From Cash Driven to Cashless Economy: The detailed analysis of Modi’s surgical strike on Black Money

Unprecedented, that’s the word that came to mind, when our Hon. P M Narendra Modi ji announced his surgical strike on Black Money. It is a surgical strike.  In fact, one the boldest move done to curb the black money menace in the country. The timing is perfect and it is like getting all your pawns in line and giving a Check, and do read to the end, there is a Check-mate too; which we believe will come after this.

The article covers the following:

1. How much money in circulation and is the plan to change the circulation viable in next say 50 days
2. Brief history of demonetization
3. Getting all the ducks in line; a brief overview of all acts leading to today
4. Impact on salaried employees
5. Impact on everyone else from farmers to vendors to real estate developers to jewelers
6. The tax-man will come knocking and what is the expected tax collection
7. De-constructing so-called money washing schemes
8. Impact on economy

(Note: we have purposely avoided all the generic details as they are adequately being forwarded on WhatsApp and readily there on FinMin or RBI website or even on TV channels. Here we talk of real impact and what will happen to the best of our ability)

How much money in circulation and is the plan to change the circulation viable in next say 50 days

Now, everyone is aware the existing Rs. 500 and Rs. 1000 notes shall cease to be legal tender and same should be deposited.

Let’s get to facts first. As per RBI Annual report, there are Rs. 1,663,300 cr., cash in circulation of which 85.3% is in notes of denomination of 500 and 1000. This is huge, as Modi is targeting to replace Rs. 1,418,000 cr., into new notes. So, what is the achievability factor:

1. With just ~50 days to do it, the government has set a target of exchanging Rs. 28,360 cr., per day.
2. Or with ~134,000 bank branches, this works to ~Rs. 21,16,417.91 per day per branch.

Now, the above computation excludes the number of post office available for Exchange.

Brief history of demonetization

Earlier similar act was undertaken by PM Morarji Desai in 1978, wherein at the close of Banking hours, the notes of Rs. 500, Rs. 1000 and Rs. 10,000 stopped being legal tenders. Current act by PM Modi is being compared with that. In fact, arguments are put forth that despite that, black money was created later on; so things will not change much. However, the current process is different wherein you are replacing the entire currency with new tender. So, all kind of original or fake money should come back. In fact, with new printing format, entire fake money in system will be rendered valueless. So, case of that money being used will be off the table. Importantly, there were cases of harassment where people depositing monies in banks where amounts were higher immediately IT officials were called etc., which is not the case now. In fact, there is huge difference in the economy then and economy now. As Lord Meghnad Desai said on TimesNow, this activity should be done every 10 years to ensure such monies are out of system. We will do a more detailed post elaborating the above including the Economic History of India.

Let’s get back to Modi’s Surgical strike.

Getting all the ducks in line

We have done an elaborate piece on Black Money http://tfipost.com/2016/10/black-money-india/

Let’s first see how they brought out the pieces together:

1. Started with Jan Dhan Yojana, wherein unbanked people were first bought into the Indian Banking ecosystem
2. This was aided by Aadhar Seeding and DBT, and losses to the Government were to be curbed by the same
3. Then came online Income Tax redressal, so that harassment by Income Tax officials could be curbed; so honest tax payers or refund seekers would not be troubled
4. Faster refund orders, in fact, this year Refunds of properly filed returns are already out
5. This was followed by a parallel moving of Goods Services Tax and Real Estate Regulation Act
6. Income Disclosure Scheme, wherein people were supposed to declare any income
7. Now, old high value currency notes are withdrawn and fresh monies are to be circulated in.
8. Next move, which will further push the black money based properties is the recent re-vamp in the Benami Properties Act, which was notified in 1^st Nov 2016.

Today’s move is a JOLT towards moving the country to being a cash-less economy.

Important points to ponder are, how does it affect salaried employees?

The salaried employees who are one of the most honest tax payers would be most un affected, these are the guys who use debit/credit card etc. They remain generally unaffected. They may face problems with withdrawing cash which would be Rs. 4000 per day, but that is a minor inconvenience.

Impact on everyone else

As of now, one may deposit whatever cash he or she has in a bank account if he can explain the source. Generally, deposits more than Rs. 2.0 L shall be monitored by Income Tax Department to assess whether the amount is to be treated as income in the current year return. In fact, any businesses or individuals or firms or companies who are able to explain the source of cash are pretty much sheltered. There is no major issue to them. Let’s take a few examples:

1. Say a small shopkeeper, who has done good amount of Diwali sales and is sitting on cash. In a normal scenario, he would have used that cash for further purchases. In fact, his income would have not have been subjected to either Direct tax or Indirect Tax (i.e. VAT). Generally, someone doing Cash Sales of ~Rs. 5.0 L per month is making about ~10% profit on it; so say Rs. 50,000 per month or Rs. 6,00,000 per annum. This or higher amount would have to be declared as income in his Income Tax return. Now, Rs. 5.0L per month is ~Rs. 60.L per annum, so he will be questioned by the authorities about why he has not done a VAT registration. This brings the person in the tax net; increasing overall tax collections.
2. Vegetable vendors would be affected in the short term as there would be a dearth of Change money. Generally middle class families keep monies in cash for domestic expenses which are generally paid in cash. The vendors will find it difficult to sell and they won’t be able to accept the monies. Probably, in urban areas the purchases may shift to Malls. This would be temporary; I repeat. What would be the way out? Pay Rs. 100 or lower denomination.
3. Now, let’s a take an example of company doing turnover of ~Rs. 1 cr., to Rs. 100 cr. These companies generally have cash in their books. In fact, may company have cash ranging from Rs. 5.0 L to Rs. 50.0 L which they withdraw and hold in office or used for cash advances. If the books are in place, there is proper accounting, these companies should be least concerned about the impact. For instance, companies in Facility Management or Manpower supply must have cash as they need to give their workers temporary cash advances. These companies have their labors working in distant regions like on Dams etc., where the access to ATM is difficult; so they give Cash Advance. This money can be easily deposited in the bank account. Consider Infrastructure Company, a small one, which pays to JCB equipment at Rs. 1500 per hour as rent. The transactions are generally in cash. Companies keep record of such cash; and they won’t be having much trouble.
4. Restaurants are places that would be affected as they generally don’t prefer taking credit card. Bigger restaurants are fine, but an overwhelming majority of smaller ones deal in cash. Further, their food purchases from local market are also in cash. They must work around that and pay in cheque or online transfer. If they are honest tax payers, they won’t be in trouble.
5. Farmers selling vegetables at Mandi would face troubles as till date, they preferred cash payment. This was earlier an accepted norm but with the current announcement, paying cash would be difficult and monies must be transferred to bank account. What can happen now is that Farmers would face problems as there is Daily cash limit of Rs. 4000 and they must make purchases either for daily needs or for fertilizers. The farmers who are in the Jan Dhan Bank accounts will see an increased usage, while other will now have to open bank account. Further, farmers generally purchase fertilizers on credit from shops who are happy to comply. It will be a painful process and troublesome to have it via the banking route, but in the long term it will go a long way in bringing them in the overall tax bracket. The spending and purchase which hitherto was not part of the official banking channel will now be accounted for. There is huge transaction level change envisaged here, for example, the Government now plans to make the whole Fertilizer Subsidy under the Direct Benefit Transfer mode or under Aadhar Card linkage. This whole process once in action will change the way Rural Economy performs.
6. Big companies would not be much affected; they generally have their own internal processes; and cash is not preferred. Larger means large listed companies.
7. Real Estate transactions would be the worst hit sector. Real Estate sector can be segregated into three simple sections:
   1. Residential
   2. Commercial i.e. Shops
   3. Land transaction

The residential real estate in cities like Pune or other Tier 1 is more organized, where the purchase of flats by salaried class is via Bank Loans. So, to that extent larger developers are shielded. In other cities, i.e. Tier 2 or non-metros the ratio of Black White ranges from 50:50 i.e. 50% white to 60:40 or even higher where 60% can be black. The transaction or documents happen at something called as Ready Reckoner rate, which are low than actual transactions. These developers would be sitting on cash. Generally, no one would have declared whole lot of it under Income Declaration Scheme. So, now it will come under scrutiny.

The same would apply to commercial units or shops. These kinds of payments in cash are more prevalent in land deals or one-stroke large deals. The cash used by companies for acquiring land would be in trouble today. Let me give you a quick rundown on how things work. Companies cannot acquire agriculture land, so they have agents with cash who acquire land and collate it. Then these lands are converted to NA status again via cash payment and then transferred to company. This is a tedious process and involves huge cash. The entire stash of cash is in risk now. The holder of cash cannot deposit it; it will have to move back to the company. Since, this is off the books cash, the company will find it difficult to deposit in the bank account. This would be double whammy. The current move by Mr. Modi will go a long way in closing this cash based land acquisition. As of now, farmers sitting on cash acquired by land sale would be in trouble and must pay tax on the same.

8. Bureaucrats or Government officers sitting on cash from bribery will be in huge trouble; less said the better.
9. Jewelers are making loads of money. The Gold is being sold at premium as people must dispose their cash. The jewelry sector will see huge revenues. I was already seeing jewelry shops open late night and have heard that jewelers were charging Rs. 2000 to Rs. 4000 premium on existing price.

The Tax-man will come knocking

As of now, there is no limit to people depositing cash. There is news saying that deposits over Rs. 2.0 L shall be monitored and that is natural. The word MONITORED means that what you deposit should be justifiable and you should be paying tax on that related amount in your forthcoming Income Tax returns. So, for example, if you had return of Rs. 12.0 Lakhs last year and now you are depositing Rs. 10 L, probably you should be ready with an explanation, else you are in for trouble from the tax-man.

Already, we are hearing news of people charging for money conversion etc., and jewelers selling gold at premium and market price of gold buying in cash is Rs. 45,000 plus.

Frankly, all said and done, either from YOU or the Jeweler, the money will move to bank and it will come under Formal banking channel. In the Jeweler will end up paying tax on this additional revenue as the cash needs to be deposited in next 50 days. So, whatever fancy schemes people come up with, in the end the money will go the bank, and I am expecting some additional tax collection of ~Rs. 140,382 crore. How did I arrive at this crazy number?

What is estimate of tax collection then?

So, the total banking cash expected to be deposited is Rs. 14,18,000 crore. Of this, say 33% gets taxed as income for people and assuming that only 33% of it is hidden cash (which gets taxed) and actually 66% is JUSTIFIED cash, still taking a tax rate at a lower side of 30%, the government can garner income tax revenue of Rs. 140,382 cr. This amount is still 9% of total tax collection and anything higher than above will be huge.

Deconstructing the money washing scheme

Someone told me, that people are willing to pay 10% to clean off their books. I was like Okay, let me see if I have to deposit Rs. 50,00,000 in account what happens.

Let’s list down the steps and see the government will end up taking loads of tax. Here we go:

1. Someone gives me Rs. 50,00,000 to deposit in my account
2. For me Rs. 50,00,000 is an income or say Revenue.
3. I will have to a reason for Rs. 50,00,000
4. Say I am services company, I will have to charge service tax at 15% which will be Rs. 7,50,000 so total money required will be Rs. 57,50,000 of which Rs. 7,50,000 will go to Government Kitty in first place.
5. Then say I am able to justify that I have 20% Profit margin after all expenses, so my profit amount is Rs. 10,00,000 on which I have pay 30% tax, which works to Rs. 3,00,000. So, this amount needs to be paid to Government kitty.
6. Now, since it’s a sales transaction and I am charging service tax, the other person has to deduct TDS so, on Rs. 50,00,000 he will deduct 10% TDS of Rs. 5,00,000 and pay to government first and I have to pay file a return claiming the differential amount as Refund, which right now will be difficult to get.
7. Now, for providing this service the said company will charge 10% which works to Rs. 5,75,000.
8. What does the guy with Black money get in the end is Rs. 39,25,000 by giving a cash of Rs. 57,50,000.
9. The story does not end here. Since he has given me cash and I have return this Rs. 39,25,000 in some way, which I will either have to withdraw in cash and give or do RTGS.
10. In the end, the money holder makes 68% of his black money or pays 32% in various taxes.

So, technically, money washer will be screwed. There are many other loopholes in this, which people may explore, including trying to transfer money from Hospitals or petrol pumps or jewelers. But, the point is in the end, it will get taxed somewhere. Moreover, if some Petrol pump guy is giving you RTGS, how to justify why you got the money. This is going to be troublesome. Probably, in this scenario, it is better if people had adopted the Income Declaration Scheme and slept peacefully.

Impact on entire economy

There can be temporary slowdown in the GDP growth rate and cash expenditure would be curtailed. Its not that people will eat less onion etc., but there is slow down on account of cash spending in buying white goods, or two wheelers or four wheelers. The construction sector will see temporary setback, as with cash been drained construction activity will be slow. Probably, cement and steel will see slowdown in demand. The next hit sector may be restaurants as they will not be able to accept cash. They will have to either accept credit card or customer have to pay in Rs. 100 notes. It will take three to four months for the monies to stabilize as the currency comes into circulation.

Moreover, as I stated above, there will enhanced tax collection, parallel economy to halt, real estate prices will correct, and more importantly, the Banks will have huge cash deposits. In fact, CASA ratio or CRAR will improve; which will make them better. Further, the fiscal deficit can also come down due to this measure. This is already reflected in the drop in 10 Year Yield today to sub-7% or if I heard it right at 6.7% as quoted by Bloomberg.

All in all, it’s a huge positive for the economy. Further, keep an eye on the changed or updated Benami Property Act, that is going to be next one on the card coupled with RERA (i.e. Real Estate Regulation Act disclosure norms). Modi has really undertaken a major Swach Bharat Abhiyan. Be part of it, it’s a huge Historical moment which will alter the economy for good over the next 10 to 20 years.

On a concluding note, Rs. 14,18,000 cr., of Rs. 500 and Rs. 1000 notes coming back to system can have a multiplier effect on GDP. The ratio of cash in circulation to GDP is ~7.35x for 2015-16. This money coming to banking system and moving can create an additional 0.5x to 1x impact of GDP. At just 0.5x additional GDP boost, we are looking at ~6.8% increase in GDP without doing much, but just bringing the money into system. THIS IS TRULY UNPRECEDENTED.

PS: Today stock market tanked on Trump winning; which was insane. Why insane, US Market is up and we tanked as if, the world came to an end.

Source:

http://finmin.nic.in/172521.pdf

http://finmin.nic.in/172522.pdf

http://www.pmindia.gov.in/en/news_updates/historic-announcements-on-ending-corruption-and-black-money-by-pm/?comment=disable

https://www.rbi.org.in/scripts/AnnualReportPublications.aspx?Id=1181