Dr. Susmit Kumar, Ph.D.

The demonetization action taken by the Modi government may not have yielded significant windfall for the government, but the action against benami property, to be taken next, may yield a windfall for the government.  

In the early 1970s, the Wanchoo committee on black money had recommended withdrawing high value banknotes. Although the then Indira Gandhi administration did not implement the findings of the Wanchoo committee report, Morarji Desai government withdrew Rs 1,000, Rs 5,000 and Rs 10,000 notes from circulation in 1978 as a means of curbing counterfeit money and black money. 500 banknote denomination was first introduced by the Reserve Bank of India (RBI) in 1987. 1000 banknote was reintroduced in 2000. In 1946 also, banknotes of 1,000 and 10,000 rupees were withdrawn and new notes of 1,000, 5,000 and 10,000 rupees were introduced in 1954. Post-independence, the 1,000 rupee note was once again introduced in 1954.

On 28 October 2016 the total banknotes in circulation in India was 17.77 trillion rupees (US$260 billion). In terms of value, the annual report of Reserve Bank of India (RBI) of 31 March 2016 stated that total bank notes in circulation valued to 16.42 trillion rupees (US$240 billion) of which nearly 86% (around 15.28 trillion rupees) were 500 and 1,000 banknotes. By demonetization of 500 and 1,000 banknotes, the government may have hoped that banks may not get some of these high value banknotes and the government might use this saving in the next year budget.

As per a Central Board of Direct Taxes report, black money is largely held in the form of benami properties, bullion and jewelry. According to data from income tax probes, black money holders keep only 6% or less of their ill-gotten wealth as cash. This is the main reason that nearly all 500 and 1,000 rupee banknotes are deposited in bank after the demonetization announcement.

Although the government was not able to get any windfall from the demonetization step, the country has seen a lot of benefits from it, some of which are as follows: 

  1. End of counterfeit currency - Due to some new features introduced in the new 500 and 2,000 banknotes, these are very difficult to reproduce by the counterfeiters. Its arch enemy Pakistan was one of the main agents for producing counterfeit currencies.

  2. Decrease in terrorism and Maoist insurgency - Pakistan was printing fake Indian currencies to fund terrorist activities in India which became evident after the sudden lull in violent anti-government agitation in Kashmir. It is said that Pakistan supplied counterfeit high value Indian banknotes to fund stone-pelters in Kashmir. Immediately after the demonetization, the anti-government agitation all over Kashmir disappeared and schools and colleges re-opened after several months. After the announcement of demonetization, Maoist insurgency is also down as Maoists' amassed money, mainly in high value notes used to run their movement, has become useless.

  3. Reduction in corruption – it is for time-being as after some time, people would use the new banknotes in corrupt practices.

  4. Effect on Coming UP, Punjab and Goa elections – It is said that the political parties in these states had amassed hundreds of crores worth of demonetized 500 and 1,000 banknotes to spend during the elections. Hence demonetization would result in less unfair practices during elections.

  5. Increase in bank loans – after the announcement of demonetization, several lac crore rupees are deposited in bank and some of them may not go into circulation immediately, it would reduce the banks’ NPA (Non-Performing Asset) ratio with respect to the deposited money. Hence bank will have surplus money to provide loan at reduced rates.

  6. Decrease in inflation – as there will be less money in circulation, the prices would decrease. But inflation also depends on the trade deficit of the country. If due to any reason, like rise in crude oil price in world market, trade deficit increases, then rupee would go down, resulting in higher inflation.

  7. Increase in digital transaction – Now due to demonetization, more and more people are learning and using digital financial transaction. The government is also taking steps to provide monetary incentives for digital transaction. Due to digital transaction, government would be able to monitor the incomes and expenses of people so that it can levy taxes.

On the other hand, the demonetization has dampened the real estate in which large amount of black money was being used. It would decrease the economic growth rate of country for next few years. As nearly 30% of the home construction cost is spent on labor, the demonetization has drastically increased the un-employment in un-organized labor market. Since the announcement of the demonetization, outbound trains from Delhi are reported to be full of laborers, working in NCR region in housing projects, mainly from UP and Bihar. Also majority of un-organized laborers do not have access to the banks and they are finding difficulty in coping with demonetization.

Hence in short term, the Modi government may get over-whelming support from majority of Indians for its demonetization step as only people, with black money, would oppose it. Due to this, the BJP may win state elections being held early next year.  But in long term, the demonetization would result in the rise of unemployment in un-organized labor market, related to the housing industry. It is said that since the demonetization, there is 20% to 30% drop in housing prices all over the country. It will also reduce in economic activity, related to the housing industry like cement and steel.

Therefore the demonetization alone would create a danger for the BJP in winning the 2019 elections. BJP has witnessed it in 2004 elections when it went to the electorates on the slogan of “India Shining” and lost the election because people in rural area did not get much fruits from the economic steps, taken by the NDA government, which had largely affected mainly urban areas only. In 2004 Andhra Pradesh state elections also, the then Chief Minister Chandrababu Naidu faced defeat for the same reason although he was the main person behind making the state the Information Technology hub in the country, creating significant number of jobs in cities like Hyderabad.

The action against benami property, the government’s next step to root out black money and corruption, would further dampen the housing industry and may result in further steep decline in housing prices because maybe 30% to 40% of the present homes, found as illegally owned, would come into already over-supplied housing market. The drastic decrease in home prices would cause a large number of home mortgages to go underwater, resulting in increase in NPA of the banks. A home mortgage is called underwater if the price of a home falls below the outstanding loan against the home. Any drop in home prices would also result in a decrease in surplus money to be spent by the people.

The 2008 mortgage crisis in US resulted in 30% to 40% drop in home prices in several states, causing the Great Recession. It caused the rise in unemployment to double digits in several states. The Bush and Obama governments spent trillions of dollars to prop-up the housing industry to bring the country out of the recession. India may witness a similar meltdown in housing industry after the action against benami properties. But unlike the US where individuals owned the homes, the Indian government would seize the benami properties, increasing the government coffers. Also the home mortgage sector in India is only about 10% of its GDP whereas it is 20% in China, 88% in UK and 81% in US, and hence an increase in underwater home mortgage would not create the Great Recession, witnessed in 2008 in the US.

Unlike the banknotes, the benami property cannot be converted into legally owned overnight by transferring the ownership to somebody else or converting into bullion, the steps taken by black money hoarders after the announcement of demonetization, and also the government intend to inquire the ownership history of all the immovable properties since 1947. According to a study, nearly 94% of black money is held in the form of benami property, bullion and jewelry. Hence action against benami property would result in hundreds of trillions of rupees worth of assets in government coffer after it seizes them. The Modi government needs to wisely deal with the seized properties. If it would try to sell them immediately, it would result in sharp drop in housing prices. Also immediate sell would result in purchase of these trillions of rupees worth homes by the financial investors who will make huge profit by selling the same at higher prices once home prices would stabilize in next few years. The government needs to maybe form a semi-government agency, a new Navratna, to deal with seized homes and primly located lands. The government may sell minority share, say 20% to 30% of the ownership of the new Navratna, to private investors. Initially the semi-government agency may put these seized homes as rental homes, resulting in constant flow of money to the government coffers, and sell the same to individuals once home prices would stabilize.

The government should make it mandatory that the owner of a property or land anywhere in the country needs to have an aadhaar number or PAN which is to be associated with the property. In the very beginning of action against benami property, the government needs to give three months or six months deadline for the owners of a property or land, to get an aadhaar number or PAN. This will help the government in finding benami properties and also keeping a tab on the properties obtained by illegally obtained money. In the US, the government keeps a tab on income, expenditure and wealth of each and every person as every one has to use his Social Security Number (equivalent to India's PAN or Aadhaar Number) to conduct any financial transaction.

Hence unlike the demonetization, the action against benami property may result in the income of trillions of rupees which the government can spend on welfare schemes and infrastructure, alleviating the large un-employment in un-organized labor sector, created by the demonetization and action against benami property.

Apart from the action against the benami property, the Modi government should make it illegal, to keep 10 lac cash by a firm and a lower amount by an individual without informing the government, to curb the black money market. It can also make it illegal to keep bullion above certain limit.

Additional information