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August 14, 2011

Page: 17/29

Home > 2011 Issues > August 14, 2011

The Menace of Black Money
India desperately needs systemic reforms

By CSS Rao

CORRUPTION and black money are like two sides of a coin. They always co-exist. Most macro socio-economic problems faced by our country have deep, underlying inter-connection. It is impossible to wish away corruption or expect its solution as sought through the Lokpal Bill or the Charter of Demands put forth by Civil Rights Societies which merely seek to enhance policing powers/punitive provisions of law. Instead, we must consider ways of preventing the root cause of corruption, based on an in-depth analysis of its causes and contributory factors.

It is a tragedy that the country is witnessing audacious dishonesty, blatant misconduct and outright disrespect to the motherland by people in high public positions incessantly abusing their power and authority for personal gain. Added to this, we are faced with leadership deficiency, with many politicians simply lacking the wherewithal to provide effective leadership in changing times. Our leadership is barely able to grapple with the brazenly dishonest conduct of their own team members or cope with the pulls and pressures of coalition politics. With little will, energy or time left for governing the nation, it seems evident that UPA-II is fast losing control and has become a helpless spectator of the national events that are overtaking it.

In several cases, the bureaucracy is seen either indulging in direct corrupt practices and gross abuse of powers or playing a collusive role to politicians, unmindful of the serious detriment resulting from their actions of dishonesty and disregard of national interest. We must admit that without the whole-hearted participative role of bureaucracy, none of the mega scams perpetrated by the scheming politicians could have ever occurred.

The non-government sector is also a major contributor to the evil of corruption, business malpractice and black money generation. It is therefore important to allocate equitable blame on the private sector. Having done this, policymakers must initiate serious, committed measures to resolve this menace based on a thorough understanding of the underlying historical causes of black money in India, the decadal contributory factors, the manner in which it is generated, the method by which it travels and changes hands, the forms in which it is stored, and the various ways in which it is deployed. In order to remedy India’s malaise of black money, let us consider the following serious approach:

1. First, to state the objectives of the exercise what are we trying to achieve and why?

To bring the vast fiscal resources currently held/circulating as black money in India on to the mainstream of our economy to achieve accelerated all round national growth, with thrust on infrastructure and rural development.

This is based on the universal belief that fiscal resources in the hands of federal governments — when properly deployed for national welfare projects — yield greater common good to the nation and its citizens, than when expended by individuals in fragmented form to pursue narrow pecuniary objectives.

2. Genesis and continuing causes of generation of black money

Steeped in India’s economic history, the problem of unaccounted money has been prevalent for generations. The historical causes, which are well known, include:

* High level of taxation since Independence

* Proclivity to hold money privately, not deal with banks, based on traditional practice

* Predominantly agrarian economy

* Low compensation levels to government employees necessitating generation of private income to meet rising costs of living.

3. Decadal contributory factors

* Need for cash by political parties and aspirants for election campaigns at Centre and States driving them to indulge in illegal monetary activities

* Widespread corruption in Central and State Governments and adjunct organisations/agencies enlarged by the process of privatisation of major business and service sectors and related misuse of discretionary powers of politicians and bureaucrats

* Demand exceeding supply for various goods and services resulting in widespread urge to seek illegal gratification

* Evasion of direct and indirect taxes encouraged by archaic tax laws

* Corruption in sections of judiciary

* Multifarious illegal and criminal activities across geographical territories

* Corruption in non–government entities and business houses, contract kickbacks

* Manipulation of value in import/ export transactions

* Agricultural sector revenues held/ circulated largely outside the banking system, especially in rural India.

4. Quantum and form of holding/ circulation of black money

The National Institute of Public Finance Policy (2007) has estimated that the average amount involved in Indian black economy constitutes around 20 per cent of the gross domestic product of the economy, and operates as a flourishing parallel economy. Some economists assess the present level of black money to be even higher. Many measures to curb this menace have been enunciated in the past by eminent economists and academically-oriented decision makers in Government as well as by specially constituted Central committees. However, there has been little impact in resolving this problem, in the absence of real solutions and a strong political will to change the economic landscape of our country.

5. Some unique characteristics of black money

Money is extremely dynamic. It never rests, regardless of its colour. Black or white, it is constantly deployed for economic activity. The principal distinction between them being that in the case of white money, taxes are paid to the government, while in the case of black money, it is evaded. Barring this, money in a macro sense plays similar intrinsic roles, regardless of its colour.

Black money is ubiquitous, and in rampant circulation throughout the country, permeating nearly every walk of life. It often moves in tandem with white money. The amazing feature of the flow of money in India is that it is constantly changing colour. For example, when a person who has received illegal gratification (and therefore holds black money) spends that money to buy an asset or service from an accredited source, the money becomes accounted – and therefore white – in the hands of the recipient company, which is, for example, a white goods manufacturer or a star hotel. Conversely, when a company draws cash from its bank account to gratify an officer for extending official favours, or to pay the cash component of a real estate purchase, then, white money immediately becomes black.

This dynamic and constantly changing scenario — with an adverse, far reaching impact on the national economy — can only be quelled by an array of diverse solutions comprising both long term and short term policies and strategies, which include both apparent and lateral remedies.

6. The enigmatic hawala and illegal flight of capital from India

In 2006, the most recent Global Financial Integrity study shows that the average amount stashed away from India annually during 2002-06 is $27.3 billion (about Rs 136,466 crore). It means that during the five-year period the amount stashed away is 27.3x5=136.5 billion (about Rs 692,328 crore). This figure has been acknowledged by the Government of India.

Despite the Government of India being well aware of this illegal flight of capital from India over the years, it has been utterly helpless to track down its true owners, more so to retrieve these funds to India — a public clamour we often hear to no avail. The real solution lies in establishing pragmatic monetary policies and stringent fiscal systems that prevent such outflow in the first place, rather than attempt to retrieve what has left the country clandestinely.

The illegal money received by acts of corruption or financial malpractices are partly retained in India for investment/circulation in clandestine business transactions. The other oft-publicised route is to remit such money out of India through the incomparably reliable, efficient, proven and widely used parallel banking system known as hawala, with transaction routing as shown above. As is evident, Indian money never leaves our geographical boundaries.

What happens is, the cash is transferred by the holder to the Indian agent of the foreign party. The foreign party then transfers his hard currency money to the true beneficiary’s account abroad which is layered and structured variously through multi-location cross holdings so as to effectively conceal the identity of the beneficial Indian owner of such money – novices excepted. Since such funds abroad are held in bank accounts owned by trusts, companies and other legally permitted entities whose ownership itself cannot be established by virtue of Bearer Shares being legally tenable, and Trustees most often being Bank employees themselves, ‘duly authorised’ to represent the ‘owners’, tracking true ownership of funds is virtually impossible for they can neither be identified nor accessed — and hence recovering such money is well-nigh impossible. Alternatively, it is remitted into the bank accounts of business associates or relatives living abroad. The Indian agent then delivers the rupee cash to a local party designated by the foreign party.

From this it must be understood that no money has actually left India, the so-called money originating from corruption or business malpractice remains intact within the Indian monetary system.

If, as demanded by many, the illegal remittances are sought to be brought back, this can relate only to foreign funds which can be confiscated by Indian authorities and repatriated to India through legal process with the consent and support of authorities in the host country. For all other funds — which constitute the overwhelming majority of such money — there is no possibility of recovery, for reasons explained above.

Assuming theoretically that such reverse flow of money is possible, the illegal rupee funds would flow back to serve broadly similar economic purposes, as stated above. Consequently the overall position in Indian economy and the end-use of such money — which is always dynamic — remains unaltered by and large at the macro level.

Thus, both the impossibility as well as impracticality of attempting to retrieve the money stashed away abroad are both apparent from the above explanation. So anyone waving CDs purportedly holding names of owners of bank accounts abroad is merely deluding the naďve. Criminals do not leave behind their visiting card at the scene of crime.

7. Analysis of past programmes to curb menace, lessons

Several schemes have been implemented by the Government of India during the last two decades to bring the menace of black money under check. Some of these programmes met with marginal success, while others, proved more efficacious, albeit served only to slightly improve matters for a limited period of time, during the tenor of the scheme. Thereafter, the magnitude of the problem regained its status quo position, and presently, continues unabated, with no sign of the trend reversing.

However, following are some of the important lessons and hard facts we have learnt from past exercises:

        -         That evidently, the policies and laws of the Government since Independence have been ineffective and opposed to the interests of both the nation and its citizens, leading to the present mess

        -         That the inherent tendency of Indians is to remain dishonest/ delinquent in fulfilling their responsibilities towards the Government, unless faced with stringent and compulsive (but fair) laws

        -         That a multi-pronged approach is essential to harness black money and to prevent its future generation

        -         That without authentic and irrevocable amnesty no meaningful results can come about

        -         That the proclivity of the public at large to hold on to cash is very strong and deep rooted, hence new schemes enunciated by the Government of India to harness black money should be really attractive to its owners, in more ways than one

        -         That the malady can be cured only by directing solutions to remove the underlying causes, not treating the problem at the surface i.e. adopting a preventive rather than curative approval

        -         That a decent yield should be assured to make economic sense to those holding black money to part with it

        -         That unless effective measures are instituted to prevent fresh generation of black money, the aggregate quantum of unaccounted fiscal resources in the country would not be mitigated

        -         That a straight forward and powerful yet simple mechanism requires to be devised to implement a successful scheme

        -         That the problem is complex and challenging — however can certainly be satisfactorily resolved — the right strategies combined with sustained political will alone can bring an enduring solution to the problem.

8. Why withdrawing high denomination currency notes will not solve the problem of black money

Before seeking to demonetise currency notes of Rs 500 and Rs 1000 a proper understanding of monetary policy is essential.

High denomination currency notes are essential in our country because of the low intrinsic purchasing power of the rupee and India has not yet graduated to widespread use of advanced payment formats such as electronic transfer of funds, credit cards, e-banking, and even cheques and bank drafts throughout the length and breadth of our country.

This is because India is still 65 per cent a rural economy without adequate banking infrastructure. And because a large section of the remaining 35 per cent urban economy has been accustomed since Independence to widespread financial malpractices which are now manifesting themselves as cancerous national problems.

The security features of lower denomination currency notes are always lesser than those featured on high-value notes. Since the total supply of money in the economy must be maintained at the presently prevailing level, the demonetised high value notes must be replaced with currency in lower denominations of Rs 50 and Rs 100 to an aggregate matching value.

If this is implemented, the following serious problems will emerge immediately:

(i) Physical hardship and risk of storing/carrying cash in larger volumes in both rural and urban scenarios. ATMs would become dysfunctional.

(ii) Increased risk of counterfeiting of Rs 50 and Rs 100 currency notes, which have lower security features.

(iii) The enormous time and effort required to count large volumes of lower denomination notes both at banks and at private establishments, both by issuer and receiver.

(iv) The huge additional cost of printing and distributing large volumes of replacement notes.

(v) Grey and black market demand within India will surge for US dollar and other hard currency notes, for bullion, for precious stones etc., all of which will gain increased ubiquitous usage as substitutes for rupee currency to pursue corrupt practices.

Briefly, the Lokpal Bill seeks to enhance policing powers to deal with corruption. India requires stringent administrative practices and systems with transparency in decision making, accountability in conduct of public servants and real time audit procedures to prevent/mitigate corruption, misuse of power and wilful deviation from approved procedures in the Government sector.

India also needs to extend effective moral training to young and old alike to inculcate cherished Indian values and start embracing the great virtues of honesty and integrity, particularly in public life.

In summary, we need a robust system of operational discipline and public accountability combined with a rigid code-of-conduct for those holding public offices, if the cancer of corruption and the damaging impact of black money are to be effectively cured.

India desperately needs a second Independence, with deep systemic changes and comprehensive reforms aimed at correcting the multitude of ills/deficiencies that face us today, and pave the way a clean administration and honest society much sooner than 2020. Also, the method and structure of change should be designed to secure unfailing compliance from those in political and official positions, as well as is the non-government sector.

Are committed intellectuals listening? And willing to come together to change India for the better?

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