Modi government has actually worked hard to deliver on black money

After facing severe criticism for its lofty electoral promises on bringing black money to India, Modi sarkar appears to have stuck its neck out on dealing with the issue.

The Modi-led government, running past the two-year mark in office, has taken some calculated risks to go ahead on curbing black money.

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To promote transparency, the government has taken three major steps in the last one year alone: Bringing cash transactions under tax net, cleansing the jewellery bullion market and checking the movement of black money via stock market.

The early reactions to these steps turned out to be financially as well as politically cumbersome, but the government at least did not do a U-turn as in the provindent fund issue. It displayed the courage to grapple with the risks.

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Reserve Bank of India (RBI) statistics released in April 2016 astounded banks and economists alike.

The RBI said the flow of cash had suddenly spiked in the financial system. In technical terms, it is a so-called surge in currency circulation. This is the cash that we keep in our pockets.

By March 20, 2016, the level of cash in the monetary system reached Rs 16.7 trillion, which was Rs 14.8 trillion in March last year. This is an increase of about Rs 2 trillion. In 2015-16, currency circulation grew by up to 15.4 per cent, which was only 10.7 per cent last year.

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Interestingly, from April 2015 to January 2016, a massive increase in withdrawals from ATMs was also witnessed. This deepens the mystery of the cash story.

There was nothing in the economy that could have accounted for this change. Inflation was at its lowest ebb, there was little demand in the market, and the housing and real estate sector was also in deep recession. If this stands, why then are people roaming around laden with cash, particularly at a time when mobile and electronic banking is gaining momentum, and the government is also pushing for delivery of subsidy through the banking system?

Recently, several bankers, including RBI governor Raghuram Rajan, assumed that this surge in currency circulation may have been on account of multiple state elections. However, no empirical data suggests so. This sudden gush of liquidity flow is more likely to be the result of the reduced fungibility of black and white money. This fungibility has broken down thanks to the steps taken by the government over the last year to crack down on black money.

In the last Budget, curbs were placed on cash advances of more than Rs 20,000 on immovable property. Furnishing PAN (Permanent Account Number) details was made compulsory on all purchases and sales of above Rs 1 lakh.

This year in January, Income-Tax department went a step ahead to make PAN details compulsory for transactions of more than Rs 2 lakh from any source, and notified a prison term of seven years for using a wrong PAN number. Along with this, registering PAN details for purchases of jewellery worth more than Rs 2 lakh was also made mandatory.

According to RBI figures, the increase in cash within the system started in November 2015 and reached the highest point in January 2016 by the time curbs on black money were ordered. That means, to escape strict government measures, people got busy hoarding cash since November.

Cash transaction is a major source of turning black money into white. The efforts to stop it are showing considerable results, but some of its initial adverse impact is affecting banks, where deposits fell to the lowest in 50 years. It appears that major part of small and medium business transactions is often conducted outside the banking system.

The government, accepting the risk of falling bank deposits, has kept cash transactions on a tight leash. However, now it is time to encourage bank deposits because banks are facing heavy stress.

In a white paper presented in Parliament in 2010, the UPA government had conceded that a large part of gold, jewellery and bullion trade escaped the oversight of government machinery. This business is the largest destination for black money after real estate in India. Tax rate is at its lowest. When the finance minister announced a one per cent duty on the same in Budget 2016, the purpose was not to generate revenue, but to bring this trade within the ambit of taxation.

A massive strike of bullion traders followed this decision causing extensive political damage because jewellers are traditionally BJP voters. Yet the finance minister not only stood by his decision, but accepted that the rate of tax on gold and silver was unjustifiably low.

As a result of this strict stance, both the buyer (via the PAN rule) and the seller (through excise duty) of gold and silver trade have been brought under the tax net.

The third major decision was taken recently when the government recently reached an understanding with Mauritius and tightened the provisions of agreement on avoiding double taxation, ie DTAA (Double Taxation Avoidance Agreement).

To avoid tax in India, heavy investment in share markets is made via Mauritius, which involves substantial flow of black money. Measures to check treaty shopping and round tripping of money have been lying in limbo for a long while now.

Close on the heels of DTAA review, SEBI made Participatory Notes (P-Notes) less lucrative by seeking increased disclosure requirements and restrictions on transferring the P-Notes. P-Notes are used for investment by Foreign Portfolio Investors (FPIs) in India. The existing P-note system had made it difficult for the regulator to identify the ultimate beneficiary. SEBI’s new norms will allow audit trail to prevent tax leakages.

The decision to make changes in DTAA and P-Notes may temporarily affect investment in share market, but the government seems braced to tackle the risk.

Measures to throttle the parallel economy are less discussed, but are also an important achievement of Modi government's two year rule.

Let us hope the determination is here to stay as the battle with black money is long and complicated, and several economic and political challenges still lie ahead for the government.