India’s underground economy

Black money has come into sharp focus recently with the government handing over the names of 627 Indians believed to be holding untaxed cash in foreign bank accounts.

Global Financial Integrity, a Washington-based group that tracks money transfers, said Indians surreptitiously shifted $344 billion overseas between 2002 and 2011, depriving India of vital tax revenues. Tsering Topgyal / AP Photo
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The shadow economy in Mumbai is so rampant it is hard to imagine the city functioning without it.

From developers asking for under-the-table part payments in cash for properties, customers in jewellery shops seen handing over huge wads of rupees, street traders who will exchange money at rates that beat the banks, to bribes being paid left, right and centre. Such dealings involving so-called “black money” are all commonplace and part of India’s rich parallel economy.

Black money has come into sharp focus recently with the government handing over the names of 627 Indians believed to be holding untaxed cash in foreign bank accounts. Narendra Modi, India’s prime minister, has promised to recover all of India’s money illegally stashed overseas, estimated to run into hundreds of billions of dollars, so the funds can be used to support the country’s poor. But the issue is not purely about wealthy Indians hiding money from the taxman in Swiss bank accounts; it runs much deeper, pervading all levels of Indian society and having a dramatic impact on the country’s economic trends.

The definition of black money is income obtained illegally or on which taxes due have not been paid.

“India generates a lot of black money due to high rates of marginal taxation that prevailed in the past; a large cash economy due to an undeveloped financial sector; stringent foreign exchange regulations in the past and corruption and money from bribes and kickbacks which cannot be accounted,” says Kamal Sen, the president and chief executive of Cogitaas, a consultancy that specialises in strategy and planning. “There are various tax havens across the world and they enable black money to be held abroad, usually in international currencies, but there is enough black money likely held in India, too.”

It is difficult to put a figure on how much India’s black economy is worth, with estimates varying wildly between 25 per cent and 75 per cent of the country’s GDP, says Aparajita Basak, the manager for Frost & Sullivan’s research analytics, innovation and knowledge centre.

“Construction, real estate, mining and higher education drive this underground economy, although participants across all sectors contribute through over-invoicing and trade-based money laundering activities,” says Ms Basak. “While less than a tenth of the total black economy is located offshore, the bulk of it lies within the country and affects everyday life through changing consumption and savings patterns.”

As part of this shadow economy, the cash flows into a variety of assets, she adds.

“Savings are flowing into opaque assets such as gold and real estate at the expense of formal financial instruments such as bank deposits. Consumption of luxury goods and services including jewellery, vacations and holiday homes have shot up. Meanwhile, companies are known to use a complex web of anonymous shell companies to re-route tax-free earnings back into the country.”

Black money has a significant effect on all Indians as it impacts prices in the country as well as widen the gap between the rich and the poor.

“The flow of black money into the system increases the supply of money and pushes up the prices of daily consumable products as well as assets such as real estate to higher levels,” says Ms Basak.

A report commissioned by the previous government and accessed by The Hindu, an Indian newspaper, reportedly estimated the black economy could amount to almost 75 per cent of GDP, and includes cash in India and hidden abroad by Indians.

“A lot of Indians put their money into gold because the money comes from criminal activities or they just don’t want the cash to go through the banks and get taxed,” a jeweller based in south Mumbai says, requesting anonymity.

India’s property market plays a major role in hiding India’s black money.

“In India, real estate has no doubt been the most preferred parking place for unaccounted-for money after the option to park it abroad in Swiss bank accounts,” says Anuj Puri, the chairman and country head of the property consulant JLL India. “Apart from being criminal, this trend is one of the main causes for unwholesome price trends in the real estate sector – and a serious loss of revenue for the exchequer.”

There are many loopholes that need to be closed, Mr Puri says, but he hastens to add there are some signs of improvement.

“It would be wrong to say that measures against corruption are not being taken. The scams and financial irregularities that have plagued the sector in recent years did put the spotlight on some serious regulatory lacunae [gaps] and the authorities are seriously cracking down. Today, more and more developers are adopting the new mantra offering completely transparent deals and shunning black money deals altogether.”

Control Risks, a global risk consultancy, says India’s property market is “cash-heavy and can sometimes be associated with hawala money”.

Hawala money is transferred through a third party outside the formal banking system.

It has a long history in India and “forms a large part of the country’s informal or ‘underground’ economy”, according to Control Risks. But the “system is illegal and associated with money-laundering and tax avoidance”.

“Black money starves India of much-needed investment – even a conservative estimate of the losses India incurs would be eye-watering,” says James Owen, the director for India and South Asia business intelligence, compliance and investigations at Control Risks. “The political will to tackle the problem has never been stronger: the new government has prioritised the problem from day one. But time will only tell as to how successful the government can be in its attempt to clamp down on black money, given the size, scale and systemic nature of the problem.”

All of these factors contribute to unsettling India’s economy.

“In a worst-case scenario, a thriving black economy, if unchecked, can result in a complete collapse of an economy,” says Ms Basak. “While India is far from such a dire situation, it is impacted in multiple ways.”

She says India’s major macroeconomic concerns of stubbornly high inflation plus gaping current account and fiscal deficits could be alleviated by addressing the black economy.

“On the fiscal side, the government is not only losing out on the tax collections on the black money but all subsequent taxes as such money permanently stays out of the organised system. If addressed, the additional collections will help to boost tax revenues and lower the country’s fiscal deficit,” she says. “Meanwhile, the increasing conversion of illicit savings into assets through gold purchases has pushed the current account deficit to unsustainable levels until the monetary authority introduced curbs on the imports of the yellow metal last year.”

If such money was legally brought into India’s economic system and invested into industry, that could help various sectors and the economy to grow, analysts say.

Black money “encourages corruption providing the means to store income from corruption”, says Mr Sen. “It undermines the legal financial system. It reduces funds for productive investment in the organised transparent sector.”

Policies need to be put in place to control illegal flows of cash, he adds. India has taken a number of steps to attempt to stem the problems, including an amendment to its prevention of money laundering act in 2012, which made it easier to prove the crime. A whistleblower protection bill, passed this year, is also expected to help uncover cases of black money. But much more needs to be done.

“Tax compliance is both a policy and criminal issue, prosecution should be swift and strong while policies should be rational and simple,” says Mr Sen. “Corruption is by itself a criminal problem, to the extent it generates black money it is linked, but elimination of corruption should be seen as a problem in itself with black money being treated as an enabler of corruption.”

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