Demonetization a success or failure-time will tell

As per the RBI, an estimated Rs.15.28 lakh crore has been deposited as on June 30, 2017 as compared to Rs 15.44 lakh crore in circulation. PM Narendra Modi's decision to cancel the tender of 85% of currency in circulation on 8th November 2016 was greeted with delight in some quarters and anger in others but the overwhelming feeling was one of bewilderment. But we must keep in mind that the Modi government has taken a number of initiatives to root out black money & demonetisation was just one of them. The others are the drive against benami property, GST, the push towards a less-cash economy. One can't analyse or fully appreciate the black money crackdown by only focusing on demonetisation. It is a major move all right but one of the many aimed at rooting out black money.

Critics of demonetization say that that it did not root out black money and the move has failed since all the money has come back. There is one major counter argument to this. The important aspect of demonetisation is not the amount of money that has come back into the banking system. Bear in mind that money doesn't become white just because it is deposited in banks. The money leaves an address, a trail. The depositors become known to bankers and the income tax department. Suppose businessman A had Rs.one crore of illegal money stashed away in his house. He was forced to deposit it in his account but this does not mean he has escaped scrutiny. The tax department can now go after him and unearth his income and financial transactions for the year and demand appropriate tax. Not only that, they can also question his income of previous years' income and demand tax on that. They can go after any benami property he has. There is no escape once you become known as a tax evader.

Thus demonetisation has achieved an important purpose in putting a name tag to every rupee in the banking system. It is up to the individual to match his deposits with his income sources, and he will have to maintain the income flow within reasonable limits in future. Any sudden drop in future incomes would again show up on the income tax radar and the account would be suspected as being used for diverting funds. Bear in mind even if the money is transferred from one entity to other (say purchase of gold at a premium) converting black money into white would require at least one entity to bear the burden of taxes, which is the entity that is depositing the money. In such a case the entity usually pays indirect taxes – excise or service tax -- to show revenue received.

Tax revenue by the central government rose by 18% in FY17 & central excise shot up by 33.9% and service tax collection was up by 20.2% at a time when the economy had come to a virtual standstill.

One more observation is that domestic institutions have been flushed with funds ever since demonetization was announced and even till date the latest rally in equity markets is purely driven by excess liquidity. It maybe a mere co-incidence but it could also be possible that the notes that were previously hoarded in homes & not in circulation is flowing into the equity markets after being deposited into banks.

What is driving liquidity in the markets?

UNION BUDGET 2017-18 – Reviving Demonetized India

Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 9 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.He also manages a portfolio on the online platform Kristal. Find link to the strategy named 'The Tortoise' 

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