There has been huge public support for the centre’s demonetization drive by replacing old Rs 500 and Rs 1000/- notes with newer currency. The public in general has been vexed with increasing indications of black money in the system and whole heartedly supported demonetisation while being fully aware that this may cause temporary hardship in their day to day lives.
But as the fine print is getting bigger and as the full implications of this bold move become clearer, one thing can be construed as a certain possibility. That is a big knock on the economy, not just for a month or quarter but for a period far exceeding that.
Let me explain.
Tax calculations imply that the tax liability for anyone willing to deposit a crore of unaccounted money into the banking system before 30th of December, will be around Rs 85 lacs. The tax liability for Rs 50 lacs of deposit is around Rs 40 lacs. This is because of the 200% penalty as applicable in the prevailing income-tax laws. It is a no brainer if any one will ever deposit Rs 1 crore just to retain his share of Rs 15 lacs and then endure income tax scrutiny for prolonged period. This will ensure that a large part of this unaccounted wealth may not finally flow back in to the banking system. It is not for me to speculate as to what these black money hoarders will do since depositing into banks is not a practical option for most of them. All that is of relevance to me at this point is that accruals to the banking system due to this sudden demonetisation will be negligible.
Now let us compare this situation to what was happening till 2 days before. A lot of this unaccounted black money was flowing into some productive uses and into some unproductive uses. Among productive usages, I would include real estate, luxury goods purchase, domestic vacation travel etc. One may be surprised by my inclusion of real estate in this list but let us not forget real estate, particularly building construction, supports another 15 to 20 industries such as steel, cement, paints, tiles etc besides supporting India’s biggest chunk of unorganized labour force. Hoarding in gold can of course be counted as an unproductive usage.
After demonetisation, a big part of this hoarded unaccounted wealth can no longer flow either into the hitherto productive usages nor flow into the banking system. It can either be parked in unproductive usages such as gold, or leave the country through some well established hawala channels or simply be destroyed.
Either way, neither the economy nor the banking system can benefit. This is not to question the move itself per se, but it is just an attempt to take a hard look at the implications and what it might lead to.
Brace for a prolonged impact on the economy.