Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial

Dirty Money Is Not Just Black

(From my column at Yahoo!)

We complain about black money. For most of us, black money is money in suitcases, printed notes of currency. We imagine that there are huge stashes of currency in politicians’ houses, that industrialists are, quite literally, rolling in the stuff. Our new-age yoga enhanced civil society members even demand that we should stop the use of Rs. 500 and Rs. 1000 notes because they help corruption.

And I say that at a macro level, we should be more worried about white money.

Because RBI’s statistics — they release this every week — say that the total amount of rupees in notes printed is about Rs. 10 lakh crores. Our GDP is about 80 lakh crores. Even if 30% of the total money printed was being hoarded as black money, it’s about 4% of GDP. This is not small; but I argue that this is not big enough. I mean there is much more illegal money out there than 4% of GDP. And that also means the black money is being laundered into white money quite easily.

From doctors to lawyers to small hotels to vegetable vendors, there is a large amount of cash exchanged.  Some of these merchants keep the money in cash, and refuse to declare them, thus creating black money. Many buy property, transferring money to the uber-rich, who can now launder the money.

At the really big money level, laundering money isn’t very difficult. First, the cash generated is sent out of the country through hawala, which involves calling someone who says give cash to person X and we’ll deliver dollars to person Y. Once it’s offshore, it’s brought back in, in various ways. Since Switzerland, till recently, didn’t ask too many questions, a lot of money went into Swiss banks (and banks in Dubai and other not-so-cooperative countries).

Then some of it was channeled back to India as "FII" —a foreign institutional investor – money, back into the Indian equity markets. There are then numerous ways to use that money to pump up the stock price or otherwise distribute the money in the "white" channel. In 2007, when SEBI and the RBI expressed their desire to curb such investments by demanding more details of the eventual source, the markets tanked 10% and hit the lower circuit the next day. SEBI clarified that the restrictions would apply only after 18 months and everything went back on track.

Why does equity investing become attractive? Equity investing is tax free if you hold the money for over a year. Also, for short term money,  FIIs also use the Mauritius route to come into India, and because of a Double Taxation Avoidance Treaty, India doesn’t tax such entities — and it turns out that Mauritius doesn’t either. No tax means a great opportunity to launder money; the only problem with black money is that no tax is paid on it.

(If a minister is paid the highest ever rental for any commercial property at the time, that seems to be ok. Because he’ll pay tax on it. Or so it seems.)

Special Economic Zones (SEZs) for instance, pay no tax. So all one has to do is set up an SEZ in India, and then send money in from abroad against an invoice. When software exports were tax-free, money was laundered there. Now with the Minimum Alternate Tax (MAT) reaching 20%, this avenue is less useful.

Agricultural income is tax free, so within some limits, there is "income" generated there. You can’t really question a farmer about why he ended up selling SO many coconuts, can you? But this avenue is not open to most of us anymore, especially not to film-stars.

The answer isn’t to ban high denomination notes. The answer is to take serious action against the laundering of black money. We need to question the source of any money coming to India, especially FII money — if they’re not willing to reveal details, tell them to go away.

We also need to remove all tax-free concepts, including agricultural income, SEZs and Equity investing (the last one is going away next year). NGOs that get income tax exemptions need to be monitored very closely; they are another way to turn taxable income into "tax-free" money.

Since this will inconvenience actual users or farmers, introduce an upper limit — say 10 lakhs a year of profit — below which the tax-free rules continue to apply. There is absolutely no need to keep things tax-free after you’ve crossed a certain profit limit, even if you wanted to encourage industry. (Stop when it’s encouraged!)

We must absolutely bring back the illegal wealth stashed abroad; but it’s complicated to figure out how. Does Swiss bank money of people who are now abroad not be brought back? Does a person of Italian origin, who can move money to family in Italy, then qualify as not having black money? Does one give legitimate income — from investing in India through FIIs — thumbs up, simply because we aren’t able to prove that the original money, years back, was really black money? Or do we go to the other extreme, and say that all money is black unless proved to be white? The "proof" will take years of court process to prove, no one will get access to the money, except the people in power.

But we don’t have an alternative right now — set up a mechanism to query every single account that has money owned by Indian residents, and question their sources. In fact, find out who have recently transferred OUT their money out of fear of such an investigation, and question them even more.

We need to pick up enforcement of laws against the conversion of black money to white. I have no doubt that we are generating far more than 4% of our GDP in black money — but the figures show that the money doesn’t stay black; there is an efficient, functioning system that helps launder the money. We can get to that system and arrest the kingpins — it’s an open secret now — but we simply choose not to. Our fight against corruption must open this can of worms.

Banning the Rs. 500 note will only create problem for small businesses like vegetable vendors who have to carry cash around to buy things. It will create no problems for corruption — because the corrupt will still use cash and quickly convert that cash to white money. Banning such notes is the equivalent of the security theater we see in malls, where it seems the terrorist code of conduct is that you hide your bombs only in the boot or under the car’s hood, nowhere else. Effectively a Rs. 500 note ban does nothing to deter corruption, but inconveniences normal people. In fact, it’s better to probe every real estate sale in the last three years — there is surely more cash exchanged illegally there than in any other transaction. The money trail will reveal, in double-quick time, that the money gets whitened very fast.

We’re enraged about the colour of money, but the area is, in the most unfortunate pun ever intended, grey.

More Yahoo Columns:

  • Adil Fanaskar says:

    Excellent article ” Dirty Money Is Not Just Black”…!!!

  • Neeraj says:

    Dear Deepak,
    I have been following you for quiet sometime now and you really write well. But your view on not changing the Rs.500 notes is not correct.
    Please read through the reasons that BABA RAMDEV has given… Also if you need to bribe a officer or anybody.. it becomes very difficult to bribe giving small notes of R.50 or Rs.100… The 500 and 1000 rupee note is really encouraging corruption at a micro level also..

    • Sorry, but I disagree. I don’t use the 1000 rupee much, but the 500 is really useful to carry nearly a month of grocery shopping worth in my pocket. You can’t throw out the baby with the bath water. Until small shops start accepting payments through cheques or cards or such, until we have reduced KYC norms to help such people get accounts and card swipers, and until we can ensure that the system isn’t alienating the small shop owner from using the bankign system, till that time cash is a necessity.
      Do you pay your own maid by cheque? Can you? Can you help her get a bank account? Otherwise you will probably end up paying her in cash. Say she works in four houses and gets about Rs. 6,000 per month. You would rather pay her in Rs. 100 notes? That is sixty notes that she must carry – a neat bundle, and quite prime for a mugging, don’t you think? With money this cheap, everyone needs to pay more, and when you pay more you can’t have the same small denomination notes. Want to stop corruption? Reduce the inflationary cost, ask the RBI to stop buying dollars and rapidly reduce the amount of money in the system – then the 500 rupee note will not even be necessary. Don’t ban the note now!
      Does Ramdev pay his people in cheques (or through bank accounts?) I think you’ll be hard pressed to find them not using the 500 rupee note – yet, they will inconvenience themselves. The corruption at the highest order is not in notes – it’s in actual money transfers using the banking system, like we saw with Shahid Balwa and Anil Ambani and Raja and DMK. They transferred 200+ cr. through the banks only, for a bribe. Corruption in large chunks happens outside of the cash system – and I mention that as a statistic as well – the amount of “cash” that’s idle as black money stuffed in mattresses is very little compared to other things nowadays

  • Manu says:

    May be you like to check this out..

  • Manu says:

    Reasons to Ban Currency Notes of Rs.500 and Rs 1000 in India Effects of Ban on Currency notes of Rs. 500 and 1000.
    Reasons to Ban Currency Notes of Rs.500 and Rs 1000 in India
    Effects of Ban on Currency notes of Rs. 500 and 1000.
    Yes it is possible to ban Currency notes of Rs. 1000 and Rs.500.
    Yes it is the necessity to ban Currency notes of Rs. 1000 and Rs.500 in India.
    Currently how the total Indian currency is divided?
    1. Rs.100 Notes = 23%
    2. Rs.500 notes = 44%
    3. Rs.1000 notes = 24%
    Notes of 100,500 and1000 Rs. account for 93% of the Total Currency Money.
    Fake currency notes are also found only in the currency notes of Rs.500 and Rs. 1000.
    As per media reports currently fake currency in circulation in India is more than Rs 1,69,000 to 200,000 Crore.Please know that Reserve Bank of India has no power to ban the currency notes of 500 and 1000.
    Only government of India is allowed to ban the currency notes.
    Only government of India got power to ban the currency notes.
    The central bank only prints currency notes, denominations are decided by the government,”.Government of India Reports says that 70% Indians earn daily Rs.20.
    If someone is earning Rs.20 daily then he must be spending Rs.20 daily.
    I assume that if any Indian is earning Rs.100 daily then also he can spend daily Rs.100.
    What is the meaning per capita income?
    What is the definition of Per capita income?
    Per capita income is calculated by evenly dividing the national income among the country’s population.
    Per capita income – income per person in a population
    Per capita income is often used to measure a country’s standard of living.
    Now Know the Per Capita Income of few countries
    1. per capita income of US is 40000$
    2. per capita income of UK is 20000£
    3. per capita income of Japan is 40,00,000¥
    4. Per capita income of India is projected to grow by 17.3 per cent to Rs 54,527 in 2010-11 from Rs 46,492 in the year-ago period. Currently Per capita income of India is Rs.46, 492. Per capita income (at 2004-05 prices) stood at Rs 36,003 in FY 2011 against Rs 33,731 in the previous fiscal, according to the latest data on national income. Official data released on Feb.7 2011.
    5. Per capita income of India in US dollars will be $ 1041.6321 as per conversion rate June 8, 2011. INR Rs. 46, 492 = US $ 1041.6321
    Divide Per capita income with highest denominator note and you will find the magic number and magic number for US is 400, UK is 400 and Japan is 400 and India is 37.
    India needs to get the magic number 400.
    Now what is the highest currency denominator in USA, UK and India?
    1. USA highest currency denominator is $ 100 and Per capita income is 40000$
    2. UK highest currency denominator is 50£ and per capita income is 20000£
    3. India Highest currency denominator is Rs. 1000 and per capita income is $ 1041 or INR Rs. 46, 492
    Now do you see that ratio of Per capita income and highest denominator currency?
    1. USA = 40,000 $ = highest currency note 100$
    2. India = 1041 $ = highest currency note is INR Rs 1000 = 22.409 $
    When highest denominator note is 100$ what is the per capita income?
    Per capita income is 40,000 $
    In other language when per capita income is 40,000$ what should be the highest denominator note?
    It is 100$
    Now divide 40,000 by 100 it will be 400.
    Now what is the per capita income of India it is $ 1041
    Then what should be the highest denominator note for India.
    40 000 = 100
    1041 =?
    The answer is 2.60$ should be the highest denominator note for India.
    100 Rs. = US $ 2.24 – As per Conversion rate on June 8, 2011
    1041 multiply 100 = 104100
    Now divide it with 40,000 it will be 2.60%
    Now same way if you will find different nations you will come to know that
    Their ratio of per capita income to highest denominator currency is 400.
    For UK magic number is 400
    For Japan magic number is 400.
    Not exactly 400 but it will be near to that in every developed country.
    Thus India does not need the currency notes of more than Rs.100.
    Today in India when we read about corruption amounts and fake currency notes found the number is in Crores always.
    Did you ever heard that fake currency notes of 50 and 100 found in Crores of Rs?
    Did you ever heard that bribe of Rs.1 Crore given in notes of Rs.50 and 100 notes?
    These types of cases are rare I have never heard or read about this.
    I am not here writing how the corruption happens in India.
    Every one knows when corruption happens corrupt people use currency notes of Rs. 500 and 1000
    To give bribe everyone knows that currency notes of Rs. 500 and 1000 are used.
    What will happen if suddenly Government of India bans Rs.500 and Rs.1000 notes?
    Nothing will happen for few days people will find it very difficult to do business.
    To gain something one has to suffer the pain also.
    In developed nations 90% transactions happen through banking system.
    In India only 20% transactions happen through banking system.
    Today why no one is interested in the development of banking system of India?
    The reason is easy access to high denomination notes.
    Once we will ban these notes village people will also demand open the banks in our area.
    All the banks will see the growth opportunities in village and they will start to open banks in villages.
    If you will ask any economist if he will tell you that good country is one where all the transactions happen through banking system.
    Keeping poor people out of banking system is not good sign for any country.
    I think that presence of high value notes in any country is the sign of corrupt country and corrupt culture and corrupt politicians.
    Do you know that America also banned the high denomination notes in America in year 1969?
    Year 1969 America banned High value notes to stop corruption.
    America became the very corrupt country. The criminals, mafia dons and white collar criminals took full control of American economy.
    That time American banking system was not developed.
    All the transactions happened in Cash using notes of $ 500, 1000, 5000, 10000 including one lakh dollar note.
    American population citizens were suffering because of corruption of politicians and mafia and white collar criminals.
    In this situation President Richard Nixon took the bold step.
    He did what no one expected.
    In year 1969 President Nixon withdrew all the notes of higher than 100$
    It was a great blow to corrupt people; this started the development of American banking system also.
    American people found it very difficult to shift suddenly but to get something one has to suffer the pain also.
    White collar criminals and politicians found it very difficult to accept bribes and do the corruption this it helped to reduce the corruption in America also.
    As the notes of higher denomination were banned, baking system started to develop very fast in USA.
    Now when we will ban the Notes of Rs.500 and Rs.1000 common citizens of India will face the problems for few months, but they will get used to banking system.
    Government will be forced to develop our banking system in India.
    Always remember purpose of Rs.500 and Rs.1000 notes is nothing but to develop black economy in India.
    To take and give bribe, to do corruption.
    Do you want Corrupt India or Honest India?
    What America can do it why we Indians can not do it?
    Demand and Support ban.
    Ban Rs.500 and Rs.1000 notes in India.
    And start a journey towards Honest India.

    • Thanks Manu. First, where is the source of this information – i.e. that 100 Rs. notes are x percentage and 500 rs. notes are y percentage? Thanks.
      Second, India’s per capita income is $3280 according to purchasing power parity, which is more relevant. What costs $1 in the US may not cost the same here, which is why PPP comes in). A 1/400 relationship of that is around $8 or such; but that is not the point. You’re right, but that forgets that most of the Indian spending and income is in the cities where the per-capital is likely to be >$4000 per year. For that, the Rs. 500 note is perfect as an upper limit. (I don’t use 1,000 rupee notes, so I don’t care if those are banned)
      You talk about per-capita income ratios. The US per capita GDP in 1969 was $21,000. (This is when the $500 note was banned) The $100 was 0.5% of that. Our per capita GDP is Rs. 46,000. The Rs. 500 is 1% of that. It’s not very different. (We could use a Rs. 300 note perhaps)
      The issue’s also that in the US most people pay everything by cards or cheques. In India we don’t – we can’t pay our grocers or maids or guards by cheque, and we talk about banning notes. If each of us makes an effort we can reduce our dependance on Rs. 500 notes, and then I don’t care, ban them. I think we need to open up financial inclusion and banking anyhow. But why would you do it when you will hurt mostly normal people’s lives, and not change any corruption (believe me, the corrupt can easily continue even with Rs. 100 notes).

  • Siddharth says:

    I reckon it costs Rs10 for a vada pav. so for Rs500 you get only 50.
    Now thats inflation and value of Rs500.
    Yes its easy target for fake note mafia, et al to circulate these Rs500 notes. But then wheres the action on the culprits? Have we not seen the stamp paper (telagi) scam wich ran into many thousands of crores!
    I would say its utter nonsence to ban Rs500 as its a huge inconvenience for most common public.

  • Px says:

    The way inflation is mounting on a common man, one cannot do without the Rs 500 note (raja pakistani or the note most counterfeited by the is. and marketed by the d gang)
    Deepak ur absolutely right 500 note is now indispensable. The Rs 100 note is the new 10.
    One needs to carry 500 if one wants to do 3 days to a weeks worth of grocery shopping for a family…
    The question is how long will it take this govt and crazy inflation to make the Rs 1000 note indispensable?

  • Walter says:

    Dear Deepak
    I recently say a note on you blog on a NGO named oxfam. U mentioned that its spending more on fundraising than on implementation. there are few other who are spending more than that on staff salary especially on directors and top level executives rather than implementation. Also they are spending on lavish meetings and trips, Couple of them are Leprosy mission & World Vision. why can’t you do a research on these orgs also as u will get more masala in these org as these are religion based orgs

  • ramprasad says:

    Mr. Deepak , this is a poor justification that “I will be inconvenienced , so don’t ban 500 rupee notes”
    Most of the countrymen don’t see that kind of money.
    If transacting a large amount in cash people would be forced to use bank transfers, or plastic. That will automatically make it difficult to hide income.

  • Aditya Nalapat says:

    So what Mr Deepak Shenoy says is that black money is no longer stored in politicians houses, an hawala transactions resulted in black money pouring out of the country an returning to India. For Discussion sake , would it not be that much harder to carry out these transactions in a situation where high denomination currency is not available. In a hawala transaction, high denomination currency is maintained in both countries. Outward remmitances and inward remmitances are netted off. But in both countries hard cash is required for these transactions. When you ask a hawala operator to transfer 50 million to another country and you provide him a truckload of 100 ruppee bills, this would be an immediate threat to his business. Imagine ten such transactions. My knowledge on these transactions are based on what i have read and heard, do correct me if i’m wrong.

    • Aditya, hawala has existed when 500 rupee notes didn’t exist. To tackle corruption we have remove sources, not remove the method. That means if terrorists are using the telephone, the suggestion is to ban the telephone. Sure, it will remove telephone talking terrorists, but they’ll find other ways to communicate! And it’ll inconvenience everyone else.
      It’s not much harder to be corrupt with 100 rupee notes, if the idea is really to be corrupt. You have to stop sources, and by that I mean investigate real estate transactions, absolutely crush offenders, and so on. This banning notes isn’t going to help – all it will do is inconvenience everyone.
      Today, to buy groceries, I might spend Rs. 2000 a fortnight. That’s pretty much the situation with any middle class family. The merchants don’t carry card machines, so I need cash. 8 notes (Rs. 500 x 3 + Rs. 100×5) are convenient. 20 notes of Rs. 100 are not. And many families spend Rs. 3,000 (mine’s a small one) at a time, in the wholesale markets. All you will do with banning Rs. 500 notes is to make life inconvenient for most.

      • Aditya Nalapat says:

        Nice to see a reply so fast at 1 AM. I think a lot of people are scared of the baba’s ideology and in no way do i support it. He uses the word Ban. That means a sudden change, one that no one is ready for. I believe its a process. One i would describe a progress, that is to get more people to embrace banking in the years to come. If we succeed in ten years, maybe we would be in better position to plug a loophole. A banking system has several advantages and to some extent if not all thwart corruption. It would make paying bribes on land deals harder. (Once again you ask , making it harder does not help cure the idea of crime, but crime is inherant in the human race, we could hope that we all turn saints, till then lets tighten the controls)
        I would love to stop sources. That requires regulators, an we’re all looking for that secret formula to keep our regulators from getting corrupt, and it lies in the process, stricter controls, more reliance on banking is one of those controls, why not work towards it ?

  • Aditya Nalapat says:

    And to talk about convenience , no one is expecting a revolution in a day. An operation involving elimination of high value currency would require an ALMOST 100% banking situation. This means anyone earning any income that would be difficult to be paid in 100 ruppee notes must have a bank account. This will include your maid, but not the beggar on the street. Although the thought of your maid being able to operate a bank account may seem preposterous, keeping a realistic ten year target to achieve the objective would not sound so. We achieved a green revolution in five years, in ten this seems achievable. Security must be developed as well. We may be inconvinienced at first, but you will find shopping with a card when you need something costing above Rs 500, or direct debit through your mobile banking is quite convenient , even for transactions in the nearby chaat shop. My view , if not to fight corruption moving towards better use of banking is a step for progress and we should work towards it..

  • Aditya Nalapat says:

    “The corruption at the highest order is not in notes – it’s in actual money transfers using the banking system, like we saw with Shahid Balwa and Anil Ambani and Raja and DMK. They transferred 200+ cr. through the banks only, for a bribe. ”
    In response to the above statement, moving towards a greater banking system would only help plug one of the wholes. When transactions in the nature of bribe occur through banking channels, they are easier to trace. The 2g scam actually proves this. How do we stop this from happening. That by itself is another issue completely. I feel it requires a very high level of transparency is required to deal with corruption of this sort. The fact that it took so long for the first come first serve policy of the govt to be unearthed. An ideology which i believe in is that a government is different from a company and its reporting requirements cannot be the same as that of a company. Unlike a company you cannot measure a governments success with a profit figure. That means merely reporting at the end of the year is meaningless. That is why corruption flourishes more in the government than in a corporate. Better transperancy ? I feel the government should have its entire accounts available online, right down to its tea and coffee voucher scanned and uploaded. It may be hard to visualise, again a ten year target sounds practical. For one thing we dont have to wait for the CAG to audit the accounts at the end of the year. The 2G scam may not have been given any breathing space to happen. And kalmadi would have had to toe the line and we the people need not have hung our heads in shame before the world !

  • I have suggested, in the past, about a drive to pay maids through a cheque. I even tried to get my maid a bank account. Not possible. Why? Because of tough KYC rules. These people don’t have an address proof, nothing that is “acceptable”. After months of trying, we have finally got our security guards bank accounts by giving a letter from the association, and now they get paid by cheque.
    Preposterous is fine, but someone needs to come here and work on the ground to see the problem. The fantasy of universal banking is not going to happen by decree; you have to solve these problems, and regardless of large notes banning, it’s a better goal to get all these people in the banking system. And it’s not just banking – there’s NPS Lite for retirement, small ticket insurance from insurers, small ticket mutual fund investments, the works. We have a ton of products but very few takers because they simply don’t know.
    Oh, btw, the fin min, in the economic survey mentioned this as one of the causes for inflation – that is, when poor people start putting their savings into the system, it causes a big jump in money supply, and that causes some inflation. That’s an interesting side effect but it’s no big deal really because all the RBI has to do is sell dollars, get rupees and remove them from the system. Unfortunately, the RBI doesn’t have the gumption to do that.

    • Aditya Nalapat says:

      I’ll agree with you on this. Its hard to get a bank account if you only have small savings. Address proof is hard to come by. All said and done, many nationalized banks do accept letters from the employers. Universal banking and cashless society are definitely theoretical. But ever since the green revolution happened, i believe that , even in our country things can happen and its not just my mindless positiveness. I have always thought about using two politically polar states to compete on a goal such as this. Media could play a role. Visualize Maharashtra and Gujarat competing to improve their banking coverage. Sometimes all it takes to get a job done is to play on people’s ego and pride.

  • dinesh kumar mishra says:

    The idea of stopping use of Rs. 1000 and Rs 500 notes is wonderful. If the average income of an urban corrupt officer is considered as Rs. 40,000.00 per month . He shall spend Rs. 6-7000 on children education, 12-15000 on rent, 7-8000 on car /transport, 5-6000 on grocery items, 2000 on electricity, 500 on gas, 1000 on entertainment, 2000 on milk, 2000 on vegetables , there remains no money for any other activity.Now the average black money earned by him is around Rs. 20000 (It may be legal but not accounted for) which gives him strength to be able to move with other members of the society.
    Out of the total monthly requirement rent,electricity,education fee,car loan repayment and other things can be paid by cards or through bank.Only milkman and vegetable seller has to be paid in cash, which is possible with 100 re note.
    A property sold in Rs. 1 cr is registered at a value of Rs. 20 Lacs ,rest of money is paid in 1000/500 Rs note. This type of false values will come down immediately if the two high denomination notes are stopped.