Why PM Narendra Modi’s move will lead to disruption than economic benefit

Stamping out black money in the economy is a noble goal.

But demonetisation of Rs 500 and Rs 1,000 notes will cause huge disruption, push up the demand for gold and dollars as safe stores of wealth, give a big boost to e-wallets and credit cards and, most significantly, send into disarray the finances of all political parties that had filled their war chests with cash to fight the Uttar Pradesh elections and had no clue about the demonetisation move in the offing.

It will inconvenience small traders and businessmen across the hinterland, where the reach of the modern banking system is yet rudimentary. Will it put an end to black money? Hardly.

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People with large amounts of black money would convert it into gold and foreign currency, happily incurring the conversion costs this would entail, both when rupees are converted into precious metals or dollars and when these are converted back into rupees. The real way to stamp out black money is to disincentivise fresh generation and clean up political funding.

Political parties spend thousands of crore rupees on their campaigns and rallies but declare only a few hundred crore rupees of income. The bulk of their income and spending are not accounted for.

To supply that money, businessmen have to generate black money, through overinvoicing of project costs and imports and other such means.

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Implementation of the goods and services tax would create multiple audit trails that lead to a unified database of production and income. Much of real estate still remains outside the ambit of the formal economy, and will stay like that till a system of registering land is instituted, in which the ownership of every bit of land is entered into a central registry maintained and guaranteed by the government.

Once benami holdings become impossible, black money would become more difficult to maintain. Till then, measures like demonetising currency in an economy like India where more than 80 per cent of all transactions are in cash will serve more to disrupt economic life and to disarm political rivals than to curb black money.

(This piece appeared as an editorial opinion in the print edition of The Economic Times)