Demonetization and the Indian Economy I

Demonetisation

India was the sixth-largest economy in the world, according to the updated World Bank figures in 2017. It is also expected to be a global economic power in the near future and is one of the favourite destinations for foreign direct investment (FDI). From the times of ‘licence raj’, the Indian economy has grown leaps and bounds following the liberalization process which started in 1991. India, however, faced the problem of the unaccounted or black economy which is a drag on the economy. Unaccounted money is generated both locally and abroad. Big money – illegal income is generated by tax evasion in real estate and exports/ imports. It is also generated by corruption in another myriad of ways. Illegal monies held by Indians abroad were obtained by over-invoicing imports / under-invoicing exports, corruption in defence deals and from gold and diamond trade with Dubai. The Government of India recognizes the generation of black money by two major processes, the first being from economic activities that are not permitted or are illegal, like corruption & crime and the second through economic activities that are legal either by out of book transactions, or by manipulation of books. It is obvious that practices like out of book transactions or manipulation of books, cannot exist or go on for long in the absence of the first reason, i.e corruption. Significant black money is hence generated either directly by corruption or aided by corruption.

Corruption has grown along with prosperity and if left unchecked will be a stumbling block in the future. Transparency International, a famous corruption watchdog, ranked India as the 87th most corrupt country out of 178 countries in its 2010 corruption perception index. Another ominous portend is that the World Economic Forum ranks ‘corruption’ as the second most stumbling block in ease of doing business in India after ‘lack of Infrastructure’. Corruption and bureaucratic red tape slows down normal business leading to reduced growth and makes domestic and foreign investors wary. In a 2011, KPMG survey on the leading corporations on the issue of corruption painted a bleak picture of the state of affairs in the country. The major corporations felt that corruption is affecting GDP growth, financial markets and foreign investment. The institutional framework was not effectively controlling corruption.  Corruption leads to a significant negative impact on the economy and negatively affects the general welfare of the country.

In the extreme case, corruption kills as discussed by researchers in 2011 in ‘Nature’ magazine. Using 30-year data, they show that 83% of death from building collapses due to devastating earthquakes occurred in corrupt countries. Less extreme and less dramatic damages due to corruption are also discussed extensively by researchers. They have a negative impact on public finances by undermining economic activity and governments efforts to fight poverty. This has adverse effects on the economic indicators of the country. It distorts investment; increases the need for regressive consumption taxes. It affects private investment, as corruption levies an additional burden on businesses and misallocated human resources. It affects income distribution and leads to uncertainty and short term focus.

Studies compared corruption to cancer and stated that corruption has a similar effect on the development of the nation that cancer has on a biological species. They have also argued that corruption worsens resource allocation; skews economic competition; increases risk for the investors and negatively affects public expenditure.  Researchers have stated that “there is increasing recognition that corruption has a significant adverse effect on economic growth”. Empirical studies have evidenced that there is a negative correlation between corruption and per capita income; that corruption skews public expenditure towards less productive activities.  A study in 2006 discussed the effects of corruption in the growth of the MENA economies using indictors of 90 countries during 1960 – 2006 period. The study evidenced significant direct and indirect negative effects on the growth of MENA economies. Another study, covering the 1996 -2002 period using 19 performance indicators including GDP, FDI, compensation levels, supported the detrimental effects of corruption on the major performance indicators.



Author:
Dr. Srikanth Parthasarathy
Associate Professor, Rajalakshmi School of Business, Chennai
Email: srikanth@rsb.edu.in