The assessment, in this note on demonetisation, is not in the nature of a cost-benefit analysis and does not take account of: (a) cost to the government (of implementing this exercise), (b) hardship that the citizenry may have to put-up with, (c) the private costs that people may have to bear. However, it is pertinent that the effectiveness of the weapon (tool) utilised be assessed against the declared objectives of fighting (a) corruption, (b) black money, and (c) terrorism.
The weapon or tool unleashed is “demonetisation” by ordering to end the legitimacy of the erstwhile 500 and 1000 Rupee notes in circulation, from 00:00 hours of November 09, 2016. A 50-day window would be open for complete withdrawal of these ‘old’ high-denomination (OHD) notes in circulation. With some caveats, those desirous of surrendering these now-redundant notes, could either deposit these in their accounts (with banks and post offices) or may exchange for new currency in the denomination of 500 and 2000 Rupee notes and the existing smaller denominations.
It is expected that counterfeit currency will be eliminated – but it is also possible that some innocent, gullible, and poor are left nursing them. But, that buck stops with the holder. And one can only speculate on the volume of such currency, unless all of it is sucked-up by the banking and post-office system and subsequently quarantined. Further, new stock of counterfeit currency of that denomination may not proliferate for some time.
If this were the only source of funding of subversive activities then demonetisation can be very effective to check propagation of such activities. But, perhaps some funding for subversive activities is also derived from ransom / protection money that may operate as a parallel taxation system, wherever the writ of the ‘state’ is weak. This latter form of financing may require more ‘forceful’ state intervention.
Often, black income is equated with unaccounted income. But, the former is perhaps only a sub-set of the latter. For example, there may be exchanges through illegal or illicit trade (smuggling) then it is the bypassing of law that renders this as black economy income. But, if laws are inadequately designed, then there could be grey areas that generate unaccounted income but not through illegitimate activity. For example, the extant constitutional arrangement places agriculture as a provincial or state subject, and implementation of agricultural income tax under provincial purview. But most states do not have a provision to tax such income. Consequently, no effort is made to maintain any meaningful oversight on agricultural income. This is only one channel that fosters growth of unaccounted income and unorganised sector, but all within legitimate constitutional limits.
It is extremely important to understand the mechanism of generation of black money / unaccounted income. High taxation and / or prohibition, with poor or weak enforcement fosters a black economy. Corruption or bribery is only one form of propagation. The ‘speed’ money is quickly transformed into either current consumption or an asset (most likely, real estate or gold). But, then its fortunes get closely linked to the general inflation which affects all income, black or white. To the extent that black economy offers or raises liquidity, it also fosters inflationary tendency. But, that is indistinguishable from a similar inflationary tendency due to high (and differential) rates of taxation.
Those indulging in patently illegitimate activities could find their existing stock of resources suddenly losing value. But the extant exercise alone may be inadequate to stamp-out all black-money or future propagation of unaccounted income. In their attempt to convert the existing stock-holding of the OHD currency, those with large stocks would be especially under surveillance. Most would try to parcel out the stock into small sizes, and some could also attract the attention of the tax authorities.
That the OHD notes constitute 86 per cent of the value of extant Indian currency in circulation could be true only in terms of the genuine currency issued by the RBI. But, it may not necessarily constitute the same fraction when the stock of all counterfeit currency is also included.
One may only speculate on the level and volume of counterfeit currency of small and high denomination in circulation.
This round of demonetisation would make a significant dent on circulation of counterfeit currency of OHD notes only.
The success of the exercise to effectively choke the funding of subversive activities would depend critically on the likelihood that counterfeit currency (a) is its principal source of financing and (b) mostly constitutes of OHD notes.
Unless the banks adhere to stringent ethical standards, only some of the corrupt could get trapped and most are likely to escape the long arm of law.
But more importantly, demonetisation alone has extremely limited potency to root out corrupt practices and or future generation of unaccounted income.
Stamping out of corruption and black economy entails remodelling the institutional structure and mechanism designs to foster (a) improvement in oversight, (b) ‘organisation’ of economic activity, and (c) strong enforcement of law.
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