Under Modi, India May Be Generating Less Black Money Than Before

One of the less remarked features of today’s Indian economy is the probability that it is generating less black money than before.

The big areas for black money generation have traditionally been in real estate and construction (both down in the dumps), big bank lending to cronies (where bribes are paid to bankers so that money can be siphoned out to finance the promoters’ equity), misallocation of scarce resources (now gone, as mining and telecom spectrum leases are being auctioned and thus rendered less capable of generating illegal “rents”), and marketing of liquor (now coming increasingly under foreign domination, and hence less prone to cash deals).

Black money generation from adulteration of diesel and fuels is gone as prices have been deregulated. The scope for small ticket black money generation is also being gradually eliminated by the use of direct benefits transfers in subsidised products like LPG, which will soon be extended to kerosene, fertiliser and food at some stage.

The Great Export Crash of 2014-16, where we have seen exports fall for 15 months in a row, may be yet another pointer to the deceleration in black money growth. Underinvoicing of exports and overinvoicing of imports have been major sources for the creation of illegal black wealth abroad, and these may be coming down.

The April 2015-February 2016 export fall of 17 percent has many causes: one, of course, is the global slowdown, which has reduced overall demand; another is the relative overvaluation of the rupee, which makes Indian exports relatively uncompetitive; and, third, of course, is the possibility that businesses may be selling more in the domestic market, which may be more profitable than selling abroad right now.

However, there is also a possibility that the shrinkage of the Indian black economy market is impacting export figures. Logically, if your balance-sheets are impaired, it is better to bring in cash by overinvoicing exports than sending it out to tax havens by underinvoicing it. But the export crash suggests that this may not be happening.

In 2010-11, we saw an interesting phenomenon where some sectors saw extraordinary and unexplained growth in exports, leading analysts to suspect that businessmen were overinvoicing exports in order to bring back black money held abroad, as the climate for hoarding money in tax havens abroad was getting tougher.

According to a 2011 Kotak Securities report by Sanjeev Prasad, Sunita Baldawa and Amit Kumar, there was a huge divergence between export data provided by the government and the actual export figures reported by major companies. They noted: “Our study of exports data of major engineering companies (including automobiles and metals) shows that the increase in their exports does not reconcile with the steep increase in official exports data. In fact, the gap is quite substantial.”

For example, official data showed a huge 79 percent engineering export growth in 2010-11. But engineering companies in the BSE 500 (a proxy for India Inc) showed a mere 11 percent growth, from $38 billion the year before to $68 bn.

The Kotak analysts suggested that some of this could be the result of overinvoicing. They wrote:

Some reports have alleged that some individuals may have been compelled to bring back funds through the official route by simply overinvoicing exports or even resorting to fraudulent exports thanks to (1) increased international scrutiny of accounted funds in bank accounts in Switzerland and other financial centres, and (2) heightened debate in India about action against unaccounted overseas wealth.

Among the big anomalies they pointed out was the case of export of metals and metal products which spiked from $13 bn to $ 29 bn. But 22 companies in the BSE 500 showed total exports growth of just under $1 billion. Where did the extra $ 15 bn growth come from? Could not have been from small companies that go under the radar.

Another example cited by the Kotak report was “copper articles” where exports grew more than four-fold from Rs 8,500 crore to Rs 36,700 crore.

The Economic Times investigated one particular area of exports and found no earthly reason why exports should have shot up 350 percent in one year (from $1.8 billion to $8 billion in 2010-11) when copper prices hadn’t risen much, nor had the import of copper scrap soared (India doesn’t produce much copper).

So there was a huge likelihood that in 2010-11, exports were deliberately overinvoiced in some sectors to bring back black money and avoid scrutiny abroad.

The purpose of explaining what happened in 2010-11 is this: to create illegal wealth abroad, you underinvoice exports. To bring back black money, you overinvoice it.

It is thus not unreasonable to surmise that some of the explanation for the export crash of the last two years may be for one of these two reasons (i) underinvoicing has started again, which would indicate a flight of capital from India after Narendra Modi came to power (unlikely); or (ii) a rapid drop in the overall generation of black money from exports, aided by the sharp global slowdown (more likely). Of course, both could be true, but with explanation (ii) holding a bigger share than explanation (i).

Consider the logic:

Given the escalation in the hunt for illegal wealth abroad, both by the Modi government and the Supreme Court-appointed Special Investigation Team (SIT), it is unlikely that more black money is being shipped abroad.

Given the sharp fall in profitability in domestic businesses, and also because of the high level of debts, it actually makes sense to overinvoice exports so that money is brought in and used to bolster local businesses that are at risk of going under.

The fact that the latter did not quite happen leaves us with the possibility that the overall generation of black money may be coming down in the Indian economy.