Back in 2014, Raghuram Rajan said it won't be easy to flush black money

Raghuram Rajan was not sure if demonetisation helps in curbing black money

Back in 2014, when the Reserve Bank of India was withdrawing Rs 500 denomination notes from the system to introduce new notes with better security features, many had constructed it as an effort in demonetisation. Then central bank governor Raghuram Rajan, however, was not sure demonetisation helps in curbing black money. 

Raghuram Rajan's view on demonetisation

“I am not quite sure if what you meant is demonetise the old notes and introduce new notes instead. In the past demonetisation has been thought off as a way of getting black money out of circulation,” said Rajan answering to an audience query at the 20th Lalit Doshi Memorial Lecture on August 11, 2014 at Mumbai. 

“It is often cited as a solution. Unfortunately, my sense is the clever find ways around it. They find ways to divide up their hoard into many smaller pieces. You do find that people who haven't thought of a way to convert black to white, throw it into the Hundi in some temples,” Rajan said, adding, it was not easy to flush out black money.

“I think there are ways around demonetization. It is not that easy to flush out the black money. Of course, a fair amount may be in the form of gold, therefore even harder to catch.”

His solution to the problem was to focus on tracking data and better tax administration that would discourage creation of black money.

“I would focus more on the incentives to generate and retain black money. A lot of the incentives are on taxes. My sense is the current tax rate in this country is for the most part reasonable.”

“We have a reasonable tax regime, for example, the maximum tax rate on high-incomes is 33%, in the US it is already 39% plus State taxes, etc., it takes it to near 50. We are actually lower than many industrial countries.”

Therefore, “there is no reason why everybody who should pay taxes is not paying taxes. I would focus more on tracking data and better tax administration to get at where money is not being declared. I think it is very hard in this modern economy to hide your money that easily,” Rajan had said. 

Prime Minister Narendra Modi on Tuesday night declared that Rs 500 and Rs 1,000 denominated notes will be considered invalid, in an effort to flush out black money from the system.

According to RBI's annual report, at the end of March, there were 6.3 billion of Rs 1,000 notes, and 15.7 billion of Rs 500 notes -- 7% and 17.4% of those in circulation, respectively.

In comparison, there were 15.8 bn of Rs 100 notes, about 17.5% of the notes in circulation (90 bn).

If the RBI has to replace the entire stock of Rs 1,000 and Rs 500 notes with Rs 100 ones, the cost would be more than Rs 10,000 crore.