Are we living in a 'shadow economy'?

Aug 11, 2010

In this issue:
» Indo-US social security pact
» Buffett ready for inflationary bout
» A new price index to reflect consumer behaviour
» Chinese banks seeing red
» ...and more!!

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Out of its population of over a billion people, India has only 31.5 m tax payers. Assuming we leave aside 50% of the population that is marginally above or below the poverty line. Of the remaining 500 m, 94% still remains un-taxed! Thus depriving the government of critical funds to empower the economy. Problems relating to fiscal deficit and the like could be solved with efficient taxation. But the real problem lies in an economy that evades taxes. As per unconfirmed statistics, India tops the quantum of black money hoarded with Swiss banks. At over US$ 1.5 trillion, it could more than double the economy's GDP if accounted for.

Calling it a 'shadow economy', an article in Bloomberg enlists the problems associated with unaccounted incomes. It turns out that countries have two economies: the official one and a shadow version. The official economy is the one that governments measure in terms of addition to GDP. This is by way of tax receipts, employment numbers etc. The shadow economy is all the money and jobs generated outside the official economy. It may be either legal or illegal. The 'shadow economies' for the US and Greece accounted for only 9% and 31% of the respective GDPs in 2008. Nevertheless, these funds could have saved the economies billions of taxpayers' funds. Not to mention - plenty of embarrassment. The official figure for India is not known. But probably the government should work on making the official economy more attractive. This could be done by reducing the incentives to participate in the shadow economy.

What do you think would be the best way to reduce the share of India's shadow economy? Let us know your views or post your comments on our facebook page.

 Chart of the day
Data source: TRAI, Economist

As per the international statistics, at 43%, Asians are the maximum users of the World Wide Web. They are the biggest contributors to internet penetration doubling to 25% in 2009. However, it needs to be noted that Indians are yet to contribute a fair share of web browsing. As today's chart shows, India still accounts for an abysmal 2% share of global broadband connection. As against this, Chinese broadband providers cater to the largest subscriber base globally. India still has a long way to go when it comes to catching up with China's numbers on this account.

Indian workers who work in US have to contribute a portion of their salaries as a contribution towards social security. Pretty similar to how a part of our salaries is contributed towards provident fund. But when we leave our jobs, we can either claim or transfer the provident fund contribution that we make. However, in US, the workers cannot claim benefits or get a refund unless they have worked in US for 10 years or 40 quarters. The Indian government has been trying to get the rules amended but to no avail. However, their efforts finally seem to be paying off.

India and the US are close to inking an agreement that will link the social security systems of both the countries. This will allow workers from each country to draw from their contributions. As per the Indian officials, the agreement should be finalized and inked during President Obama's visit to India, scheduled for later during the year. If this agreement goes ahead, it would be a breather for India. Especially for the Indian IT sector which pays over US$ 1 bn to the US in the form of social security but with no benefits or refund.

Money news reports that Warren Buffett's investment vehicle Berkshire Hathaway has shortened the duration of its bond holdings. As of June 30, 2010, 21% of Berkshire's bond holdings were due in a year or less, compared to 18% as on March 31. Also, the proportion of the same was 16% in June 2009. Now, it is common knowledge that when inflation occurs interest rates rise. And as a result, longer duration bonds fall more in price than shorter tenure ones. Thus, it can be assumed that the Oracle of Omaha seems to be getting ready for an inflationary bout. He does not want to suffer a significant loss of capital.

Interestingly, this thinking runs counter to that of most experts. People these days seem to fear deflation more than inflation. Well, we are no experts in these matters. What we can say with some degree of certainty is that thanks to the Fiat money system and irresponsible politicians, economies will continue to gyrate between inflation and deflation at all times. Thus, it pays to invest in companies that are able to increase prices in times of inflation and protect their volumes in times of deflation. This option is certainly way better than trying to change one's investments based on which of the two 'flations' is around the corner.

Sticking to inflation, India is set to see more of it over the next few months. But this will not be due to food prices escalating. Rather it will be on account of a new wholesale price index that will debut in September. This index will give a slightly higher weight to manufactured products. And thus, will raise the chances of elevated readings for the next few months. As per reports, the new index will have the fiscal year through March 2005 as the base year. Further, it will comprise 676 products compared with 435 in the current index.

It may be recalled that India's inflation has run persistently high for quite some time now. While initially soaring food prices were the main culprits, the inflation has now spilled over to manufactured goods as well. The new price index is seeking to reflect a more contemporary consumption behavior as a result of which the weight of primary products will reduce a bit. Although food prices have risen considerably off late, if one looks at the trend since 1994, the pace of food consumption has been slower than that of manufactured goods. Thus, with inflation likely to remain on the higher side in the coming few months as well, the RBI will have to keep up with its monetary tightening measures.

Chinese banks currently have more than US$ 339 bn off-balance sheet assets. And the banking regulator for once is not comfortable with such huge quantum of unaccounted loans. It has ordered the banks to transfer off-balance sheet loans onto their balance sheets by end of 2011. This mandate could deal a heavy blow to the banks' profitability. Provisions on the loans could be as high as 150% of potential losses.

This move will also increase pressure to raise equity capital to meet the new requirements. China's five largest banks, including Agricultural Bank of China, are raising more than US$ 60 bn to stock up capital. This is a much needed move, especially since a record US$ 1.4 trillion in new loans was extended last year. If even 0.5% of these go bad it will lead to a US$ 7 bn loss for the system! Seems like the Chinese government is finally waking up to the need for strong banking regulations.

The recovery in output and employment in the US has slowed in recent months. And this has already begun making the US government anxious about the country's recovery from the crisis. With that in mind, the US Federal Reserve yesterday took fresh steps to lower borrowing costs. It announced that it would use proceeds from its maturing mortgage bond portfolio to buy more government debt. This is nothing but an effort to keep market-set borrowing costs down. Weak data from the economy has been haunting authorities in the US since late June this year. Consumer spending has softened. Manufacturing appears to be losing steam. The unemployment rate is stuck at 9.5%. With the Fed now ostensibly worried about the recovery, more such policy moves are being expected from it going forward. Whether these will solve the problem, is anybody's guess.

After a brief stint in the positive territory, the Indian indices succumbed to profit booking in index heavyweights since early trades today. The benchmark indices shed gains backed by selling pressure in pharma and IT stocks. Asian markets across the board are trading lower with Japan and South Korea leading the pack of losers. The BSE-Sensex was trading nearly 70 points (0.5%) lower at the time of writing. The European markets have opened on a cautious note.

 Today's investing mantra
"The chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions." - Benjamin Graham

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43 Responses to "Are we living in a 'shadow economy'?"

Ashok Aggarwal

Aug 16, 2010

Government has to honestly go after Tax Evaders. It is not difficult. Even a Layman can assess from life style of a person or family whether they has taxable income. Penalities should be stiff and well publicized so that these act as a detterrant. The Tax Officers who bring Tax Evaders to book should be suitably rewarded. There should be surprise checks on it's own tax officers and corrupt ones should be given Exemplary punishment to send out a clera signal. Government should strictly avoid any Voluntary Disclosure Scheme as it sends out signal to public that it pays to be a Tax Evadr.


Biju John

Aug 14, 2010

one reason for the shadow economy growing is lack of confidence in our Governments that the tax paying people will get something in return in terms of common amenities and facilities. The second major reason is that we are a country of hypocrites, we need to have a paradigm shift in our attitudes, we are ready to spend more on tax evading than tax paying, it's a question of our basic integrity...


Dhaval Radia

Aug 13, 2010

I see such huge size of shadow economy for 2 reasons, 1) most important player in shadow economy are politicians who parks their unscrupulous money out side country and thus out of official economy. We need to nail them, grill them & hang them for this. 2) second reason for shadow economy is the complex tax structure – direct and indirect. We earn – we pay tax…!!, we spend - we pay tax…!! This definitely encourages a common man and business houses to evade tax and infuse money in the shadow economy. So by simplifying tax structure and lowering taxes we can get rid of shadow economy to a much extent. Any ways our hard earned money is being spent on corrupted politician's well being by way of CWG. With huge current account deficit and high interest cost on our country, we have no right to conduct CWG



Aug 13, 2010

Because of this shadow economy only country saved from the diaster in 2008 not because of RBI or efficiancy of our govt. you start giving more money to the govt. more scames likely to come. Common wealth games, IPL, Telecom what not. Long live shadow/black economy.


Abhay Kothari

Aug 13, 2010

The only way to reduce the unacconted economy is by being very very tough with politicians/bureaucrats who are living beyond their means. Corruption is the root cause of generating and usage of unaccounted wealth.
Is it possible to punish politicians/bureacrats? That's the million dollar question.


Ramesh Rajpal

Aug 12, 2010

Most of the business people either don't pay any tax or very minimal tax. The reason being that there is no security available to the individual that he will get any support for his living when he is not in a position to work any more. India is full of corruption-deep rooted and institutionalized. People who pay their taxes sincerely and regularly i.e. the salaried class [low and middle income] are harassed the maximum.Instead of Babugiri if better governance is practiced, things would be much better.


Ganapathy Sastri

Aug 12, 2010

Reduce marginal tax rate to 20%. Enforce stringent penalties on defaulters.



Aug 12, 2010

Reduce the tax rates. Reduce the corruption level- in all fields including politics. In many places to get even simple work doen, one has to pay money in cash. This leads to need for generation of black money to meet the needs in this shadow economy. Change has to start from the top. Our politicians must take a vow that they will make concious efforts to stop corruption.



Aug 12, 2010

Let the government simplify laws and tackle corruption and let politicians become honest.This will bring back part of the money. Also money swallowed by bureaucrats and politicians is several times more than that stashed abroad. The Loka Ayukta in Karnataka has caught buraucrats red-handed with illegal cash and assets worth over 50,000 crores. Nothing has happened to anyone of them! This amount is only a small part of the money in corrupt bureaucrats hands in one city!


Zephyrine Goveas

Aug 12, 2010

Was there not a condition which said that all the individuals owning a telephone or mobile connection should file tax returns? I think this has not been implemented. Further, when the agricultural income is tax free and majority earning may be through agricultural income, this section of the population will never file tax return. Further, I don't think all car owners are filing tax returns. I know at least one case where not only the person owns car but he also a below poverty line card!

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