The Unhurried Man’s Guide to Black Money

Everything you wanted to know about it, but were afraid you’d hear nonsense if you asked

In an interview given by Julian Assange of WikiLeaks to an Indian newspaper in April 2011, he claimed he had received a list of 2,000 Swiss bank account holders from a whistleblower called Rudolf Elmer that indicated these accounts held more Indian money than any other. Last week, Elmer told an Indian news channel that politicians, cricketers and film stars figured on this list, but refused to divulge any names. It has added grist to Indian rumour mills running on talk of ill-gotten gains.

Going by the millions who supported Anna Hazare, it is clear that there is countrywide anger against black money, and that policymakers and other politicians must do something meaningful about it. One of the steps would be to pass a strong Lokpal Bill, which, many Indians believe, can eradicate corruption in a jiffy. The Government has also thought of a scheme that will allow Indians to bring back money hidden abroad after paying a not-too-stiff penalty.

Some good is bound to come of all these proposals. However, there is another aspect of black money that many are unaware of: almost everything you have read or heard about India’s so-called ‘black economy’, especially about money stashed abroad, is either an exaggeration or a blatant lie. Most of what is doing the rounds on the subject comes from discredited and/or biased sources.

In the run-up to the general election of 2009, LK Advani, the BJP leader who plans a rath yatra against graft, claimed that the quantum of money that had been taken out of the country since 1947 was a mind-boggling $1.4 trillion, a figure nearly the size of India’s 2010-11 GDP. This figure is bloated. Experts say that the colour of any money connected with corruption is black. This is false. We are told, time and again, that black money generated within the economy only has negative economic and political consequences. This is only partially true.

Yet, India’s popular discourse on black money keeps mixing up real concerns with irrelevant issues. To help separate the wheat from the chaff, and set the record straight, Open answers a series of frequently asked questions (FAQs):

“I hate the terms ‘black economy’ and ‘black money’,” says the Delhi-based economist Bibek Debroy, “Their use suggests that the world of finance is neatly divided into black and white, and the twain never meet. The distinction between the colours of money is actually blurring—black becomes white and vice-versa.” For example, if real estate deals have a cash component, as they almost always do, buyers can make payments from their legal income. In such cases, white money turns black. Likewise for bribes paid with legitimate funds.

It can go the other way round too. There exist several money-laundering routes that help businessmen convert illegal earnings into white money. In the recent past, many firms have shown huge inflows from fictitious software exports, helping them bring back money stashed abroad as tax-free income. In some cases, even though exporters paid taxes on such foreign ‘earnings’, they got government incentives in the form of import licences and other subsidies.

Another common misconception is to think of all corruption cases as generators of black money. “In the 2G scam,” says Surjit Bhalla of Oxus Investments, “there is little black money [involved], apart from bribes that may have been paid to the former Telecom Minister A Raja, or other politicians and middlemen.” It was a classic case of crony capitalism, with favours doled out by policymakers to businessmen. The Centre gave spectrum/licences away at ridiculously low prices, which led to a huge loss to the exchequer, but what telecom firms paid for it was white money. Later, when some of these licencees sold stakes in their businesses at exorbitant rates, the payments they got was money that was accounted for and thus white.

It often works the other way round; the circulation of illegal money adds efficiencies to an inefficient economic system. “Illegal incomes provide an economic function,” argues Barun Mitra, managing trustee, Liberty Institute, “It helps lower transaction costs in economies where they are high. It lubricates economic wheels. Its impact is positive, or it won’t be created in the first place.”

Real-life experiences back this observation. Both individuals and businessmen use bribes and illegal payments to accelerate processes that would otherwise take too long, be it to get a proposal through at a ministry, grab a contract, or ensure than an electricity connection is granted earlier than usual. The time saved, or the ease with which a tender is won, is worth more than the money paid.

This explains why countries with a higher degree of economic freedom generally generate the least amount of black money. According to the 2011 Index of Economic Freedom, put out by the Heritage Foundation, Singapore, Canada and Switzerland are among the 10 freest, while India is ranked No 124 on a list of 179 countries. As expected, the three countries in the freedom top 10 are also among the 10 least corrupt countries, going by the 2010 Corruption Perception Index tabulated by Transparency International; India is at No 87 (No 1 being the least corrupt).

A 2010 report by Global Financial Integrity (GFI) estimated Indian black money at $640 billion, as accumulated between 1948 and 2008. This sum, much less than Advani’s figure, was still about half the size of India’s economy in 2010, and of this, over 70 per cent (or $462 billion) was reckoned to be stashed abroad in banks, tax havens and global assets. But the GFI report added that its estimate ‘is significantly understated because economic models can neither capture all the channels through which illicit capital can be generated nor the myriad ways in which the capital can be transferred’.

In the same vein, the report stated that as per the ‘traditional model’, the quantum of black money parked overseas is significantly lower at a meagre $25 billion, or under 2 per cent of India’s GDP. This model tends to measure net outflows (money that went out minus the money that came back to India), as opposed to gross outflows (only the money going out). But the traditional model was trashed by the GFI report as it could not ‘capture the genuine return of those funds’. However, the ‘traditional’ figure began to seem more credible after the Swiss National Bank, the country’s central bank, disclosed that the total deposits of Indians in Swiss banks stood at only $2.5 billion in December 2010.

The GFI report indicated that contrary to expectations, the amount of Indian black money kept overseas has gone up in the post-reforms era (1991–2008). This was primarily due to two reasons. Since reforms did not go hand-in-hand with the strengthening of key institutions of governance, deregulation merely provided ‘an added incentive for those seeking to transfer illicit capital abroad’. Also, according to the report, reforms have led to greater income inequality. Thus, there is more money in the hands of private firms and high networth individuals who are the ‘primary drivers of illicit flows from the private sector in India’ (rather than common citizens).

 “The debate on black money has become a bogey,” as Mitra puts it, “My biggest problem with Manmohan Singh— who is honest, and no one accuses him of any wrongdoing—is that he has not pointed at the real reasons for the growth of black money. He has not articulated that the problem lies with the combination of bad laws, weak governance and an inability to punish the guilty.”

This is another popular myth. Many think that if this money had not fled overseas, or was reflected in the legal economy, it would have wiped out India’s debt, made the fiscal deficit vanish, and provided huge sums that could have been spent to improve infrastructure and invest in welfare schemes. However, as mentioned earlier, most of this money might indeed have returned to India, especially in the last two decades. The Government appears to have deliberately left a few loopholes for this.

Take the Mauritius route, for instance. For years, Indian policymakers have been criticised for not taxing merger and acquisition deals that take place via Mauritius. In such cases, Indians sell Indian assets to foreigners through Mauritius-based firms. Since the payment is received in a country that does not tax the gains on such deals, and with which India has a double-taxation agreement (so India cannot tax it either), the Indian seller pays no tax at all.

The prime example of this was Essar’s sale of its stake in Hutchison-Essar, an Indian telecom firm, to Vodafone. It was only later that the Indian tax authorities filed a case for the recovery of tax dues, a case that is being fought in the Supreme Court. In other instances, Indian money in tax havens, including Swiss banks, has been routed as foreign direct investment through Mauritius-based firms. India is Mauritius’ top FDI destination.

Other loopholes are available too. One can invest indirectly in Indian stockmarkets from abroad through participatory notes (PNs), which are contracts one signs with a foreign institutional investor or hedge fund that buys and holds shares on one’s behalf. These are now a favourite instrument used to invest illegal funds in Indian equities. A report by a sub-committee of the Union Finance Ministry reveals that most of the money flowing in through PNs is illegal; it could even be related to narcotics and terror.

However, it helps the Indian economy to have any kind of funds—legal or illegal—being put to productive use within the country, rather than their staying away or going elsewhere.

Yes and no. As explained earlier, black money may actually contribute to growth if it finds its way back into the economy and turns white. Obviously, the quantities that remain out of circulation, hidden in tax havens, invested globally, or collecting dust within India, have a negative impact. Therefore, it is still critical for policymakers to find ways to curb its growth and expanse.

The same is true of inflation. “One can say that the black component in property buying and gold is artificially driving up prices,” says Debroy, “It could also be true of inflation in other financial assets such as stocks. But its effect is limited to these specific sectors. Since the weightages of these sectors in overall inflation is low, one cannot say that the black economy has a macro impact on it.”