Demonetisation - What was the targeted black money held in cash?

Total black money (cash) in the system was estimated to be 3 Lac Crores or 3 Trillion. This number is now being questioned. One reason this number is important is that some believe that this is the number government was targeting using the demonetisation initiative. So what is this number? Is it 3T? Is it more? Is it less? Does it matter?

As an aside, that logic is flawed. The government has not given any target for black money it wants to unearth. It has maintained that it wants to unearth all black money. The government's definition as supplied by the White paper on black money 2012 includes cash, assets and everything. In short it refers to black economy not just cash.

Simple calculation

Nevertheless, the number 3T came from media and they calculated it thus. The total currency in circulation 15T (only 500 and 1000 notes). about 20% of this is in black hence 3T is in black. 

Pseudo-data backed

Another way is to estimate how much percentage of black wealth held in cash. If you look at the data from white paper on black money, it is about 5% for those were caught. So one journalist calculated 5% of 15T (currency in circulation) to arrive at 0.77T as his estimate. To put it in context, this is  comparable to the amount government got through tax amnesty scheme. Naturally, he pooh-poohed the government. But this calculation is wrong on many levels. First, 5% of wealth (stock) is not same as 5% of 15T (which is flow - money in circulation). So 15T is not comparable to wealth of Indian economy. When IIM teachers make such miscalculation, I am surprised.

My calculation

(In INR)

India nominal GDP = 125 T

Total currency in circulation = 16 T

Ratio = 7.8

Estimate of black economy = 62T

Estimated cash in circulation (using about ratio of 7.8) = 7.9 T

(By Arun Kumar Estimation of the Size of the Black Economy in India, 1996–2012 EPW = he says its 60% based on some regression. check out his paper)

Now to temper the estimates: The size of black economy may be lower i.e. Arun Kumar may be over-estimating. Say the size of economy is 25% (this comes from world bank estimates).

So 25% of 125 T = 31 T

currency supporting 31 T at ratio of 7.8 will be about 3.9 T

The ratio logic: The ratio for the black economy will be different. One can argue both ways. The transactions are black so ratio will be lower or that people want to rid of the black cash so ratio will be higher. But for bulk money (high amounts) it is difficult to move black money. So ratio could be lower. Which means the black cash will be higher than 4T.

So 3 Lac crore / 3 T is ok estimate.

But does it matter?

No. First, this money is fungible. It can move from black to white. You cannot trap it completely. So what can be done?

First get this flow into stock. Let the currency come out white - but wealth will still remain black. Let it go into assets, gold and other stock items. It is easier to shoot at stock than flow. Second if you are vigilant, their conversion will give their location away. To do that we need to push the cash holders into converting, Coax them into action. Demonetisation does that trick. Now that thieves are moving they become visible.

Now the black money is both visible and cash component is revealed. The success will depend on whether the government takes out the black money or not. Let us wait and watch.

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