A note about notes

You come back home one day and see that your house is flooded with water. You check and find out that a couple of your taps were left open. What would you do?

A. Leave the taps running and try and drain the water?

B. Turn off the taps first and then drain the water?

I would argue that, reasonably, you would take the first option – cut off the source that creates the problem and then cleanup the effects of the problem.

And this, in a nutshell, represents my frustration with the current government of India’s approach to tackling black money through demonetization of the Rs. 500 and Rs. 1,000 notes. While I applaud the step they have taken to flush out stockpiles of cash, they have undertaken no serious reforms to tackle the issues that creates these stockpiles in the first place, such as: extremely poor public service delivery [1],  crumbling judicial infrastructure [2] and mutual incentives for both parties involved in real-estate transactions to under-report the value of the transaction [3].

I understand that many would argue that people who have the said stockpiles have either already converted, would find ingenious ways to do so – or that they simply don’t have the said stockpiles in the first case and that they hold black money in stocks, gold, real estate or other instruments. I also agree that in heat of the moment many people have equated all cash to black money, which is a ridiculous position.

The government needs to be held accountable for any fantastical claims they make during this period. For example, merely deposit of record cash in banks is not a metric of success – and the cynic in me says this perhaps points to desperate attempt to recapitalize banks at the expense of the citizens. Neither is a temporary – or even a permanent – bump in cashless transactions in urban areas.

I would also specifically caution against using the percentage of unconverted notes to declare victory against black money. There would be numerous reasons why all (alleged) 86% of all notes are not converted or deposited during this period – ranging from the data (both about the initial assumptions and collection figures) being wrong,  to delayed conversions, to people developing a completely parallel economy using the old notes – and ad infinitum.

The pain and suffering people are enduring must have lasting gains for this move to be legitimate – otherwise this is a grand delusion remnant of gems like Mao’s ‘Great Leap Forward’.

While many reasons have attributed to reason behind this move (black money, security, curbing fake currency), I would prefer to focus on only one – the primary stated motive of curbing black money. If this move does indeed have lasting effects on the economy, then tax collection should go up substantially in FY 2017-2018 as would be reported in the Budget for 2019. That alone, to me, would indicate that this move had a lasting impact on the nature of transactions in India. Since GST would most likely be introduced in April, 2017, it would be difficult to delineate the effect of GST vs. demonetization on indirect taxes. Therefore, for me, the metric to watch out would be the gains in direct income tax collections for FY 2017-2018 – provided of-course, that there are no tectonic changes in the Direct Taxes code between now and then.

To summarize: I have cautious optimism about this move and hope that this does not turn into yet another instance of this Government’s harping of process over performance as it is prone to do.

[1] Poor Public Service Delivery: This is what typically leads to forced transactional corruption were ordinary citizens have to pay bribes simply to get government services owed to them by right.

[2] Crumbling Judicial System: I believe that this exacerbates both forced and compliant corruption – there is no justice for victims of forced transactional corruption and no checks on people and businesses using corruption to get undue favours.

[3] Real Estate Transactions: Typically, the buyer has to be pay the registry cost (which is approx. ~10% in some states) and the seller has to pay the capital gains on his profit (~15% for long term capital gains). This cause a perverse incentive for both the parties to undervalue the transaction.

 

 

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