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Why a higher proportion of cash returning to banks may actually be a sign of success of demonetisation

The window given for regular deposits of old currency notes under demonetisation expired on 30th December 2016. There have been numerous attempts by various commentators to declare the entire demonetisation exercise a failure, but somehow none of these op-eds (which have mostly been short on facts), have cut any ice with the public. Now as the window has ended, a new parameter is being raised to declare that the demonetisation scheme failed.

As reported by Swarajyamag.com, in the last couple of days, some media outlets have run speculative reports claiming that most of the demonetised currency has come back into the banking system. A Bloomberg report said yesterday that Indians have deposited 97 per cent of the demonetised notes till 30 December. Business Standard report claimed that the figure was 94 per cent.

The Indian Express based its post on the Bloomberg’s data and asked whether: “Demonetisation complete failure?” since 97% of the notes came back. No other argument was put forth. Leftist site thewire.in also made similar arguments, albeit with slightly different figures. Firstpost’s Sandipan Sharma too toed a similar line:

But, on current evidence, it seems most of the money may actually end up getting legally tendered in banks, entering the system as white money. Whither kala dhan?

So why do they say that demonetisation has failed since most of the cash has come back into the system? This claim could partly be based on this theory, which was first started by the media itself:

Currency Notes issued by the RBI are RBI’s liabilities to the bearer of the notes. Since due to demonetisation, after 30 December certain notes stop being legal tender, they will no be RBI’s liabilities any more, and a waiver of liabilities would result in an accounting profit for the RBI, which could then be passed on as dividend to the Government of India.

This theory was floated by the likes of the Indian Express, the Economic Times (twice) and also The Hindu Businessline. Many other sites promoted this theory too, but just a sample is being presented.

In early December itself, the RBI had itself stated that it had absolutely no plans to pass on as dividend to the government, the amount of money that does not come back into the system once the deadline of the demonetisation exercise expires on December 30, 2016. This one statement by RBI should have ideally shut up all those who claimed that a higher percentage of notes returning to the system would mean a bigger failure for demonetisation. But then, that would need them to be honest.

The other argument made to show that a higher percentage of money returning to banks is a failure of the scheme is the one placed by the likes of Sharma in Firstpost: “Whither kala dhan”, meaning, if all the money came back into the banks, it means there was no “black money”. The argument is based on the stupid notion that any money deposited into the banks is by default “white”.

The fact though is, “black” money can turn “white” only once you pay taxes on it. As such, all the money deposited in banks will have to be explained by the depositors by showing the source of income (on which tax has already been paid) or, the depositors will have to now pay tax on these deposits. And there in lies the key: contrary to what is being argued, a higher amount of money coming back can actually be good:

1. As explained above, every penny deposited will have to be explained and the appropriate tax on it will have to be paid. The tax can vary from 30% (regular income) to 50% (under the Pradhan Mantri Gareeb Kalyan Yojana) to even upwards of 80% (in case the depositor is caught cheating the tax department)

2. The above is just the one-time gain. There is also a recurring gain. Once a person deposits his cash into the bank, he indirectly alerts the tax department that he is capable of earning that much money over a few years. Take for example a trader who was never filing taxes previously. He now deposits say Rs 25 lakhs in cash into his accounts. Assuming he has accumulated such cash over 5 years, his annual net savings would be Rs 5 lakhs odd, and his annual income could be more than that. Till now, the tax department had no clue that this trader could earn such income. Now they know. And the tax department doesn’t forget. Not only will the trader have to pay tax on Rs 25 lakhs, henceforth, he will be on the radar of the tax department. Assuming that he goes back to his old ways and doesn’t file taxes in the future, now the tax department at least knows about him and knows how to catch him. There can never be any estimate of this recurring incremental tax being earned by the Government.

There are other arguments too, which would debunk this claim by media that a higher amount of cash returned is a sign that demonetisation has failed, for example lower interest rates etc, but these two key factors will have to be kept in mind. End of the day, the cabal which wants to declare demonetisation as a failure will have to work harder in the face of hard facts.

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