Demonetization of Rs. 500 an Rs 1000 Notes in India and
its possible effects
This article has Five parts
Part-I
Benefits
of this process
Direct Revenue to the Government
1)
If we look at the
balance sheet of RBI1, every single note issued by it is a liability (as RBI
guarantees to pay the bearer specified amount as printed on the note). So, if
by 30th December any part of recalled currency notes of Rs. 500 and
Rs. 1000 denomination does not return back to RBI (which, as per some estimates
may be as high as 2-3 lakh crores) the unreturned portion of say, 2-3 lakh crores
will vanish from liability portion of RBI’s balance sheet, as the guarantee of
RBI to pay the bearer of note lapses. Therefore, RBI will have to show that
amount as an extraordinary income in Profit & Loss accounts for FY17, which
it could either pay as dividend to government of India or use it to re-capitalize
some of its subsidiaries for infrastructure financing or use it for other
purposes.
2)
It is sure and
clearly visible from trends that despite threats of prosecution from tax
authorities, people are flooding their savings and current accounts with money
more than the specified limits. The higher deposits, if not backed by satisfactory explanation
will attract penalties as high as 50-60%. Several businessmen will also try to
justify the high cash collections on account of higher sales or revenue generation
during FY16-17, this will also attract tax @10-30% + surcharges. All this
process is going to earn the government a windfall of tax revenues. Estimates vary from 1-3 lakh Crores.
3) The
government is likely to generate 2-5 lakh crores of revenue in this process of demonetization.
This amount is huge, if we see total fiscal deficit target for FY16-17 it is Rs.
5.33 lakh crores. Government might be in a situation to cement this gap up to
100% in one go. During last budget lots of notable economists criticized the government
and finance minister due to its decision of fiscal contraction despite poor shape
of infrastructure in the country. Now,
this decision gives room for fiscal expansion and increase planned expenditure
and that without affecting inflationary forces, leaving room for RBI for
monetary easing.
1.
RBI-BalanceSheet-Page-144
https://rbidocs.rbi.org.in/rdocs/AnnualReport/PDFs/11P2E7FC90CC39794A068E24313AFE0D535F.PDF
Banking
Sector Overhaul and Disinvestment
1)
Lots of undeclared
money will come into the system, increasing liquidity.
2)
Banking sector will
get a fresh dose life and blood due to high cash deposits. It can start another
phase of lending to boost economy and generate employment. As hoarding cash has
already been discouraged and technology is ripe for low cash/cashless economy
more and more transactions will be routed through banking channels, creating
more avenues for expansion of their business, opening of new branches, new
offices, creating new jobs etc.
3)
Due to high deposits
and that in the form of CASA (Current Account and Savings Account deposits), a source
of low cost funds for banks, there is more money available for lending, this
will increase the lending and NII (Net Interest Income). Banks will also be
able to Write-off more and more NPAs and clean their Balance Sheets. This will
tremendously impact their market valuations and government will be in a
situation to proceed with Disinvestment plan at rather attractive share prices.
4)
Government had set a
target of generating Rs. 56000 Cr. through disinvestment of public sector
undertakings. As the share prices of government owned banks will increase, it
will make it easier to meet the targets or overachieve it. As more money will
go to government it will cement its budget deficit and bring it in a situation
of a large fiscal expansion and that without even touching the inflationary forces.
5)
Under such favorable
situations in banking industry, government may go for its long awaited plan of
mergers and amalgamation in PSU banks to create larger than life, International
size/standard banks in India, which are need of hour, as source of large scale
finance is needed for infra projects and era of Development Financial Institutions is already over.
6)
The huge
availability of CASA and increase in turnover and transactions in banks, banks
could easily lower lending rates and banks will also be able to lower the
interest rates on loans, which will stimulate agriculture and industry in the
country. Cheap capital is one of the prerequisite for stimulating growth in an
economy.
Economy
and Financial Markets
1) As rightly stated by Jean Dreze (Welfare Economist and former
member of UPA’s National Advisory Council) that "Demonetization in
a booming economy is like shooting at the tyres of a racing car," this
decision is going to shave off a few percents (%) from the GDP growth numbers,
may be 2%, as predicted by notable economist and former prime minister Manmohan
Singh in his historic address to Rajya Sabha.
2) Demonetization process directly sucks out the liquidity
surplus from the market. Most of the transitions (60-70%) in India are cash
based and you can’t transform a cash based economy into a cashless economy overnight.
This decision has already impacted the transactions across the board. Ask any
retailer/wholesaler/hotel owner/restaurant owner or any other business owner per se,
if this decision by the government has impacted their business? ‘Ayes’ will be
the most common answer.
3) Overall demand has fallen as cash (especially change) has
become a scarce ‘commodity’ to possess. Supply of cash in the market is lower, especially
notes of lower denomination like Rs.100 and Rs.500 and Rs. 2000 is almost of no
use, as nobody is willing to provide you change of Rs. 1900 for purchase of Rs.
100 goods. This is seriously going to impact the market and the booming
economy. Financial markets, often called barometer of economy, has already
indicated this trend in advance. So the big question arises why the government has
shooted in its own foot just before the marathon? We will try to figure it out
in part-2 of this article.
Cashless
Economy
1)
The present situation
has already led to surge in amount and volume of cashless transactions. More
and more no. of people is switching over to online and cashless modes as no
alternatives are accessible. Installation of POS terminals, use of mobile
wallets like Paytm etc. have surged like anything. But how long this will
continue? Once the new currency notes are available in the market, are people
still going to use online means?
2)
To answer this
question we should first see how new notes are being printed and being
supplied. Total value of Rs. 2000 currency notes on order for printing is Rs. 7
lakh crore (50% of total recalled currency notes of Rs. 500 and Rs. 1000). This
clearly suggests that the government wants to create an artificial deficiency
of usable currency notes (change, Rs. 500, Rs. 100 and other smaller
denomination) in the market to continue to promote its agenda of cashless transactions
via mobile banking apps and cards as most of the transaction that happen on day
to day basis are low value transactions. In coming days, even after demonetization
is over, people will have to willingly or unwillingly switch over into cashless
mode as government may secretly suck back the more currency notes of lower
denomination from market via banking route.
3)
There are several benefits
of a cashless economy or society. As, most of the transactions could be easily
identified and traced, consumption pattern, demand, supply inflationary trends etc.
could be identified, it helps the central bank/government to take more accurate
decisions based on quantitative data of consumption and velocity of money. Transactions,
turnover, tax liabilities etc. could easily be identified and measured. High
speed mobile networks 3G/4G penetration is ever increasing, smart phone penetration
has increased, technological awareness of people is increasing therefore time
is ripe for proceeding towards this direction.
Poverty-Inflation-Subsidy Cycle
1)
India has developed
a very unique problem especially in agriculture sector. If government keeps MSP
(minimum support price) higher to help farmers earn higher income, it increases
inflation, makes raw material costlier and make poor die of starvation or
suffer due to malnutrition. If MSP is lower Farmers don't get enough money to
meet their expenses and they suffer. Several farmers commit suicide everyday due
to poor market rates and lower profit margins. Therefore government generally
keeps the MSP higher to incentivize farmers and keeps the processed grains
cheaper via subsidizing the finished products to support poor consumers. In this process
the government bears high expenditure
but has no other option but to continue with the trend. Problem is increasing
day by day as income of lowest strata of population in not improving but MSPs
have to be revised almost every year. There
are also political compulsions to do so.
2)
This problem has its
roots in unequal distribution of wealth. Rich (especially tax evading rich) get
money surplus as taxation process fail to absorb their surplus money as they are invisible to the system. They use this surplus money for consumption and sometimes
even wastage. Their consumption creates artificial demand in the market, which
on one hand drive economy but at other hand increases inflation. This inflation
increases the cost of almost all factors of production. Therefore, inputs and
labor cost become high but at the same time income of a poor farmer /salaried class or a micro/ small
manufacturer does not increases with the same pace and their standard of living
start deteriorating and government has to intervene by way of subsidizing the
products. This leads to two way control of market at both ends input as well as output.
3)
Rising inflation
also compelled the central bank to do monitory measures to suck out excess of liquidity
from the market by increasing policy rates. But this too has becomes
counter-productive as people who transact through black market remain mostly unaffected but doing business for poor/normal public becomes difficult. Economy
slows down but inflation persists. RBI blames central
government for fiscal measures and government blames RBI for monetary measures.
This is what has been happening in India for decades.
4)
The only possible
long term solution to the above problem is to make the distribution of income
more uniform if not equal, reducing the budgetary deficits and letting the prices to be controlled by market forces. Which neither the politics nor the welfare economics allows. Demonetization process is likely to touch even this grey area in multiple ways:
a)
It has suck out
excess liquidity from the market, especially the kind of liquidity surplus
provided by the black money.
b)
It has led to more
uniform distribution of wealth as some of the rich used poor for laundering
their cash by employing them to exchange cash for them or getting it deposited
in their bank accounts for some commission.
c)
Government may
generate anything between 2-5 lakh crores in the process and use it to lend
smaller sums to poor via more micro loans at minimal interest rates or on their
benefit schemes or by other means or ways possible.
d)
Poor might not
become rich in this process but large no. of rich will sure become poor in this
process. This is likely to down the rich-poor income gap and lower wasteful
consumption.
.......to be continue, more details to be covered in 2nd, 3rd, 4th and 5th part.
