The decision to ban the existing Rs 500 and Rs 1,000 currency notes as legal tender in one stroke is a bold measure taken by the government. While estimating the scale of black economy in the country is difficult, on considering a recent estimate that lists the magnitude of India’s black economy at 20% of GDP, such tightening of noose on those dealing in underhand practices is a welcome move.

According to an analysis by Central Board of Direct Taxes (CBDT), the biggest source of generation of black money is evasion of commercial tax, which involves misreporting of the transactions in the books of account. The manipulation of financial statements creates unaccounted income that amounts to black money.

This drastic measure by the government will certainly have some effect. First, this would paralyze the intentions of those who have hoarded illegal cash and will thus act as a one-time penalty for them; this will cover people who engage in generation of illicit money through commercial tax evasion, and also corrupt officials. It can be argued that the corrupt government officials would have lesser avenues to convert black money into white, and hence be affected to a greater extent. The other problem this will help address is regarding currency counterfeiting. It has been reported that the country’s economy has witnessed a disproportionately faster rate in usage of high denomination currency notes in the last few years as compared to the rate of its expansion. As most fake currency is found in the 500 and 1000 denominations, it is hoped that the new currency notes (of Rs 500 and 2000) being introduced following the ban on the current series of these notes will come with suitably enhanced security features.

The fight against the menace of black money is far more complex, and requires more concrete and stronger measures by the government. To enhance the tax base and improve tax collection, it is crucial for the government to unearth black money in the economy and bring those resorting to tax evasion under the tax net. It is one thing to collect information based on which people can be held accountable for holding unaccounted moneys, but it is another thing to analyse that information, execute searches, detect cases of unreported income, and identify cases of tax evasion. The Income tax department failed to achieve the target of tax collection in the past due to lack of adequate staff whereby most posts were lying vacant for several years. It is imperative to recruit regular professionals in the department and equip them with necessary skills to trace black money transactions for streamlining the tax collection process. Strengthening of Income Tax Department, the entire apparatus under CBDT, the institutional enforcement machinery- the Finance Intelligence Unit, and the Directorate of Enforcement will be of vital importance in dealing with the problem.

Sectors like real estate, jewellery market and financial markets need bigtime reforms as they are most vulnerable to generation of black money. Tightening regulations in the financial sector, improved reporting and monitoring mechanisms in the jewellery sector and improving state legislation can address loopholes in real estate transactions. In addition, measures bringing greater transparency in the global financial system are also needed to act as deterrents to moving money offshore.

The present move has taken most people by surprise, and a big challenge in the coming days would be the hassles that people will have to go through and the explaining required at the banks in the process of exchanging moneys. The immediate repercussion of this will be on informal sector and unskilled service providers who hardly use electronic transactions, particularly in the rural sector. The move seems to have overlooked a range of hardships that common people will experience in the transitioning process. The government has started recognizing and responding to some of these immediate challenges, this however needs to be done more proactively looking at the size of the problem.