Estimating the Size of Black Economy in India

The issue of black economy is a hotly debated issue in India and it has been the key target of policy action from last four decades. The debate is further fueled by demonetization of higher currency notes in the country. In this context, we estimate the size of black economy in India for the period 1970-2013. A currency demand approach is adopted for this purpose. The test of structure break indicates for a break in the system therefore we employ Johansen et al. (2000) cointegration test. For estimating the empirical model we utilize fully modified ordinary least squares (FMOLS) for taking care the endogeneity problem. The estimates indicate that the Indian economy has a sizable black economy. Specifically, in the last estimated year, 2013, it is computed to be US$957 billion or 52% of the Indian GDP. Nevertheless, since early 1990s, perhaps because of a range of fiscal reforms, it has been decreasing. In the light of these findings, policy implications are brought out.