Fighting black money: Barking up the wrong tree?

Prime Minister Modi made an election promise to bring back within 100 days the massive amount of black money stashed abroad and give each poor Indian a share of 13 lakhs of this booty.

A few weeks back, as part of this promise, the Modi government made public a few names of Indians charged with illegally keeping money abroad. Despite all the hype over black money, how serious is this fight against black money?

First, there is wide variation in the estimate of black money stashed abroad. Some reports put the figure at US$1.4 trillion stashed in Switzerland. Swiss Bankers Association and the Government of Switzerland claim the total amount held in all Swiss banks by citizens of India is US$2 billion.

Second, many of these accounts held abroad are not necessarily illegal. Non-resident Indians are legally allowed to hold foreign bank accounts for some time even after they return to India. Also, an amount subject to a ceiling of $ 200,000 can be legally taken out each year by an Indian resident through normal banking channels. Even more importantly, by the time the legal proceedings are started against an individual, the person concerned, getting advance tip-off, would be emptying his bank accounts. A case in point is that of horse trader Hasan Ali who is alleged to have a massive amount of $8 billion in his Swiss bank account. Ali was arrested but the account was found to be empty.

The same could very well be the case for many accounts in the list of 627 names recently submitted by the government to Supreme Court for legal investigation.

Third, why would people keep money in Swiss accounts permanently earning some 1 per cent on deposits while the same could earn many times more in India (or some other emerging economies) if brought back to be invested in such countries through a number of legal channels. The typical case would be that money would first be sent abroad using devices like under-invoicing of exports (the under-declared foreign exchange earned would be retained abroad), over-invoicing of imports (the unspent amount of forex would be kept abroad) or some people – like film actors, politicians, and middlemen and agents in international defence purchase contracts — would be earning in forex abroad. No tax is paid in India on these earnings. At the first stage, all these black money may very well be kept in foreign bank accounts. In the next stage, the money would be brought back as legitimate “foreign capital” which gets preferential tax treatment in India.

For example, “foreign investors” can invest in India by buying Participatory Notes (P-notes) issued by FIIs registered with SEBI in India. But the names of the buyers of P-notes need not be disclosed. Hence, Indians having money abroad can easily invest in India as “foreign investors” through this route. Further, if an FII is registered in a tax haven like Mauritius, no tax needs to be paid on capital gains in India because of Double Taxation Avoidance Agreement with such countries.

It turns out to be No-Taxation Anywhere Agreement. So, an Indian investor first evades taxes on the principal sum earned by taking it abroad and subsequently also does not pay any taxes on the investment income earned in Indian stock market. This kind of “round-tripping” of domestic money as foreign investment is fairly common in countries like India and China. To get some idea of the magnitude involved note that some 55 per cent of FII money into India has come through P-notes. Other options to launder black money would be to bring it back as gold imports, NRI bank deposits or remittances from abroad.

P-route investment
Why does not the government stop the P-route investment? A charitable rationale would be that if the P-route is closed by India, this money would then be invested in other countries like China. Under the existing arrangement, even if the government is not earning taxes, at least the supposed benefits of FII money are accruing to India. But on the flip side, this inflow and outflow of FII money impose a cost in terms of increasing the volatility in the secondary stock market and the foreign exchange market. Do benefits outweigh the costs?

If the government is really serious about black money, then it should focus more on the domestic economy where this black money originates and then multiplies. A study by National Institute of Public Finance and Policy (NIPFP) commissioned by UPA-II government (whose report has been kept under wraps by the government) has reportedly put the estimate on black money in India to be around $1.35 trillion. An ASSOCHAM study puts the figure around $ 2 trillion which is the same as India’s current GDP. If we take the amount of black money held by Indians in Swiss banks to be $2 billion (as testified by the Swiss government), then black money stashed in Switzerland amounts to be merely 0.15 per cent of total black money in India and is insignificant in relative terms.

Clearly, a far bigger problem of black money is within India. Most of it originates in land deals, allocation of government contracts and natural resources, capitation fees in higher education and funding political parties and leaders who rampantly spend many times above the ceilings imposed by EC to fight elections and amass huge personal wealth.

Much of this money then gets invested in real estate. The hyped promise to bring back black money from abroad is a convenient way of diverting attention from the real sources of black money and its beneficiaries.

(The writer is a former Professorof Economics, IIM Calcutta)