Prime Minister Narendra Modi's shock announcement to demonetise the Rs 500 and Rs 1,000 currency overnight was primarily aimed at catching those who hoard black and illegitimate money in these denominations off-guard. The sudden announcement and its implementation within four hours of the speech may have prevented flight or conversion of such money into other asset classes, but it has also resulted in a lot of collateral damage.
In the three stories to follow, Business Today examines the cost of the decision to the banking system; how hoarders are devising innovative ways to skirt the ban; and the tax implications for those who would wish to deposit old currency into their bank accounts.
The Cost to Banks
Imagine evacuating old currency notes of Rs 500 and Rs 1,000 from over 200,000 ATMs across the country. Replenishing with new notes of Rs 500, Rs 1,000 and Rs 2,000 is not only a logistical challenge but also involves huge costs for banks. Hassled bankers, already struggling with low credit off-take and deteriorating asset quality, will have to incur these additional costs and at the same time profitably deploy the additional deposits coming their way.
Former finance minister P. Chidambaram was quick to give an estimate of Rs 15,000-20,000 crore for the demonetisation process. The previous government didn't opt for it as the cost-benefit analysis didn't work.
"Economic destabilisation is far worse than any other event that could shake the country," says Melwyn Rego, Managing Director and CEO of Bank of India. While bankers are tight-lipped on the costs and humming that national interest is paramount, they are quietly assessing the costs. The sudden decision has already pushed banks to deploy additional workforce and extend banking hours. "People from corporate and administrative offices have been deployed. The costs would include staff, overtime and logistics (topping up ATMs regularly)," says a banker, on condition of anonymity.
For banks, costs related to ATMs are very different. First, they are making changes in the software of ATMs so that they recognise the new currency notes. Second, they have to evacuate the old notes and dispatch them to the Reserve Bank of India, or RBI, and fill the machines with new notes more frequently due to high demand and absence of high-denomination notes for now. State Bank of India's research department, in a note, has said the RBI and the government have to maintain the ratio of Rs 100 and Rs 500 notes in circulation even after printing the new Rs 2,000 and Rs 500 notes. "Any deviation from the existing proportion will increase the cost of ATM replenishment and cause an incremental increase in ATM transaction costs," says the report. For example, if you withdraw 5,000 from an ATM, you should get one note of Rs 500 and five notes of Rs 100 in both the old and the new system (the rest would be in high-denomination notes - four Rs 1,000 notes earlier and two Rs 2,000 notes now.)
However, the demonetisation has created a new window for banks to get additional deposits from customers. There are estimates of Rs 5-6 lakh crore making its way into the banking system. The bank deposit base is currently Rs 90 lakh crore. The government move is a blessing for bankers as deposit growth for public sector banks, which control 70 per cent banking in India, has slumped to single digits (at 4.6 per cent). It was 15 per cent five years ago.
But experts say the bigger challenge will be to profitably deploy these funds as credit growth is already low due to low capacity utilisation and excess leverage in companies. Otherwise, costs would go up, as interest paid on such deposits would be at least 4 per cent. Some bank executives murmur that the government should ideally compensate them for their cash handling public service.
The estimate for printing cost alone comes out to around Rs 8,000 crore. As per the RBI's latest data, there are some 1,567 crore notes of Rs 500 and 632 crore notes of Rs 1,000 in circulation. The cost of printing is Rs 2.50-3.50 per note. Assuming the additional printing of 632 crore notes of Rs 2,000, the total cost comes out to be Rs 8,000 crore.
Many say the RBI is in a best position to bear the printing cost burden as it would have some surplus left due to shrinking money supply (its liabilities will fall). At present, when the RBI prints currency (part of liabilities as a promise to pay), it also creates an equivalent asset in the form of investments in bonds of the US and Europe. Now, since a lot of notes are being discontinued, a part of it won't come back into the system. There is a strong possibility that the surplus will be transferred to the government for infrastructure investment or capitalisation of banks.
But there is also a view that the Indian economy is primarily a cash economy. The RBI has to create that much currency that was in the system before demonetisation. Otherwise, the economy would choke for want of cash.
Hoodwinked. But, really?
A New Delhi-based proprietor of a mid-sized firm with 150 workers was in for a shock when Prime Minister Narendra Modi announced the demonetisation of 500 and 1,000 rupee notes. He had close to Rs 2 crore unaccounted money with him, all in high-denomination currency. That is when he realised how handy his workers could be.
His idea is to request each worker to deposit Rs 1 lakh in his/her individual bank account. Since deposits below Rs 2.5 lakh will escape scrutiny, and since their salaries were never high enough to bring them in the tax bracket, he hopes he can park his money in their accounts, with an understanding that it will be returned to him, as and when required.
A Vadodara-based real estate developer did not want to take the risk of leaving money with his employees. Instead, he decided to make it official by paying them six months' salary in advance.
Benevolent employers are a common sight after the government's latest crackdown on black money holders. It is perhaps the safest way to launder money in times like these.
Distributing the hoarded unaccounted money is not the only escape route for black money holders who are desperate to get it replaced through banking channels. For businesses adept at creating pre-dated invoices, it is, in fact, time for a kill. Industry watchers say that the rise in prices of bullion, the bull run on commodity exchanges, rise in sale of luxury items, etc, are all signals of transactions that are happening now but invoiced for an earlier date.
Another time-tested money-laundering mechanism involves linking people who have no physical cash but loads of cash on their books with those with loads of unaccounted cash but no legitimate source of income. Income tax practitioners say there are matchmakers who can help you find your partner, with confidential agreements and commissions that will determine the manner of the reverse flow.
People who control the assets and the daily fund flow of pilgrimage centres or private religious institutional trusts may try the unreligious way of getting their high denomination currencies swapped.
If you want a less risky route, you can opt for exchanging your high-denomination currency with a lower-denomination currency. Depending on your urgency, you may get half the value, or even less. A day after the announcement, income tax officers were seen raiding trading hubs across the country to nab people indulging in such practices. But it has hardly had any impact as there are people, in dozens, who are willing to accept your money for a fraction of its value.
For the unscrupulous, there is no dearth of loopholes. It's just that the data mining abilities of the Income Tax Department are also becoming sharper these days. Whatever funds you deposit, through whichever manner, there is a possibility of scrutiny, some day or other.
Even if one does not hear from the I-T department, it does not mean the data discrepancy has not been captured; it only shows the limited manpower of the department. At last count, the I-T department had about 70,000 employees, far less than its sanctioned strength of 120,000.
If you manage to escape the scrutiny, it will be more because of the resource crunch within the I-T Department than your ability to hoodwink it.
Worth a Bonfire
In June 2016, when Prime Minister Narendra Modi warned people to declare their black money under the Income Declaration Scheme or face dire consequences, many would have laughed it off as an empty threat. Over the next few months, as a high-decibel campaign encouraged people to declare their black money, a sizeable majority resolutely stayed away. At the end of the four-month-long scheme, disclosures worth Rs 65,250 crore were made - not a mean figure but a fraction compared to the estimated unaccounted wealth of Rs 16.25 lakh crore.
That majority may well be cursing itself in the light of Modi's decision to demonetise Rs 500 and Rs 1,000 currency notes. With the currencies going out of circulation immediately, the carefully stashed away wealth has turned either worthless or stares at a penalty so hefty that it may as well stay hidden forever.
While you can deposit the old currency in bank accounts till December 30, any transaction in an account in excess of Rs 2.5 lakh will be under the taxman's radar, because it is the standard exempted threshold for income tax. In case of cash deposits of over Rs 10 lakh, the scrutiny will be more severe. If the account holder is not able to justify the source of funds, the entire amount will be treated as evaded for tax. Along with a tax rate of over 30 per cent, a penalty 200 per cent of the tax payable will be imposed, taking the total tax outgo to nearly 95 per cent.
"We have been given strict instructions to monitor high-value transactions and make no exceptions in this case," says a branch manager at a multinational bank at Connaught Place in New Delhi. "There has not been any major transaction till now (2 pm on November 11) but my hunch is people will wait and find ways to circumvent it. We will also keep tabs on transactions from multiple branches and insist on PAN card for deposits."
The window to deposit the worthless currency ends on December 30, while the new currency can be had in exchange of old (up to Rs 4,000 per person) till November 24. Should anybody miss all these deadlines, he or she can go to the RBI in person armed with a declaration and proof of identity. The deadline for that ends on March 31, 2017, beyond which the old currency will well and truly become paper.
Any reform in India generally comes with its own set of loopholes but this time around the government seems to have thought it through and the clampdown looks water-tight. Amid calls for making more exceptions for use of older currency, Finance Minister Arun Jaitley has refused to budge, saying any exception will become another excuse for money laundering. At the same time, Revenue Secretary Hasmukh Adhia has said jewellers and even farmers will be asked questions if their numbers do not tally. Agricultural income is not taxed in India, but there is apprehension that a part of the black money may be laundered as farm income.
"A person buying jewellery has to give his PAN number. Instructions being issued to field authorities to check it with all jewellers. Action to be taken against those jewellers who fail to take PAN numbers from buyers to ensure this requirement is not compromised," tweeted Adhia. "Since farmers' genuine income is not taxable, the farmers should not worry at all in depositing the old currency notes in their accounts. However, the farmer's income should not be disproportionately high compared to the yield expected from the land owned by him," he said.
The government has been at pains to assure the genuine tax payer, small trader, businessman, farmer and the average housewife that they should feel free to deposit money in their accounts and there will be no victimisation. It is presumed the laws of tax computation, prevalent today, will be applied, and enough hints have been dropped that only those with sizeable unaccountable wealth will be hounded.
Faced with the devil in the taxman on one hand and the deep sea of letting the cash rot on the other, the black money hoarder is left with little choice. No wonder sacks full of burnt Rs 500 and Rs 1,000 currency notes were found in Bareilly in Uttar Pradesh. Over the next few weeks and months, this may not remain an isolated case.
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