There have been lots of discussions around RBI’s latest annual report, with many taking the easy way out and declaring “Demonetization was a big failure”. I had several discussions with my closed friends on this topic and somehow the return of 99% cash to the banks is being looked upon as a failure of this initiative.

My work experience till date has been in the area of detecting money laundering(ML), terrorist financing(TF), tax evasion and related crimes so I am and will always be a huge supporter of this move. This is the reason I was compelled to write a piece and share my thoughts in a simple language, taking my area of expertise as an example to define the benefits.

Basics

Why was demonetization necessary you may ask. India is and has been a cash based economy for long. This makes it quite difficult to detect the flow of funds, identify and detect people/businesses who are tax evaders, detect ML/TF related crimes etc.  One of the prominent ways you can detect such activities is when funds pass through the bank account. Now think in context of India where majority of population does not even care to have a bank account, forget on-line payments. Demonetization forced each an everyone to forcefully go to a bank and get their cash exchanged. This is where the biggest gold mine was struck. All of a sudden the government authorities were able to virtually see all the citizens/businesses net-worth in one go! It does not matter whether 99% of the currency in circulation was exchanged or 100%, the point is everyone, for once, came under the radar of authorities.

Benefits

India is a huge country with 1.25+ billion people. In such a wide range of people, there are a few who did try to cheat the system during the cunrrency exchange period (e.g. get cash exchanged through their maids, drivers etc. or using different acounts). People use such examples to claim the failure of demonetization. Of course no execution is perfect and there are so many opportunities to slip the crack. This does not make the effort worthless. I myself have seen several occasions where things were missed here or there, just because the launderer acted smart for once. But this gives opportunity to course correct and exactly what the govt. of India did. They made so many changes along the way till the deadline for currency exchange. Coming back to the benefits I see:

  1. Widening of tax base: Salaried employees, businesses paying proper taxes and poor people who did not even have enough money to fall in tax bracket had nothing changed for them. However the moment there was a huge surge of cash on a PAN card of your neighbourhood kirana store (general store), he/she would automatically come under tax radar! If they haven’t filed any taxes in the past and during demonetization they converted say 20Lakh (~$31K), it raised suspicion, not only because an individual with such networth did not report their income, but a business (kirana store) which never filed taxes! This is just an example. Imagine how many such cases would have come out from the demonetization.
  2. Identification and closure of Shell companies: I won’t go in details on what Shell companies are as there are some really good write-ups in context of India (West Bengal dominates list of shell firms under scanner OR How shell companies turn black money of India Inc, politicians into white and vice versa). Basically these are companies only on paper, with no existence, where the sole purpose is to move illegal money into mainstream finance world as legitimate cash. Now consider this in context of demonetization. Lots of illegal cash was stashed across such companies which had to be converted (otherwise it would be worthless). The moment cash came out for conversion and hit the banks, real identities of such companies was investigated. This led to a closure of more than 100K shell companies. Just imagine the impact on all those who were using such companies to convert their illegal cash! There are still who complain that rich people/politicians etc. were not standing in queue for converting their cash. Of course, they have better ways to hide, but not after such a huge crack-down!
  3. Increase in suspicious activity reports: Every bank is responsible to identify and detect any suspicious activity related to ML/TF activities, in India and other countries. Imagine the challenge Indian banks face with lots of cash floating around, without hitting their customer accounts! This challenge was overcome in just one single move of demonetization. People who did have accounts and never used them, finally started lining up to convert their cash or deposit their cash in the accounts. This led to a huge surge in activities and a fun time for detection teams at all the banks 🙂  Take for example I have 3 accounts, one each at Axis, ICICI, Yes bank. Now I never used these accounts in last several years. While I opened these accounts, I informed the banks that I am a salaried person with Rs20K a month salary. Now say I have been very corrupt, buying selling properties in black/white and have accumulated 1 Crore (~$157K) in by bank lockers, in my home cupboard, under my trunk 🙂 Now I have to convert this old currency during de-monetization. The moment I deposit these funds in the bank, the bank will start looking into my history. How can a person with a package of 2.4 Lakh/month (20K*12) accumulate such an amount in just 3 years! Hence my account will be analyzed and reported to the authorities. As simple as that. I don’t have exact numbers but found the below graphic from someone on Twitter on the suspicious activity reported, compared to previous years. There can be no benefit better than this in my opinion!
  4. Crackdown on Hawala:
    Copyright Taru Bakshi (posted https://www.slideshare.net/TaruBakshi/indian-money-at-swiss-banks)

    This is not a new term. If you have been living in a cave then this is a good refresher for you on Hawala 🙂 Indeed they have found new ways after demonetization but on and nearer to Nov 8th,2016 they were hit very hard! This exchange works on hoarding cash at two ends with the hawala operators (without any actual transfers). Imagine the “pain” these operators and their customers would have gone through when in one stroke all that cash was made invalid! This was one of the best by products (in terms of benefit) from this exercise.

  5. Move towards digitization: After demonetization, all of a sudden, Indian people realized (or were forced to realize) the benefit of online payments, purchases, transactions etc. BHIM app, PayTM kind of services started getting more reach. People have become much aware of the benefits of e-wallet. This is a slow but gradual process and will take some time. I work in Netherlands and many a times pay even 50 cents using a card (I never carry cash). Sweden is moving towards becoming a fully cashless society. I hope one day India reaches that stage too. Apart from all other benefits, the biggest blow will be to corruption and illegal/underground economy.
  6. Slashing of fake currency and network: This is a mixed one for me too.  Of course the idea was that only genuine currency would end up in the bank and most fake ones will be destroyed. With reports that 99% was indeed returned, on the face of it, this does not look like a good move. However it was a huge setback to the fake currency providers nonetheless. All their investments to publish fake currency went for a toss in just one go! They had to re-invent the wheel (which is not impossible I assume) but the shock to this network was good enough to be counted as a benefit.

What may come next

Recently RBI released a new 50 and 200 notes. Introducing 2000 was not such a great move, however filling the void created by 1000 was necessary. I hope going forward 2000  and 500 notes are also invalidated so that our economy is only dependant on lower currency bills. Such kind of move to enforce smaller bills will demotivate hoarders of black economy as you will need a huge storage space 🙂

Conclusion

Go through this brief report from the Ministry of Finance where they state the benefits. Indeed 99% of the cash was returned (or may be 100%), this does not mean the whole exercise was a flop. It would have been wrong if the govt. of the day and relevant authorities would not have followed-up all red-flags raised by this move. Looking at the news reports this is not the case and people/companies are being chased. For once let’s appreciate this move and hope this is followed-up with even more crack-down.

P.S. If you are on Twitter and not following @ED_Dir, do so and see how they are cracking down recently!