Would bringing black money back Into the system increase inflation?

[Srijan Narang]

Many of us believe that just as printing more money in an economy can increase inflation so can bringing the black money back in India. But let us not jump to conclusions and try to understand the situation.

What is Black Money? It is basically the income on which no income tax has been paid to the Govt. If it's in the form of cash, then of course its origin is difficult to ascertain. On the other hand, when in the form of wired money, transactions are carried out in such a manner that it leaves no traces. Also, in a lot of cases money if often sent outside India to the banks of countries who keep your information confidential and where Income Tax is negligible.

Now although this money has no origin "on record", it has already been accounted for in our Economy. Therefore, the tax which the Govt. should have received on this money is gone and secondly, it would slow down the economic activity of the country. Note that the Govt. earns most part of money through Taxation, which it then further uses for its various expenditures like infrastructure development, to develop facilities for general public, to provide aids, pensions, etc. So increase in Black Money implies decrease in the Capability of the Govt. to function properly due to scarcity of money.

Let's assume that except for the money that Govt. is holding for its expenses (collected via taxes), rest all the money is white money in our economy. We'll call this money Free Floating money. This money is owned by the citizens only. A part of this money is with people directly, for meeting their regular expenses. Rest is deposited in the banks. Out of the money deposited in the bank, a part of it is used for lending, casting aside the amount required for functioning of Banks and to maintain a minimum reserve as per statutory provisions. This money is used by Entrepreneurs to set up various other businesses and thus to boost up our economy.

Now consider a scenario where a part of the money is out of the country as Black Money, sitting idle, doing nothing. Note that how a huge amount of money has been carved out of the Free Floating money. Correspondingly, this money is not available to be further circulated in the economy and hence, cannot be used.

Since the money in circulation is less and Govt. doesn't have enough money to function and to run the country due to less amount of taxes being collected, the Govt. will now need to borrow the money from International Bodies like World Bank, IMF, etc. which then results in increasing Fiscal Deficit. Consequently, for this Fiscal Deficit, we'll need to pay interest every year which puts further pressure on the Govt.

What happens when this Black Money comes back to India?

Well, the money in the circulation increases. The surplus money will attract less loan rates in the Banks and the money will be made available to the public. This will, in turn, be used by the citizens for 'increasing the Economic activity' of the country, which will inevitably help in strengthening the value of Indian Rupee.

Inflation will go down, burden on Govt. will decrease, we won't need to borrow from International bodies anymore, we will be able to pay off International loans with better ease. Productivity of the country will increase and the effects will reach to every section of the society.

So the answer to this question seems to be a "NO". Bringing back the black money won't necessarily increase inflation although still it would depend upon how the money is put to use.

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Regards,

Srijan Narang
Junior Undergraduate
Mathematics and Computing
IIT Delhi