“This Is Tough, But Done For the Wrong Reasons”: The Economist Arun Kumar on Demonetisation and Black-Money Generation

By Manas Roshan | 16 November 2016

On 8 November 2016, in an unexpected late-evening message on television, Prime Minister Narendra Modi announced the government’s decision to pull Rs 1000 and Rs 500 notes from circulation, making them invalid for most transactions starting that midnight. The purpose of demonetisation, he said, was to “fight against corruption, black money, fake notes and terrorism, in this movement for purifying our country.” The move has dominated the news since then—several reports have emerged of the distress caused by it, especially to the sizeable population that carries out its day-to-day dealings in cash. The consequent toll it has taken on banks and ATMs across the country has further exacerbated the situation, and is expected to continue for some time—on 12 November, the finance minister Arun Jaitley stated that the government had not calibrated the ATMs for the new currency, and that the process would take at least two or three weeks to complete. The demonetisation has also led to a debate on its effectiveness in restricting the black economy and on whether the government acted too hastily, catching even policy insiders by surprise.

Long before kaala dhan or black money became part of common parlance in the 2000s, Arun Kumar, an eminent economist, doggedly pursued the subject in the 1980s and 1990s. Kumar taught at the Centre for Economic Studies and Planning at Jawaharlal Nehru University, and, in 1989, had played a role in drafting VP Singh’s election manifesto. In 1999, he published a major work, titled The Black Economy in India. Kumar’s work is among the most authoritative accounts of the extent of problem caused by the black economy in India. On 12 November 2016, Manas Roshan, an independent journalist, spoke to Kumar. Roshan and Kumar discussed the consequences of demonetisation, how black income is generated in India and other methods by which governments can best tackle corruption and black money.

Manas Roshan: Do you think the Modi government’s decision to demonetise large currency notes will curb the flow of black money or illegal wealth?
Arun Kumar
: This will demobilise the stock of black wealth or a part of it, but it will not stop the flow. Because for that you’ve to stop black income generation. What happens in an economy is that you have an income, which you save, and savings are what accrue to form wealth. Income needs to be distinguished from wealth, and black money should be distinguished from black income. Black money is only a small part of the black wealth that has been accumulated.

MR: Can the effect of such a move be quantified? Data released by the Reserve Bank of India(RBI) in 2016shows that over 80 percent of the currency in circulation is in the form of Rs 500 and Rs 1000 notes, which is about Rs 13 lakh crore.
AK: Of Rs 13 lakh crore, at least half would be used in businesses: petrol stations, railway stations, airports, etc. What may be held in households may be only 5-6 lakh crore [rupees]. Now, assuming that the top 3 percent of the population owns much of the black wealth, that would amount to only Rs 1.5 lakh held per person. So the immobilised cache of black money is just Rs 2-3 lakh crore.

According to my calculation, which will be out in [the journal] the Economic and Political Weekly, the black economy increased to 62 percent of the GDP [gross domestic product] by 2013, which is Rs 90 lakh crore [A 2014 National Institute of Public Finance and Policy report estimated that domestic black money was equal to 70 percent of the GDP—approximately 90 lakh crore].That’s why my estimate was that the black “money,” or cash component, immobilised is only 3 percent of the total black income generated this year.

Black income generation will continue because there are a large number of mechanisms by which it is generated, which may or may not depend on cash circulation.

MR: As you point out, the government’s decision is based on an assumption that illegal wealth is hoarded as cash.But several economists have said that “black money” refers not to a stock but to a flow.
AK: How black income is generated is by manipulating the accounts of businesses—you understate revenue and overstate costs. Let’s say I’m producing textiles and I’m buying cotton. I’ll buy cotton worth Rs 1 crore but I’ll say I bought it for Rs 1.5 crore, and Rs 50 lakh [of black money] will be siphoned off. Similarly, in Satyam’s case, there were 10,000 fictitious employees and one Mr Raju was siphoning off the salaries of 12,000 people. Suppose you are in an educational institution, you charge capitation fees. Or there are these Kota schools where the [IIT entrance examination] question papers leak out, etc.  There are as many different ways of generating black incomes as there are sectors.

Black income is circulating. It’s not as if it is parked anywhere—black wealth is parked, black income is flowing. For instance, if someone buys property, [black income] is circulating in the real-estate business. Usually when you sell some property, you tend to invest the money in some other property. In the interim you may hold some cash, but otherwise it is circulating.

MR: You’ve described this elsewhere as the black economy being intertwined with and not parallel to the white economy.
AK: Yes, they’re completely intertwined. You’re generating a black income and a white income simultaneously.

MRWill the demonetisation have any effect on the generation of black money in the future? If the aim is to curb the creation of black money, why issue new Rs 500 and Rs 2000 notes?
AK: The reason you need to issue new notes is that the economy is circulated by cash and by banking channels. People’s habits change very slowly. It’ll take many years for your economy to become a plastic-money economy or a checking economy. When you issue currency notes in such large numbers, the same can be used for black-income circulation. The question is, how do you change people’s habits of holding cash?

Small shop keepers and businessmen, you’ll have to get them to be ready to accept credit cards, etc. That will take a quite some time.

Demonetisation and its consequent effects on the economy are very complex. In the coming months, you’ll keep seeing newer and newer problems cropping up as a result of this demonetisation. People will have fears that this demonetisation can happen again. They’ll move into gold, into foreign currency, etc. In the last 20 years, the amount of gold coming into the economy had stabilised to about 850 tonnes every year. That might suddenly start shooting up.

MR: When the Morarji Desai government decided in January 1978 to scrap Rs 1,000, Rs 5,000 and Rs 10,000 notes, the announcement was just as sudden—even the RBI was informed only two days before the ordinance was passed. What wasthe reason for this?
: There’s a more important difference between 1978 and now. Then, hardly anybody had seen 5,000 and 10,000-rupee notes. What was being circulated then were 10 and 100-rupee notes. So it did not touch the day-to-day lives of people. Today, 500- and 1000-rupee notes are in widespread circulation and everybody uses them, including the poor who may get salaries, etc. It affects everybody. And you can see that this time it hasn’t been planned well because after the first notification came, there have been several major corrections.

Earlier, day-to-day lives of people weren’t affected and you could demobilise currency by simply going to the RBI and depositing. At that time, too, it didn’t demobilise any significant portion of the black economy.

The suddenness is so that you [those with black-money in cash] do not distribute the money. But even there it’s not exactly the same. Clever people will find ways. Suppose I’m in a village and I’m a landlord in the area, I’ll get 100 people to deposit Rs 10,000 in their Jan Dhan accounts. And they’ll withdraw it later on. And the government won’t ask any questions about where I got this amount from. The government has already said it will not ask questions if you deposit up to Rs 2.5 lakh. As I’ve said the average holding of black money in cash with any one person comes to about Rs 2 lakh. The Government clearly did not think this move through. The cost will be that small traders and businesses will be completely decimated.

Discretionary expenditure will go down. If you were planning to buy a car, a refrigerator or any consumer durable, you will postpone it because you are short on currency and you are not sure of how things will pan out in the coming months. Industry, which is already growing at a rate of only one percent, will suddenly face hardship. Maybe malls or e-commerce will fare better because people can use credit and debit cards, but the poor don’t have these.

MR: In 1979, the perception was reportedly that the government intended to target the Congress party and the preceding Indira Gandhi government. Does this smack of the same kind of political vendetta?
AK: I don’t think so. Now almost all political parties, including the BJP, the Akali Dal and the other NDA partners will have huge sums of black money stocks. My own suspicion of why this was done is that the government has mud on its face because the foreign-money bill did not succeed—it only got Rs 4,000 crore. The CBI had said there was $500 billion abroad. Then the income declaration scheme got Rs 65,000 crore, which is less than 0.7 percent of the total black income generated. So it wasn’t effective. The Arthakranti people from Pune and Baba Ramdev have been pushing for it since 2013-14. They had come right then to discuss it with me and I had told them that this would be very deleterious for the economy.

MR: What about political funding, which is one of the major conduits for unaccounted wealth?A Centre for Media Studies report projected that nearly Rs 30,000 crore was likely to be spent on the 2014 general election, though official spending accounts by parties and candidates put the figure at under Rs 2,000 crore.
: Of the total black economy in one year, this is not even half percent. Election financing is a very small part of the black economy. The real step there would be that they [political parties] should come under the RTI and should be made to declare what their source of funding is. Eighty percent of the declared funding of BJP, Congress and other parties is coming from donations below Rs 20,000, which don’t have to be revealed. That should be changed.

But the point is that this forms a nexus. At the time of the election, a nexus is formed between the businessman and the politician, and that is crucial. That nexus has to be cracked.

MR: What is the link between black money, and specifically counterfeit currency, and terrorism? In Europe and America, governments have tried to discontinue large-currency notes, citing their use in organised crime and terrorism.
: According to the government’s own figures, 250 of every 1 million notes released may be counterfeit currency. That’s a very tiny amount. The second point is that once the counterfeit money is in circulation, it’s no longer with the terrorists. The terrorist can only finance herself or himself once by using that currency. It’s the new issue of counterfeit currency by the terrorist that you claim to be trying to stop. But if they are so sophisticated that they could reproduce your currency, they could do so again. As one person said, “You’ve caught the chor, but you’ve not ended chori.” The process continues.

In the West, the amount of money used in the form of EUR 500 or $100 notes is a very small percentage of the total. In India, we know that 500 and 1000 rupee notes are used in large quantities by the average person, not just by the drug trafficker. .

MR: In countries that have effectively acted on black money, such as the US or UK, the method employed was most often investigation and prosecution. Shouldn’t that be the route here in India?
AK: Correct. My argument is that if the black economy is 62 percent of GDP that means it is systematic and systemic. It is not anecdotal. It’s not that one day you do it, the next day you don’t do it. Every act of corruption is a nexus between the corrupt politician, businessman, police and the bureaucracy or the executive. Unless you break this triad, the black-income generation will continue. The politician and the others have to say that now they will not do these things. That consciousness comes about only when there are movements. At the time of the Anna Hazare and Ramdev movements, the government started quaking. Once these movements petered out, it’s back to business as usual. So, accountabilityis crucial. That’s why the RTI and a strong whistleblower’s bill are very crucial because that will encourage people to give information. We need very strong whistleblower protection. But they’re trying to dilute this through their new whistleblower bill. Our intelligence agencies are tracking hawala houses on a daily basis. If the PM wants, he can stop the hawala in five minutes. There are dozens of steps that they can take.

MR: In a column you wrote in 2011, you say that had it not been for the black economy, India’s growth would have been 5 percent faster since the 1970s; India could have been a $15-trillion economy, the second largest in the world; and per capita income could have been seven times larger. For these gains to translate into development,wouldn’t this excess wealth need to be redistributed—increase in welfare spending or minimum wage, for example?
AK: Suppose the government had collected taxes on this black economy, the tax-GDP ratio could have been 40 percent. Today, it’s just 16 percent. Therefore, when we say we don’t have enough money—the [maximum] we spend on public education and health is 3.8 percentand one percent of GDP; this could have been raised to 6 percent and 3 percent. One effect of the black economy is that there isn’t enough money for development. The second is that the money that is spent on development does not achieve [its purpose] because it is misused.In the black money economy, investment has become unproductive. Suppose you build a road without enough tar in it and it gets washed away. You end up repairing the road every six months—the shortage of resources and the effectiveness of resources spent. Rajiv Gandhi popularised the saying that if the government spends Rsone, only 15 paisa reaches the village. If you want to set up a school, it’d take seven times longer to set it up, or its quality would be terrible.

MR: What do you think of the effect of this move on the poor and those who legitimately transact business in cash? Cases of suicide and distress have been reported in many parts of the country. Is that only a temporary problem?
AK: The really poor, the bottom 50 percent, are not affected by the currency being demobilised because they don’t hold 500 and 1000 rupee notes. The problem they’ll face is in getting their work done. How do your wages get paid? As far as the lower-middle class and middle class is concerned, they’ll lack currency to go out and buy things. My fear is that this could lead to new kinds of black-income generation: dealing in gold,the misuse of Jan Dhan accounts.

MR: Some have argued for a switch to a cashless economy. Is this practical? Less than 60 percent of Indian households access banking services.
: Absolutely, cashless economy may take a long time to achieve, especially given that the poor don’t have the facilities. I think what they should do is move slowly towards a cashless society, wherever they can do it, but still realise that many will not be able to do it, given the kind of poverty we have. We’re not a European economy; we’re not even a middle-income developing economy. I think we have to move slowly on these things and try and tackle the black economy through other mechanisms. Tough things have to be done. This is tough, but done for the wrong reasons.

This interview has been edited and condensed.

An earlier version of the introduction accompanying the interview incorrectly identified Kumar’s 1999 book as Black Money in India, and stated that it had been published by the Oxford University Press. The book is titled The Black Economy in India, and was published by Penguin Books. The Caravan regrets the errors. 

Manas Roshan is an independent journalist based in Delhi.


17 thoughts on ““This Is Tough, But Done For the Wrong Reasons”: The Economist Arun Kumar on Demonetisation and Black-Money Generation”

Thank you for the informative view. I agree with you and maybe demonetization wast just a start to eliminate the anti-national elements from our economy and a overhaul of our currency which was long overdue. The next logical step would be to stop black income generation and eliminate it’s mechanisms. Why not ?

May be the PM of the country and the president of the ruling party and the cabinet ministers could set an example of transparency and show their sincerity of unearthing black money and saving the country and ultimately helping the lowly common man, by declaring their wealth, incomes and taxes paid so far …in a full page ad in leading newspapers.

Demonetisation should not be misconstrued as ‘be all and end all’ of the struggle. It has to be taken to its logical conclusion of cleansing the very system which gives rise to illicit money in the first place. The government should come out clean and take immediate steps to appoint the Jan-Lok-Pal and Lok- Ayukts, which so far has merely been reduced to only ‘attention-grabbing cosmetic’. The Supreme Court has warned the government that if they continue to drag their feet of the issue, they will appoint the Lokpal. Two crucial steps needed to push such a reform process relate to the funding of political parties and donations in the spiritual super market, the two major black money spinners.

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