A Gambit Against Black

Despite the euphoria over PM Nar­endra Modi’s move to demo­n­­et­ise Rs 500 and Rs 1,000 currency notes, opinion is divided over the outcome. While there is a consensus that it will ­affect sectors like real estate and the dem­and for gold, economists are not convinced that the move is enough to rein in black money, one of its primary objectives. “Demonetisation won’t have the ultimate effect on black money. It’s just one of the things the government can do,” says Shashanka Bhide, economist and director, Madras Institute of Development Studies. “A number of other things need to be done, including better tax administration as most of the black money goes through the leakages there. We need to expand the tax base and make tax collection more efficient.”

Many economists also think the impact may not be as expected—and could be much smaller—as there are other avenues of black money. According to economist Ajay Shah, it will not be correct to equate corruption and tax evasion with physical cash. The impact of this move on the black economy could be smaller than expected. The impact on corruption will also be small. He feels there will always be precious metals, US dollars and bitcoins, where black money can still exist. “Solving the problem of corruption calls for deeper changes to institutions. When the sources of corruption are unchanged, the people will require some methods to do transactions,” he says.

Shah feels there will be a disruption for cash-intensive business models, but only in the short run. The real estate business will suffer. Firms that have built a business model which does not involve cash will fare better.

The government, though, is confident the move will work. Obviously, the decision to demonetise the currency notes, on which the government maintained utmost sec­recy, was not done in a hurry. It was worked on for over six months, beg­inning during Raghuram Rajan’s tenure at the helm of RBI. The early pointers to demonetisation was the opening of bank accounts for all, followed by linking bank accounts with Aadhaar. Soon after came the disclosure of bank account and Aadhaar in income tax returns and then the income disclosure scheme. With all these measures, the government was slowly closing in on to nail black money. The demonetisation is the final culmination of all the efforts.

“A combination of national security concerns and the wider agenda to filter out unaccounted income guided the government to make this move,” says Mukesh Butani, managing partner of tax and legal consultancy BMR Legal. “Figures of high denomination currency in circulation over the past five years, compared to growth in the economy, indicated unaccounted money in circulation. The timing was perfect—a month after the income disclosure week ended and a week after Diwali—to minimise the impact of short-term disruption during the festive period.”

This is not the first time demonetisation is being done in India. It was done earlier in January 1946, when Rs 1,000 and Rs 10,000 currency notes were withdrawn, and again in 1978, causing no disruption in the economy. In those times, though, the rupee value of the currency notes that were demonetised was small.

This time, the move will prompt people to shift to electronic transactions and the use of plastic money will increase, at least ­initially. “With this,” says Kunal Bahl, ­co-founder & CEO Snapdeal, “the quantum of India’s economy moving through the digital pipes will witness massive growth.”

In fact, many experts are confident that there will be a brighter side to this exercise. They feel the impact on the economy will be significant as a large part of the black economy would become part of the Indian economy. This is certain to reflect in next year’s GDP figures. “GDP will go up as a lot of cash will come back into the system and the black economy will go down significantly,” says Girish Vanvari, partner and head of tax at KPMG. “With this and the GST, we should look at a growth rate of 10 per cent for GDP in the coming year.”

The attack on black money through dem­onetisation is also expected to boost government revenues in a significant way. With a large part of unaccounted cash coming into the system, a lot more money will become accountable and taxable than was the case earlier. The government, therefore, expects tax collections too to go up.

One sector that everyone thinks will be majorly affected by the government’s move is the real estate sector. The sector will be badly hit in the short run, with small-time developers facing the brunt as the cash component in their transactions is higher  and many buyers will have no legacy cash.

“The real estate market has a reputation of being a safe haven for black money, so we expect to see an impact here,” says Anshul Jain, managing director, India, of Cushman & Wakefield. “The impact is likely to be seen in secondary markets for all asset classes, thereby making real estate more illiquid for a period of time until the market adjusts to a new normal. The primary market, driven mostly by big developers, is unlikely to get affected as most reputed developers do not deal in cash transactions.” Expecting an impact on general liquidity in the market in the short term, he sees working capital needs for small and medium developers and other businesses becoming  a lot higher.

Demonetisation is also likely to increase transparency and credibility in real est­ate at a time when the setting up of  a Real Estate Regulatory Authority (RERA) in every state is expected to boost accountability in the markets. “We can expect some correction in real estate prices in markets where substantial speculative investments have been made by individuals through their black money,” says Jain.

Other real estate experts are of the opinion that this would adversely affect land prices. Anshuman Magazine, chairman of real estate ­consultancy CBRE, feels this will happen because the cash component is most prominent in land transactions. Land transactions and sale of plots are expected to dip in the short-term, esp­ecially in the unorganised real estate segment. In the short term, transactions in the secondary market are likely to be impacted negativ­ely, especially in Tier-II and smal­ler cities. “On the flipside, this move is likely to ­exert downward pressure on capital values, which is expected to result in ­increased affordability, particularly for the housing sector in the long run,” says Magazine.

Another area that is likely to take a hit is gold. It is a given that a lot of India’s black money goes into gold and with the Indian penchant for storing gold, there is a parallel gold economy that works in the country. A large part of this parallel economy is fed with unaccounted money. That will be hit, though only in the short term. Gold dealers feel the short term would be tough as the old sources of black money that went into gold will dry up.

“The demand in the bullion market will dry up as the cash supply dwindles,” says Rahul Aggarwal, director, SRS Jewels. “In the next few days, gold prices would fluctuate to meet the requirements of the consumers. Elevated prices and India’s push for more transparency on purchases and income disclosure will bring demand this year to its lowest in seven years. This will surely create chaos, albeit temporary.”

One thing is certain. The government’s move is sure to create chaos in all the sectors where a cash economy operates. At least in the short term, the outlook is bleak with stability likely to come only in the medium term. Will the economy gain as a whole? Nobody is sure and the economists are giving it a thumbs down. It will be interesting to look at the numbers at the end of the financial year when this initial chaos settles down.