Demonetising Corruption: Precision or Carpet Bombing?

“Much can happen between now and 2019. But one thing is clear that road to Modi’s reelection in 2019 goes through UP 2017-assembly elections -a state that gave 71 BJP members of parliament in 2014. UP is also crucial to BJP to eventually get majority in the upper house. Was demonetisation a dazzling masterstroke by Modi to resurrect the iconic anti-corruption crusader image he rode to victory in 2014 but that has lost shine due to pretty modest “achievement” of Income Disclosure Scheme-2016 [IDS] & abject failure of Undisclosed Foreign Income and Assets Scheme-2015? Someone who promised Rs. 15 lacs in every Indian’s account by “confiscating” black money stashed abroad and failed utterly [later called चुनावी जुमला], it was a huge come down he could not afford. Would his spectacular but what appears to be foolhardy gambit succeed? If it doesn’t appear to fetch the coveted reward as elections near, then India may be in for worse trouble. Either it would then be war jingoism at our geographical borders or identity borders may get yet again drawn to  bitterly polarise the electorate into communities”.

Brought up on the staple diet of Cinema, the Indian public visualises Black Money as residing in High Denomination notes that are concealed by the Rich & Mighty in secret vaults or even stashed in pillows, mattresses, false ceilings, sofas and what have you at home. Such rich imagery is only strengthened by occasional but not infrequent reports of government officials caught with huge stash of cash1 at home and in bank lockers.


No wonder then that Modi’s audacious decision to derecognise Rs.1000/500 notes resonated in the public mind, which believed it would flush out all the black money at one go and purify India’s economy and polity once and for ever. Public, especially the middle-class, who is in thrall of Modi’s strongman persona, even considered a little “suffering” of standing in serpentine queues at the banks to change notes a patriotic duty as it was masterly brainwashed by “nationalist” messaging. However, the sudden siphoning off massive liquidity, 87% of the total cash in circulation {or stashed in mattresses if you prefer} has caused though widespread stress to poor people, farmers, labourers, workers, vendors, small and medium enterprises in informal sector by bringing tens of millions of daily cash transactions to a grinding halt2.


Whether this move brings the desired windfall gains to Modi in the upcoming crucial state elections would depend upon how quickly the change over to new notes takes place and how much unbearable pain is inflicted upon the people before it is completed. Whatever the merits of the move, one thing is becoming clear that the implementation has been tardy. Coming to the merit, it has two components. Since mostly people vote with their emotions rather than reasons, the political-merit will only be revealed at the hustings. But how does the move measure on economic-merit? Before we proceed, a few clarifications are in order.

  1. Black Money: is generated from “income” that is not declared and therefore no income tax is paid on it.
  2. Income: is legitimate or illegitimate.
  3. Legitimate Income: is derived from economic activities {production of goods & services} that are legal.
  4. Illegitimate Income: is derived from activities that are not legal such as Drugs, Extortion, Gambling, Smuggling, Bootlegging, … and most importantly bribes extorted by the government apparatus.
  5. Black Economy: is the portion of legit economy that operates below income tax radar.
  6. Counterfeit Notes: Currency that is not supervised and issued by agency established and mandated by law of the country.
  7. Cash Hoarding: (i) Black money generated by legitimate income earners is mostly a flow and not a pool or stash. It remains in circulation while passing through the hands of many intermediaries including huge number of poor people employed by the informal sector. (ii) Black money generated by illegitimate income earners, especially bribe- takers, tends to be stashed into a hoard, of cash or otherwise, as they have no legit sources of keeping it in circulation.
  8. Parking of black money: (i) Sending Abroad: Here the black money travels abroad through many channels {Havala, Trade over/under invoicing3, etc.} and much of it returns home as respectable “Overseas direct Investment” (FDI) or Foreign Portfolio Investment (FPI*) in stocks & debts through Participatory Notes. {RBI has curiously expanded on 17 November 2016 the list of eligible instruments for FPI investment15, which is often black money coming home cloaked in respectability} Most favoured rerouting hubs for Round Tripping are Mauritius4 and Singapore with whom India5 has “special arrangements”. (ii) Real estate investments {that is why stocks of real estate companies have lost massively in last 1 week} (iii) Gold and Jewellery, which saw a quantum jump in sales in the few days since demonetisation announcement. (iv) Cash, which forms just 6% to 10% of total black money “stock”.

Coming to the objectives of the demonetisation move, let us look at the data to see how they really pan out.

Ending Menace of Counterfeit Notes:

The only known formal study made of the extent of Fake Indian Currency Notes (FICN) in circulation by Indian Statistical Institute (ISI)6 found that about 250 for every 10 lacs notes in circulation are fake amounting to some Rs. 400 Crores. The detection of 80% of FINC incidence is thanks to 3 private sector banks: Axis, HDFC & ICICI. If detection at public sector and other banks is strengthened, then 20% of all FINC can be eliminated every year.

**ISI, however, concluded6 that “the existing systems of seizure and detection are enough to flush out the quantum of FICN being infused”. The institute says that if detection can be improved, the value of FICN in circulation can be reduced by at least 20% annually.**

Even if one were to assume that actual incidence of FINC is say three times the ISI estimate or say Rs. 1200 crores; it still forms a minuscule 0.08% of the total monetary base of Rs. 14.5 Lacs crores destroyed by Modi’s move. Was it necessary to guillotine a person, when all that was needed was a targeted amputation of a gangrenous finger? Moreover, the move would only be a temporary setback for those making & pushing these FICN, because the new notes being introduced lack any novel security features7 to deter counterfeiting. Incidentally, what is the cost of this Operation Guillotine? The printing cost of notes junked can be worked out from this data:

**Rs 1,000 note required only 0.32% of its face value8 to produce but a Rs. 500 note requires 0.78% of its face value, Rs 100 note requires 1.8%, Rs 50 note 3.6%, and Rs 10 note 9.6% to print. There are 15.7 billion notes of Rs 500 and 6.3 billion notes of Rs 1,000 in circulation in India.**

The cost of junked notes thus amounts to Rs. 8100 Crores. Assuming that new notes without additional security features will cost the same for printing, the whole exercise would cost the treasury some Rs. 16000 crores.

There is a far more worrying factor that has missed mainstream media’s radar completely. There were two series of Rs. 1000 notes, 2AQ and 8AC9, that were declared by RBI as FICN; though they were as good {or as bad} as any notes issued by RBI except the “series nomenclature”. How could this happen? This takes us to the “Money Makers – The Secret World Of Banknote Printing10” and especially to firms  American Banknote Company (USA), Thomas De La Rue (UK) and Giesecke and Devrient Consortium (Germany). Thomas De La Rue is of particular interest because it’s Swiss owner was on board the Indian Airlines flight 814 that was highjacked ultimately to Afghanistan in 1999. Is this firm the source of high quality {or say equal quality} notes allegedly pushed by Pakistan and disowned by RBI? Although, the firm is not formally removed from the “backlist”, it is very much active on India’s currency note making scene.

Ending Stranglehold of Black money:

First, the tempo of rise in Rs. 1000/500 notes was in no way dampened during Modi Rule11, in fact had accelerated substantially in the last financial year.


The rise in high denomination notes in FY2016 over FY2015 was 16.42%; and going back likewise for previous years was 12.99% (2015-14), 11.59% (2014-13), & 12.31% (2013-12). This shows the proliferation of Rs.1000/500 notes cannot be blamed as merely “Legacy” issue on previous UPA government.

Further, Ambit capital research in June 2016 had said that black economy is contracting.

**Pegging India’s ‘black economy’ at over Rs.30 lakh crore12 or about 20 per cent of total GDP, a new study said it has been contracting gradually over the years but still remains bigger than the overall economic size of countries like Thailand and Argentina.**

This assessment is borne out by RBI data11 as the following table shows.


The ratio of Cash in circulation to deposits held in the banks was exactly 150% in 2013; and in subsequent years was153.57% (2014), 152.13% (2015) and 139.50% (2016). Clearly, the steps Modi government took to curb black money were yielding results going by this measure.

**The report said12 that since the NDA government assumed power, there had been a clear step-up in checks around gold transactions and it has become increasingly difficult to park unaccounted cash in the form of jewellery or bullion. Due to various measures taken by the government to tighten the noose around black money, there has been a clear drop in the prices of land and real estate and a decline in the appetite in gold, it said.**

If this was so, where was the need to take such a drastic step of demonetisation, which looks like a case of throwing out the baby with the bathwater.

Lastly, one needs to determine, not an easy task, what portion of the Rs. 30 Lakh crore black economy resides in black money -the avowed target of Modi’s carpet bombing. The total cash in circulation (what RBI terms ‘M0’) is about 12% of GDP, and Rs. 1000/500 notes amount to 10% GDP, or some Rs. 14 Lakhs crore. Quite obviously at least 16 lakhs crore of black economy resides in entities other than cash. Even of this 14 lakhs crore of cash, there are other, larger & legit claimants, such as Informal sector and formal sector, and households savings. According to an article13 the share of cash in the undisclosed income seized by income tax department in raids is mere 6% as per data of tax raids from 2012-13 onwards. Let us take this as the floor. The ex-chief statistician of India, Pronab Sen,14 estimates the size of informal sector at 45% of GDP while employing 80% of the workforce. Moreover, he estimated that informal financial sector, which drives the money engine of informal sector that is not served by banking sector, at 26% of GDP.

**This sector, comprising not only of the much-reviled moneylender but numerous other institutions such as nidhis, hundis, chit-funds, etc., will have a very hard time in exchanging its stock of currency (some of which may well be black money), and may indeed suffer a permanent erosion in its lending capacity. We might not shed any tears for them, but spare a thought for those whose livelihood depends on the capital provided by this sector because the formal financial sector will never touch them with a barge-pole.  How large is this problem? I had made a rough estimation of this during the preparation of the 12th Five Year Plan, and it came to nearly 40% of formal bank lending – that is, 26% of GDP – which is not a joke.**

Such estimates may be challenged by others and there are also significant overlaps between Black Economy, Informal Sector or Informal Financial Sector and household savings that are beyond authoritative and accurate segregation. Suffice it is to surmise that may be a maximum of 10% to 12% black economy at the most resides in Rs. 1000/500 notes; or say  somewhere between 1.8 lakhs crore (6% of black economy) to 3.6 lakhs crore (12%) is held as “Black Money”. That means the balance 13 lakhs crore to 11 lakhs crores is “white money” and would be the undeserving collateral damage of Modi’s move, which Supreme Court described as akin to “carpet bombing”. It appears that devastation caused by this blitzkrieg is going to far outweigh gains, if any.

Crucially, the root causes of black money generation like “complex tax codes -both direct and indirect” and “arbitrary discretionary powers” vested in the bureaucracy remain completely untouched. Modi wants to fight black money with a corrupted and compromised weapon. How is that possible?  {Incidentally, Modi has approved amendments to protect public servants from Anti-Corruption probe16}. Generation of black money in New Modi-Notes17 has already commenced {the unwieldy procedure established to eliminate or minimise misuse of “money changing” system has failed to deter very quick acquisition of new Rs. 2000 notes}. If high denomination notes were seen as the “overriding incentive” to park black money, where was the need to reintroduce them in altered form? But, they had to as the roll out of smaller denomination notes to fill in the void would have brought the economy to a grinding halt for months together apart from the much higher bill for printing such notes. The cumulative man-days wasted in standing in bank queues to exchange new money or deposit old money would look like small change compared to the blow dealt to the already fragile economy. Would the expected fall in interest rates due to banks getting flush with funds and the expectation of reduced inflation due to dampened economic activity mitigate some of the difficulties? Only time will tell.

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  1. Massive stash exposed.
  2. As currency dries up, business withers at kirana stores.
  3. Modi, Adani and Black Money. Where’s the Investigation Going?

4. Mauritius Route: Round_Tripping Restored!

5. मुखोटा Magic: BJP-Congress, FDI-FII.

6. Fake notes worth Rs 400 crores in circulation.

7. No time to add new security features in notes, says official.

8. Rs 14 Lakh Cr Cash Junked–What That Means For Black Money.

9. Watch out for fake Rs 1,000 notes.

10. The Secret World Of Indian Currency Printers.

11. How Demonetisation Will Boost Cashless Economy.

12. India’s black economy shrinks.

13. 10 Reasons Why BJP’s Demonetization Move Is An Unmitigated — And Politically Motivated — Disaster.

14. Shock and oh damn.

15. FPI investment base expanded.

16. Centre Approves Changes in Anti-Graft Law to Protect Public Servants From Probes.

17. Gujarat: Govt staff caught taking Rs 4 lakh bribe in new Rs 2,000 notes.


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One Response to “Demonetising Corruption: Precision or Carpet Bombing?”

  1. Making of Big Brother: Breaking Free from RSS/Hindutva Shadow? | Chintan Says:

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