisclosed income of Rs 16,398 crore. On the other hand, the surveys had led to a detection of Rs 6,746 crore during the same period.

Again, if we look at these numbers in isolation, they sound like a lot of money. But that doesn’t turn out to be the case if we look at numbers over a period of time. Take a look at Table 1. It shows the undisclosed income admitted to and detected during the search operations as well as surveys conducted by the income tax department over the last few years.

Table 1: Undisclosed income

Financial Year Number of groups searched Undisclosed income admitted (in Rs Crore) Number of surveys conducted Undisclosed income detected (in Rs Crore) Total undisclosed income (in Rs Crore)
2012-2013 422 10,291.61 4630 19,337.46 29,629.07
2013-2014 569 10,791.63 5327 90,390.71 1,01,182.34
2014-2015 545 10,288.05 5035 12,820.33 23,108.38
2015-16 445 11,066.24 4422 9,654.8 20,721.04
2016-17* 222 6,304.71 977 17,62.51 8,067.22

*Up to September 2016 in case of search numbers and August 2016 in case of survey numbers
Source: Ministry of Finance Annual Reports and the Press Information Bureau
The numbers for 2016-2017 are incomplete. But there is enough detail that lets us analyse the issue. Between April and September 2016, the total undisclosed income (or black money) admitted through search operations of the income tax department stood at Rs 6,304.71 crore. The undisclosed income detected through surveys conducted between April and August 2016 had stood at Rs 1,762.51 crore. If we add these numbers we get Rs 8,067.22 crore.

Between November 2016 and March 2017, the search actions of the income tax department revealed an undisclosed income of Rs 16,398 crore, as pointed out earlier. On the other hand, the surveys had led to a detection of Rs 6,746 crore during the same period. Adding both these numbers we get Rs 23,144 crore. Adding this to the earlier Rs 8,067.22 crore, we get around Rs 31, 211 crore.

This is the total undisclosed income identified by the income tax department during the course of 2016-2017. The number is incomplete because the information for the month of October 2016 is missing in case of search operations and information for the months of September-October 2016 is missing in case of survey operations.

Nonetheless, it is a good ballpark number to work with. Hence, the total amount of undisclosed income or black money identified by the income tax department in 2016-2017 stood at more than Rs 31,211 crore.

Is it such a big deal? Look at Table 1. The total amount in 2012-2013 had stood at Rs 29,629 crore. This amount hasn’t been adjusted for inflation. It is safe to say that in inflation adjusted terms more undisclosed income was identified by the income tax department in 2012-2013 than in 2016-2017. In 2013-2014, the number stood at Rs 1,01,182 crore, which is significantly more than 2016-2017. And it is worth remembering here that these numbers happened without demonetisation. In fact, as the numbers clearly show the efficacy of the income tax department when it comes to identification of black money has come down since 2014-2015.

To conclude, the rosy picture of demonetisation that the government is trying to paint, is really not true. The more data we look at the clearer this becomes.

Postscript: I recently did a podcast with the writer Amit Varma who is currently the editor of the Pragati magazine, on the Right to Education and how it has screwed up our education system. Most of what I spoke was based on my new book India’s Big Government—The Intrusive State and How It is Hurting Us. You can listen to the podcast here.

The column originally appeared in Equitymaster on May 22, 2017.

The State of Real Estate, Six Months After Demonetisation: Falling Prices, Desperate Builders & Return of Black Money

250px-Underconstruction_Building

Housing and real estate is one area in India where writing anything is very difficult given the lack of data. Nevertheless, a few inferences can be made from the little data that is available.

In the last edition of the Letter we unveiled the Indian Economic Thermometer (IET). One of the inputs into the IET was retail loan growth. A major constituent of retail loans are housing loans. As of March 2017, housing loans formed around 53 per cent of the total retail loans given by banks.

By tracking the total amount of housing loans given by banks, we can make a few inferences regarding the state of the real estate sector in India. So, let’s take a look at Table 1. It shows the total amount of home loans given by banks during the course of a year, over the last few years.

Table 1:

Total Home Loans (in Rs crore) Increase/Decrease with respect to the previous year
2012-13 59,647
2013-14 81,900 37.3%
2014-15 89,935 9.8%
2015-16 1,18,245 31.5%
2016-17 1,13,323 -4.2%

Source: Centre for Monitoring Indian Economy.

Table 1 makes for a very interesting reading. For the first time in five years, the total amount of home loans given by banks during the course of a year, has fallen. The total amount of home loans given out in 2016-2017 was around 4.2 per cent lower than the total amount of loans given out in 2015-2016. This is another data point that shows the largely moribund state of the real estate sector in India.

One point that needs to be kept in mind is the fact that home loans are also given out by housing finance companies. The trouble is that regular data on the home loans given by housing finance companies is not available. And this is ironical because housing finance companies are regulated by the National Housing Bank(NHB), which is a 100 per cent subsidiary of the Reserve Bank of India(RBI). It is worth asking that when the RBI can put out month on month data on loans given by banks, what is stopping the NHB?

The latest data I could find on this front was as of March 31, 2015 and that is really not of much help more than two years later, given that we are trying to look at the current state of home loans. In 2014-2015, housing finance companies gave out home loans worth Rs 75,488 crore. During the same year, banks gave out home loans amounting to Rs 89,935 crore. This means that in 2014-2015, housing finance companies gave out around 45.6 per cent of the total home loans. In an ideal world, this data should not be ignored. But given that we don’t have access to it, there is nothing really that we can do about it.

Getting back to the point. Let’s get into a little more detail into the home loans given by scheduled commercial banks during 2016-2017. Let’s look at March 2017. During the course of the month, banks gave out total home loans of Rs 39,952 crore. This basically means that 35.3 per cent of the total home loans given out during the course of the year, got disbursed during one month, which happens to be the last month of the financial year.

What is happening here? Before March 2017, Rs 18,900 crore worth of home loans were disbursed in September 2016. This amounted to 17 per cent of the total home loans disbursed during the course of the year. Hence, between the two months, more than half of the home loans disbursed during the year, were disbursed.

It is well known that builders have got a huge amount of unsold inventory with them. This inventory has been in various stages of construction. At the same time, the builders have been trying to sell this inventory for a while now, by offering a better price as well as goodies on the side.

As some of this inventory has achieved completion stage, it has become slightly attractive for homebuyers given that people prefer buying finished homes these days in comparison to under-construction ones. Also, with builders wanting to show good year end numbers they have gone easy on the price in the month of March 2017, is what bankers tell me.

There is another phenomenon at work. These days people don’t apply for a home loan just at the point of time short-listing and buying a home. They apply for it in advance and get the loan sanctioned but not disbursed. The moment they get a good price for a home, they get the loan disbursed. That is another explanation for a jump in home loan numbers in March 2017.

Also, once people buy a ready to move in new home, there is activity in the secondary home market as well. They may want to sell the homes they were living in, and that also leads to more people taking on home loans. This phenomenon is likely to play out more in the coming months, if the basic assertion I am making turns out to be correct.

Another point mentioning here is that between November 2016 and February 2017, banks barely gave out any home loans. During the period, the banks gave out home loans worth Rs 8,851 crore. In March 2017, they gave out total home loans of Rs 39,952 crore, which was 4.5 times the home loans given out in the previous four months.

A major reason why people weren’t taking on home loans between November 2016 and February 2017 was demonetisation. There simply wasn’t enough currency going around. With this, the real estate transactions came to a standstill because without currency it wasn’t possible to fulfil the black part of the real estate transaction. Those who owned homes(builders and investors) were not ready to sell homes, without being paid for a certain part of the price, in black.

By March 2017, nearly three-fourths of the demonetised currency was replaced.

This basically means that by March 2017, there was enough currency in the financial system for the black part of the real estate transactions to start happening all over again. Also, the Rs 2,000 note makes this even more convenient.

This availability of currency ensured that the black part of any real estate transaction could be easily paid, which had become difficult between November 2016 and January 2017. Once the black transactions became possible, real estate started getting bought and sold again, and this in turn ensured that home loans started to be disbursed again.

Between builders desperate to end the financial year on a good note and currency finding its way back to the financial system, people started taking on home loans again. The interesting question is whether this revival in home loans will continue. For that we will have to wait for the home loan data of April 2017.

The big question here is that are real estate prices falling? If you listen to what the real estate industry has been saying you would feel that real estate prices have either not been falling or will not fall more.

Ashutosh Limaye, Head-Research & REIS, JLL India, told ET Now thatprices have come down but by and large prices are holding.” Or as Getamber Anand told Moneycontrol.com:  “I feel prices in most markets have bottomed out and stabilised with little or no margin for further reduction.”

Let’s look at some data to see if this is true. As I mentioned earlier, real estate data is not easy to get. The simple way to figure out whether prices are going up or down or are flat, would be to look at the prices at which deals are happening. But given that there is no such data at an agglomerated level, one has to try and look at this in a slightly different way.

Every bank has to carry out what the RBI calls priority sector lending. What kind of lending gets categorised as priority sector lending in case of home loans? As per a RBI circular dated April 23, 2015, a priority sector housing loan is defined as: “Loans to individuals up to Rs 28 lakh in metropolitan centres (with population of ten lakh and above) and loans up to Rs 20 lakh in other centres for purchase/construction of a dwelling unit per family provided the overall cost of the dwelling unit in the metropolitan centre and at other centres should not exceed Rs 35 lakh and Rs 25 lakh respectively.”

This is how priority sector home loans continue to be defined. Hence, housing loans of up to Rs 28 lakh in a city with a population of Rs 10 lakh or more, and financing the purchase of a home with a price of up to Rs 35 lakh, is categorised as a priority sector housing loan. In other centres, a priority sector housing loan is a loan of up to Rs 20 lakh used to finance the purchase of a house with a price of up to Rs 25 lakh.

Let’s look at Table 2. It shows the priority sector loans as a proportion of total home loans given by banks.

Table 2:

Total Home Loans (in Rs Crore) Priority Sector Home Loans (in Rs Crore) Proportion
2012-13 59,647 1,349 2.3%
2013-14 81,900 34,800 42.5%
2014-15 89,935 20,386 22.7%
2015-16 1,18,245 19,890 16.8%
2016-17 1,13,323 26,082 23.0%

Source: Centre for Monitoring Indian Economy.

What does Table 2 tell us? We are interested only in the years 2015-2016 and 2016-2017, when the definition of priority sector housing loans was the same. What we can see is that in 2016-2017, nearly 23 per cent of the loans given out were priority sector home loans. In 2015-2016, this figure was at just 16.8 per cent. In absolute terms, 31.1 per cent more priority sector home loans were disbursed in 2016-2017 than in 2015-2016.

What does this mean? It means that banks have financed more homes with an official registered price of Rs 35 lakh or lower in metropolitan cities and Rs 25 lakh or lower in other centres. We use the term official registered price, simply because a black component always gets paid in cash, over and above the official price.

With banks financing more homes of Rs 35 lakh or lower in metropolitan cities and Rs 25 lakh or lower in other centres, it basically means that either prices have come down or more homes have been built in that segment (which builders like to call affordable housing). Hence, more homes have become available in the sub-Rs 35 lakh segment in the metropolitan centres and in the sub-Rs 25 lakh segment, in other centres.

In fact, in the month of March 2017, when the maximum amount of home loans were given out in comparison to any other month during the last financial year, 28 per cent of the loans were priority sector home loans.

Given this, home loan data does suggest that home prices have fallen. Of course, there is no way of figuring out to what extent have the prices fallen. The answer would be different for different parts of the country.

But how does all this work at a personal level? One technique of driving down the price is to keep talking to the representative of the builder over a period of time, keep him interested and keep driving down the price. Of course, this needs a lot of patience and depends on how desperate the builder is to sell what he has already built.

The column originally appeared on Equitymaster on May 10, 2017

Six Months After Demonetisation Cash is King Again and Questions Still Remain

narendra_modi

On November 8, 2016, the prime minister Narendra Modi announced his government’s decision to demonetise Rs 500 and Rs 1,000 notes, to an unsuspecting nation. The decision came into effect from the midnight between November 8 and November 9, 2016, and suddenly rendered 86.4 per cent of the nation’s currency in circulation, useless.

It’s been six months since then and more than four months since December 30, 2016, the last date for depositing the demonetised Rs 500 an Rs 1,000 notes, into bank accounts. But even after this period as far as the government is concerned, a few basic points remain.

a) How much demonetised money finally made it into bank accounts? When demonetisation was first announced, this number was shared regularly. Nevertheless, the last announcement on this front from the Reserve Bank of India(RBI) came on December 13, 2016. As of December 10, 2016, Rs 12.44 lakh crore of demonetised currency had made it back into the banks.
Given that Rs 15.44 lakh crore worth of currency notes had been demonetised, nearly 80.6 per cent of the currency had found its way back into banks, nearly three weeks before the last date to deposit demonetised notes into bank accounts.
Neither the Reserve Bank nor the government has told the nation how much money eventually made it back into the banks. This is an important question and needs to be answered.

b) The initial idea behind demonetisation was to curb fake currency notes and eliminate black money.
As far as fake currency goes the minister of state for finance Arjun Ram Meghwal told the Lok Sabha in early February 2017 that the total number of fake notes deducted in the currency deposited into banks after demonetisation stood at 2.46 lakhs. This amounted to a total value of Rs 19.5 crore.
As mentioned earlier, the total value of demonetised notes had stood at Rs 15.44 lakh crore. Given this, the proportion of fake notes deducted is almost zero and can be ignored. Hence, as far as detecting and eliminating fake notes was concerned, demonetisation was a total flop.
How did it do as far as eliminating black money is concerned? The hope was that the black money held in the form of cash will not make it back into the banks, as people wouldn’t want to get caught by declaring it. But by December 10, 2016, more than four-fifth of the demonetised notes had already made it back into the banks. Since then the government and the RBI have not given out any fresh numbers. It’s surprising that it has been more than four months since December 30, 2016, and this number is still not out in the public domain.
Also, it is important to point out here: “High denomination notes are known to facilitate generation of black money. In this connection, it may be noted that while the total number of bank notes in circulation rose by 40% between 2011 and 2016, the increase in number of notes of Rs.500/- denomination was 76% and for Rs.1,000/- denomination was 109% during this period.”
If high denomination notes facilitate generation of black money, then why replace Rs 1,000 notes with Rs 2,000 notes. Given that a Rs 2,000 note is twice the value of a Rs 1,000 note, it makes black market transactions even more easier. It also makes storage of black money in the form of cash easier, given that it takes less space to hide the same amount of money.
Again, this is a basic disconnect in what the government planned to achieve through demonetisation and what it eventually did. No effort has been made to correct this disconnect.

c) The government has still not offered a good explanation of what prompted it to demonetise. There has been no similar decision taken by any other country in a stable financial situation like India currently is, in the modern era. The best that the government has done is blamed it on the RBI. As Meghwal told the Lok Sabha in early February 2017: “RBI held a meeting of its Central Board on November 8, 2016. The agenda of the meeting, inter-alia, included the item: “Memorandum on existing banknotes in the denomination of Rs 500 and Rs 1000 – Legal Tender Status.””
Anybody who has studied the history of the RBI would know that the RBI would never take such an extreme step without extreme pressure from the government.

d) Other than eliminating black money and fake currency notes through demonetisation, in the aftermath of demonetisation, the government wanted to promote cashless transactions. As Modi said in the November 2016 edition of themann ki baat radio programme: “The great task that the country wants to accomplish today is the realisation of our dream of a ‘Cashless Society’. It is true that a hundred percent cashless society is not possible. But why should India not make a beginning in creating a ‘less-cash society’? Once we embark on our journey to create a ‘less-cash society’, the goal of ‘cashless society’ will not remain very far.”

How are things looking on that front? Look at the following table. It shows the volume of digital transactions over the last few months.

Month Volume of digital transactions (in million)
Nov-16 671.5
Dec-16 957.5
Jan-17 870.4
Feb-17 763.0
Mar-17 893.9
Apr-17 843.5

Source: Reserve Bank of India

While digital transactions picked up in December, they have fallen since then. The total number of digital transactions in April 2017 is higher than it was in November 2016. Nevertheless, it is worth asking, whether this jump of 25 per cent was really worth the trouble of demonetisation.

e) Falling digital transactions since December 2016 tell us that cash as a mode of payment is back in the system. There is another way this can be shown. Between November 2016 and February 2017, banks barely gave out any home loans. During the period, the banks gave out home loans worth Rs 8,851 crore. In March 2017, they gave out total home loans of Rs 39,952 crore, which was 4.5 times the home loans given out in the previous four months. It also amounted to 35 per cent of the home loans given out during the course of 2016-2017.

A major reason why people weren’t taking on home loans between November 2016 and February 2017 was demonetisation. There simply wasn’t enough currency going around. With this, the real estate transactions came to a standstill because without currency it wasn’t possible to fulfil the black part of the real estate transaction. Those who owned homes (builders and investors) were not ready to sell homes, without being paid for a certain part of the price, in black.

By March 2017, nearly three-fourths of the demonetised currency was replaced. This basically means that by March 2017, there was enough currency in the financial system for the black part of the real estate transactions to start happening all over again. Also, the Rs 2,000 note makes this even more convenient.

To conclude, six months after the declaration of demonetisation it is safe to say that demonetisation has failed to achieve what it set out to achieve i.e. if it set out to achieve anything on the economic front.

The column originally appeared on Firstpost on May 9, 2017

Mr Mistry, When It Comes to Buying a Home, the Price is More Important Than the Interest Rate

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Keki Mistry, the bossman at HDFC, India’s leading housing finance company, recently told The Economic Times, India’s leading business newspaper: “In my view, it is the best time to buy property. First, by virtue of the fact that interest rates are significantly low. Since 2008, we have not seen rates as low as this. I don’t believe rates will go down any further. Second, property prices haven’t gone up in recent times so one would believe there is time correction of prices.”

Asking Mistry if it’s the right time to buy a home is like asking Nandan Nilekani about the privacy concerns around Aadhaar. Or asking RBI governor Urjit Patel if demonetisation has been a success. Or asking me, if freelance writers should be paid more.

The answers in all the three cases will be a definite yes. Mistry is in the business of giving out home loans. And for him, it is always the right to give out home loans, as long as he takes a margin of safety into account and lends out only a certain portion of the price of the home being financed through a home loan.

Nevertheless, it is important to try and understand what Mistry is really saying here. The first point he makes that interest rates are low, and he doesn’t really see them going down anymore. Mistry might be right about this. Interest rates have been low because of the deluge of money that has come into banks because of demonetisation.

Mistry further says that home prices haven’t gone up in recent times and there has been a time correction of prices. And hence, this is the right time to buy property.

What does Mistry mean by a time correction of prices? Let’s say that a home was selling at Rs 50 lakh in a suburb of a big metropolitan city a few years back. Even today, it is going at the same price. Meanwhile, the price of every other thing has gone up. Once we factor in this inflation, the home has seen a time correction of prices, given that the purchasing power of Rs 50 lakh today is really not the same as the purchasing power of Rs 50 lakh, a few years back.

Given this time correction of prices, buyers should not wait any further and buy homes. This is basically what Mistry is saying.

The trouble is this makes little sense. As always there are several nuances that are involved here. First and foremost, there is the black part of that needs to be paid while buying homes across most parts of the country. It is difficult to generalise the proportion that needs to be paid in black, given that rates vary across the country. But let’s say around 20 per cent of the price of the home is to be paid in black. This works out to Rs 10 lakh (20 per cent of Rs 50 lakh).

Hence, the official price of the home works out to Rs 40 lakh (Rs 50 lakh minus Rs 10 lakh). A housing finance institution like HDFC will not finance the entire thing. HDFC’s average loan to value ratio at the origination of the home loan is 64 per cent. In this case that would mean a loan of Rs 25.6 lakh. (64 per cent of Rs 40 lakh). This is roughly around the average home loan size of HDFC at Rs 25.7 lakh.

Hence, HDFC will finance around Rs 25.6 lakh of the cost of the home of Rs 50 lakh. The buyer has to finance the remaining Rs 24.6 lakh. This basically means that the buyer needs to finance nearly half of the cost of the home. And that is the real equation that the buyer needs to take a look at.

This basically means whether the buyer has Rs 25 lakh of savings which he can use to buy a home of Rs 50 lakh. If he has the money he can buy the home. If he doesn’t, he can’t, irrespective of where the interest rate on the home loan is.

What about the low interest rate that Mistry was talking about? How much difference does it make? The EMI on a loan of Rs 25.6 lakh at 10 per cent per year for a period of 20 years would work out to Rs 24,801. This would have been the case a on a new home loan, a few years back. Now at 8.5 per cent interest, the EMI would work out to Rs 22,303 per month or around 10 per cent lower.

Hence, the lower EMI does help. But the basic question still remains; whether the prospective buyer has a savings of around Rs 25 lakh. Actually, the savings need to be more once we take brokerage, the cost of moving, making the home liveable enough, etc., into account. But for the ease of calculation we will leave all that out and just concentrate on the price of the house.

Now compare this scenario to where the price of the home over the last few years has fallen by 20 per cent and is currently going at Rs 40 lakh. Assuming a 20 per cent black part, the official price of the home works out to Rs 32 lakh. Of this HDFC would lend around Rs 20.5 lakh (64 per cent of Rs 32 lakh). Hence, the buyer would need around Rs 20 lakh to get the deal going.

This meant that anyone with savings of around Rs 20 lakh could carry out the transaction and buy the home. This requires Rs 5 lakh lower savings than the earlier example. In this situation, the prospective buyer is more likely to buy than the earlier one.

The point is similar to the one I have often made in the past, if people need to start buying homes again, the home prices need to come down. Lower interest rates just don’t help enough. And this is something Mistry needs to understand.

To conclude, it is safe to say that if 20 per cent of the price of a home being bought needs to be paid in black, then the buyer needs to have half of the price of the house as savings. Only then can he go ahead with the transaction and buy the home.

The column originally appeared in Equitymaster  on May 9, 2017

But What About the Rs 2,000 Note?

In the Diary dated December 13, 2016, I had tried to answer a question: The question was what portion of black money is held in the form of cash.

In order to answer the question I had reproduced some data out of the White Paper on Black Money published by the Manmohan Singh government in May 2012. This data was reproduced in the form of two tables. The tables had data from the search and seizure operations carried out by the income tax department. They are reproduced below:

Table 1: Value of assets seized (in Rs. Crore)

Year Cash Jewellery Other assets Total Undisclosed Income
Admitted (in Rs Crore)
2006-07 187.48 99.19 77.96 3,612.89
2007-08 206.35 128.07 93.39 4,160.58
2008-09 339.86 122.18 88.19 4,613.06
2009-10 300.97 132.20 530.33 8,101.35
2010-11 440.28 184.15 150.55 10,649.16
2011-12 499.91 271.40 134.30 9,289.43

Source: White Paper on Black MoneyThe cash seized at the time the search and seizure operations were carried out by the income tax department, was a small portion of the total undisclosed income. This becomes clear from Table 2.

Table 2:

Year Cash Total Undisclosed Income
Admitted (in Rs Crore)
Proportion of cash in total
undisclosed wealth
2006-07 187.48 3,612.89 5.2%
2007-08 206.35 4,160.58 5.0%
2008-09 339.86 4,613.06 7.4%
2009-10 300.97 8,101.35 3.7%
2010-11 440.28 10,649.16 4.1%
2011-12 499.91 9,289.43 5.4%
Total 1,974.85 40,426.47 4.9%

Source: Author calculations based on White Paper on Black MoneySo what do the tables tell us? They tell us that a very small portion of black money is held in the form of cash. People tend to hold their black money in the form of assets other than cash. And given this, what was the point of carrying out the demonetisation exercise which tried to tackle black money held in the form of cash, is a question worth asking.

As the ministry of finance press release on demonetisation said: “Use of high denomination notes for storage of unaccounted wealth has been evident from cash recoveries made by law enforcement agencies from time to time. High denomination notes are known to facilitate generation of black money.” By demonetising the notes of Rs 500 and Rs 1,000, the idea perhaps was to ensure that a lot of black money is deposited into banks. And after that the government would find ways of recovering it.

So far so good. By now, you must be wondering dear reader, as to why am I repeating things which I have already pointed out earlier, perhaps multiple times. What is the current context? Well, over the weekend I happened to read a recently published book titled Demonetisation and Black Money written by C Rammanohar Reddy.

On Page 61 of the book Reddy has a table which is more or less similar to the Table 1 earlier in the Diary. The point he is trying to make is the same as the point I made earlier, i.e., very little of black money is held in the form of cash. Hence, Reddy goes on to say: “Thus, prima facie, cash is not a dominant component of the aggregate stock of black money or of the total value of transactions in the black economy.”

If cash is not a dominant component of the black money i.e. people don’t hold a significant portion of their black money in the form of cash, then attacking it through demonetisation does not seem to make any sense. But Reddy does not totally agree with this and offers two reasons on why attacking the cash component of the economy through demonetisation can be justified. As he writes: “First, because cash is one instrument which is used for both transactions and investment-more for the former than for the latter—an attack on ‘black cash’, as it were, could have a disruptive effect on the market value of the stocks in the black economy.”

Honestly, this is the first well argued point that I have come across in support of demonetisation. What does it mean in simple English? People who have black money do not hoard it in the form of cash, that is a given. Despite that transactions in the black economy are carried out in the form of cash.

Take the case of a home that has been bought using both white money and black money. When it is sold, the payment will be sought both in white money in the form of a cheque, and black money in the form of cash. Hence, as Reddy puts it: “The availability of a buyer with cash becomes critical for effecting the transaction… Cash, is not a dominant part of the black economy, [but] it lends liquidity to the transactions in the black economy“. If you take cash out of the system, you make it difficult for those who transact in the black economy to continue transacting. And to that extent, there was some justification for demonetisation.

As I said earlier Reddy had offered two reasons in favour of attacking the cash component. Here is the second reason. As he writes: “Second, attacking cash may be the most effective way of communicating the government’s determination to deal with the black economy. So any attempts to disable its use may send the appropriate signals to the holders of unaccounted wealth and to people at large.” This is also a relevant point. It is easier for a government to attack cash than it attack hoards of black wealth held in the form of gold and real estate. That would be significantly tougher.

These are two very good reasons offered in favour of demonetisation carried out by the Narendra Modi government on November 8, 2016. Having said that along with demonetisation the government did something which has entirely opposite of what it was trying to achieve. It introduced a Rs 2,000 note replacing the Rs 1,000 note.

As mentioned earlier, while cash is not used to store black money, it is used to carry out transactions in the black economy. Also, higher the denomination of the paper money, easier it is carry out transactions in the black economy. It also makes it easier to store black money in the form of cash.

As Reddy writes: “It may have been a strange decision to take to introduce a new currency of even higher denomination, given that one of the objectives of the entire exercise was to remove high denomination notes from circulation.”

One reason for introducing a Rs 2,000, a note of higher denomination than Rs 500 and Rs 1,000 notes which were demonetised, lies in the fact that it accelerated the process of remonetisation i.e. the process of printing notes and pumping them into the financial system. It takes one Rs 2,000 note to replace two Rs 1,000 notes or four Rs 500 notes. Hence, the process of remonetisation works faster.

Having said that, it goes against the entire idea of demonetising in the first place. A Rs 2,000 note makes it even more easier to carry out transactions in black than a Rs 1,000 note, given that fewer notes are needed. It also makes it easier to store black money in the form of cash due to the same reason.

Hence, it is important that the government withdraw the Rs 2,000 note. It needs to do this gradually over a period of time. The Rs 1,000 note needs to be re-introduced. The moment a Rs 2,000 note comes back to a bank, it needs to be replaced by two Rs 1,000 notes. A date also needs to be set by which the Rs 2,000 notes need to deposited back into the banks.

Again, it is important that the mess that was created in the aftermath of demonetisation be avoided. This can be done by having a last date which is a couple of years down the line. The RBI has carried out phased withdrawal of currency in the past, which is precisely what can be done in this case as well.

The column originally appeared in Equitymaster on April 1, 2017

The Bolbachan of Cleaning Up Black Money in India

One of the issues that I have often written about in the Diary is black money.  And I honestly feel that the total amount of black money going around in India will come down only once the electoral funding of political parties is cleaned up. This is an issue I have been talking about for a while now, and I first started writing about it even before notebandi happened, and the issue wasn’t fashionable enough.

Unless electoral funding of political parties is cleaned up, the other steps taken are what we in Mumbai lingo call bolbachan. Simply translated this means just plain talk and nothing else.

In the budget (or the annual Finance Bill of the government) presented on February 1, 2017, a few amendments which were supposed to clean up electoral funding of political parties, had been proposed.

Over and above these steps, a few other amendments were introduced as a part of the Finance Bill for 2017. The Bill was finally passed a few days back on March 30, 2017. These amendments along with the steps proposed earlier at that point of time when the budget was presented, essentially make sure that the Indian electoral finance system will continue to remain as opaque as it was. Or to put it simply, we went one step forward and two steps back at the same time.

Let’s examine the issues one by one.

a) One of the steps proposed in the budget was that the “maximum amount of cash donation that a political party can receive will be Rs 2,000/- from one person.” Earlier, this limit was Rs 20,000. Further, the political party did not have to declare the names of people contributing up to Rs 20,000.

The total amount of cash donation that a political party can receive has been lowered to Rs 2,000. This means political parties can still receive donations in cash. This basically means that the black money can still be channelised into electoral donations. Of course, all this has done is increase paper work. Instead of one receipt of lower than Rs 20,000 that used to be made earlier, multiple receipts of less than Rs 2,000 will now have to be made, to get around to the current rule.

As C Rammanohar Reddy writes in Demonetisation and Black Money: “The practice so far has been to split up large collections of black money into individual donations, each less than Rs 20,000 so that the anonymity of the source is maintained. The new rule only makes this more difficult; it does not prevent it… The Rs 2,000 rule will continue to keep the door open for black money.”

Some of you might feel that I am being sceptical here, but what else can one be regarding Indian political parties. Interestingly, while the cash donation limit has been reduced to Rs 2,000, political parties still don’t have to disclose the names of people donating of up to Rs 20,000.

As Milan Vaishnav the author of  When Crime Pays: Money and Muscle in Indian Politics pointed out in a recent column: While the government has lowered the cash limit to Rs. 2,000, it has not touched the disclosure threshold, which remains at Rs 20,000. Politicians are already privately joking that the new cash cap will easily be gamed; the only difference is that their chartered accounts will demand a raise.”

This is the point I had made about bolbachan—just talk without any concrete steps that are likely to make a material difference. On the face of it, this seems like a move which basically makes sure that any donation of greater than Rs 2,000 made to a political party will have to made through the banking system. But as mentioned earlier, the donation can easily be split into multiple transactions and black money can continue to finance political parties.

b) In his budget speech, the finance minister Arun Jaitley had introduced the concept of electoral bonds. As he had said: “An amendment is being proposed to the Reserve Bank of India Act to enable the issuance of electoral bonds in accordance with a scheme that the Government of India would frame in this regard. Under this scheme, a donor could purchase bonds from authorised banks against cheque and digital payments only. They shall be redeemable only in the designated account of a registered political party.”

The proposed electoral bond is a bearer bond. As Reddy points out: “It would seem that the idea is for the RBI to issue electoral bonds, which individuals/organisations can purchase at banks (by cheque, thus keeping out unaccounted cash). The buyers can donate these bonds to political parties, which can deposit them only into their bank accounts. Because they are bearer bonds the banks will know the identity of the buyer, but the political parties receiving them would not know who the donor is. This opacity about the donor may free the political party from returning favours. However, the interests of transparency are not met by such features. In any case, which donor would not want his identity to be known to the recipient political party?

Interestingly, the Wall Street Journal points out that the bearer bonds were phased out in the  United States, in the 1980s “because they are anonymous and easily used by money launderers and tax evaders.”

And this precisely what the electoral bonds will encourage in India as well, as we shall see.

Getting back to the point, the electoral bonds seem to move things above board. Hence, instead of donating cash to a political party, a donor can now use the banking system.

The trouble is this that the electoral bonds need to be seen together with other amendments which were introduced towards the end and were not originally a part of the Finance Bill.

c) So, corporates can now donate money to political parties using electoral bonds and maintain secrecy. But that is just one part of it. Earlier, a company could donate up to 7.5 per cent of the average net profit for the last three years to political parties. Further, the company had to disclose the total amount of donations made to political parties in its profit and loss account. It also needed to disclose the names of the political parties it had donated money to.

The recently passed Finance Bill of 2017 does away with these needs. What does this basically mean? It essentially means that a company can donate any amount of money to a political party without the company or the political party having to disclose it. And this, in a country like India, where the governance mechanisms are shaky, makes for a deadly combination.

This is precisely the fear that led to the phasing out of bearer bonds in the United States. As Reddy writes: “The donor’s books will only record that bonds have been bought, they will not record who the bonds have been donated to. The political party receiving the bonds will record receipt of the bonds but the identity of the benefactor will not be known. This is the perfect cover of the anonymity for pay-offs to take place. It would seem that the business-politics links are going to be strengthened and not weakened with such ‘reform’.”

As a senior CAG official told The Telegraph: “This means, for example, that an infrastructure firm could theoretically pay up to 50 per cent of its net profits to a single party as donation without anyone getting wiser as to which party has been paid… this throws open the possibility that an order to build a highway or a railway bridge could be given to a firm and that firm could pay the donation to the party in power which placed the order with it… The beauty is that if this happens, it will be legitimate and no questions can be asked by any ethics committee of Parliament or by any CAG audit.”

To cut a long story short, these changes will take the corporate-politico nexus to altogether another level. We have seen in the past how the nexus has messed both the real estate and the banking sector in India. It remains to be seen how the consequences of this year’s changes in the Finance Bill pan out.

Of course, while the political parties can continue to be opaque and non-transparent, come July 1, 2017, all income tax payees will compulsorily need to quote their Aadhaar number while filing their income tax returns.

Welcome to the new India. As I said earlier, it’s all about bolbachan.

The column originally appeared on Equitymaster on April 4, 2017

Of Demonetisation, Black Money and Jan Dhan Accounts

On March 10, 2017, the Reserve Bank of India published a document titled Macroeconomic Impact of Demonetisation – A Preliminary Assessment. One of the things that the document analyses is the number of new Jan Dhan accounts that were opened after demonetisation came into effect and the money that flowed into them.

On November 8, 2016, the prime minister Narendra Modi made the announcement to demonetise Rs 500 and Rs 1,000 notes. Until December 30, 2016, these notes could be deposited into bank accounts and the money was credited against them.

In the aftermath of demonetisation, one of the theories offered was that many Jan Dhan bank accounts were opened and black money was transferred into these accounts. Is that correct? Take a look at Figure 1.

Figure 1 

So, what does Figure 1 tell us? It tells us that the number of Jan Dhan accounts opened in the aftermath of demonetisation did go up. As the RBI document referred to earlier in the column points out: “Post-demonetisation, 23.3 million new accounts were opened under the Pradhan Mantri Jan Dhan Yojana (PMJDY), bulk of which (80 per cent) were with public sector banks . Of the new Jan Dhan accounts opened, 53.6 per cent were in urban areas and 46.4 per cent in rural areas.”

But as can be seen from Figure 1, Jan Dhan accounts were being opened even before demonetisation came into force. And that is why the curve keeps sloping upwards even before November 2016.

I have considered data from September 2016 to see if the pace of opening of Jan Dhan accounts went up dramatically post demonetisation. It doesn’t seem so from Figure 1.

Let’s take a look at some more data. Figure 2 maps out the week on week increase in the opening of Jan Dhan accounts in percentage terms.

Figure 2 

What does Figure 2 tell us? It tells us very clearly that there was largely no spike in opening of Jan Dhan accounts during the post demonetisation period. The only spike came in the second half of December 2016, when the pace of account opening was faster than it was in the past.

This basically lays to rest one theory about many Jan Dhan accounts being opened post demonetisation, in order to deposit black money into them. But that does not mean that black money did not find its way into Jan Dhan accounts? Take a look at Figure 3. It basically maps out the total amount of money in Jan Dhan accounts from early September onwards.

Figure 3 

Figure 3 makes for a very interesting reading. Before demonetisation came into effect on November 8, 2016, the pace of increase in the total money deposited in Jan Dhan accounts was very slow (the curve is almost flat). Post demonetisation the deposits saw a very rapid spurt. On November 9, 2016, the total deposits had stood at Rs 45,636.60 crore. This jumped by 40.8 per cent tor Rs 64,252.20 crore, a week later on November 16, 2016. It jumped again by 13.4 percent for the week ending November 23, 2016.

What happened here? As soon as the demonetisation announcement was made people started to move their black money into Jan Dhan accounts. This is very obvious from Figure 3, with a spurt in deposits of close to 41 per cent in the week following the demonetisation announcement. One of the ways this was done was when small traders and merchants gave interest free loans to their employees in old demonetised notes and asked them to deposit this money in the Jan Dhan accounts. This was done on the understanding that loans would later be cut from their salaries.

The government was not caught napping for once. It limited the total amount of money that could be deposited into Jan Dhan accounts to Rs 50,000 on November 15, 2016. As a ministry of finance press release on the same day put it: “Information has been received that there is sudden spurt in the quantum of deposits in several Jan Dhan Accounts. There are also reports of unscrupulous elements using Jan Dhan Accounts of poor and innocent persons to convert their black money into white. Such spurt in deposits will be looked into closely. Jan Dhan Account holders are requested not to allow their accounts to be misused by anyone.”

This basically ensured that Jan Dhan accounts as a conduit of black money wasn’t a very viable proposition anymore. Hence, people had to find other ways of depositing their black money into normal bank accounts.

As the RBI document points out: “Jan Dhan accounts contributed 4.6 per cent in total accretion of aggregate deposits of SCBs in the post-demonetisation period.” This happened primarily because the government reacted quickly and limited the total amount of money that could be deposited into a single Jan Dhan account at Rs 50,000.

Further, the government is unlikely to disturb the Jan Dhan account holders. And given that those who converted their black money into white using the Jan Dhan route are likely to get away with it.

The column originally appeared on Equitymaster on March 15, 2017