A banking scandal highlights the problem of black money in India

India’s shadow economy

Evasive action

A banking scandal highlights the problem of black money in India

Mar 23rd 2013 | MUMBAI |From the print edition

THE videos were set to the James Bond theme tune and labelled as a “shocking mega-exposé”. They were released by an investigative website called Cobrapost on March 13th, and have hit the share prices of India’s biggest private-sector banks. The sting consisted of a journalist with a secret camera walking into bank branches, where he claimed to be linked to an unnamed politician whose house could no longer contain his cash. Staff in many branches were only too willing to help launder the money, usually by fiddling the rules for setting up accounts and insurance policies. “Yes, yes, don’t worry, sir, all people do this,” replied one bank official.

The lenders and their regulator are looking into the allegations. Even if they are bogus, they tap into a well of mistrust. A 2009 e-mail claimed that Indians held more money in Swiss banks than people from all other countries combined. It was a hoax, but still went viral.

Gauging the scale of the problem is hard. A 2010 World Bank study of 151 countries concluded that India’s shadow economy, defined as legal activity concealed from the authorities, was equivalent to a fifth of official GDP (confusing matters, it is unclear to what extent India’s official GDP already captures the black economy). That is roughly double the level of the best rich countries, but below the global average and most other emerging nations. The last vaguely official study was in 1985 and had a similar answer—19-21% of official GDP.

Both estimates look too low, especially if all types of dodgy activity are included. About 85% of jobs are in the informal sector, which is typically cash-based. Corruption is common—both “retail” small bribes and “wholesale” scams involving powerful politicians. It seems likely that things have deteriorated since the mid-1980s. True, the tax code has been improved, and the effective tax rate big firms pay has risen. But the boom of the past two decades is seen by many as a gilded age to rival 19th-century America’s, with a cast of chancers and robber barons to match.

Take tax. Only 42,800 people declare income of over 10m rupees ($184,000) a year. India’s finance minister, Palaniappan Chidambaram, says this figure is “laughable”. It is not just the rich that play fast and loose. Only 2.5% of Indians pay income tax. Surjit Bhalla of Oxus Investments, a research firm, reckons the actual income-tax take is two-thirds lower than it should be.

The asset classes in which black money is stored provide another clue to the scale of the black economy. Property and land transactions probably amount to tens of billions of dollars a year. Mumbai has a huge stock of empty apartments held as investments, their owners unwilling to sell for fear that the proceeds might enter the formal economy and be taxed.

Gold is another currency of choice. This is partly because the rate on bank deposits barely beats inflation, but also because it is hard to keep tabs on the shiny stuff. Gross gold imports are running at 2-3% of GDP. Household savings have drifted back towards more opaque asset classes. Savings in physical assets—such as bullion and housing—are running at 14% of GDP a year. Formal financial savings such as bank deposits, which tend to be cleaner, have declined to just 8%, from 12% in 2009.

A final indicator is the offshore-finance system. Much foreign investment into the country flows via Mauritius, with which India has a tax agreement. Supporters say it allows investors to avoid red tape and unfair capital-gains levies. Critics argue that Mauritius is a conduit through which Indians send and bring back black money (the island’s government denies this).

At least the cash-strapped government appears to be taking the issue of the shadow economy more seriously. It plans to cross-check bank and credit-card records with tax submissions. It has commissioned a series of studies into black money that are due in the next few months. If they are credible and made public they might help dispel a widespread view—that politicians are among the biggest beneficiaries of India’s black-money culture.