The Big Picture- Demonetization: Are the expectations of windfall gain for RBI still valid?

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The Big Picture- Demonetization: Are the expectations of windfall gain for RBI still valid?


 

As the Reserve Bank of India continues printing cash to replace demonetized notes, any unclaimed amount can theoretically be claimed as a windfall gain to the Government. In practice though deploying such gains immediately will cause disruptions in the financial system, RBI will have to take a long term view on how to deploy any such gains whether by infusing into the banking system or paying the Government through dividends. The Central Bank and the Government have yet to calculate how much the gain will be. With the demonetization of 500 and 1000 rupee notes, some 14 lakh crore rupees went out of circulation. The RBI is printing new notes of 500 and 2000 rupees denominations. However, because of a number of reasons, including the fact that a lot of the notes were counterfeit, a certain amount of notes are unclaimed which will be a gain to the RBI.

Analysis:

There are divided opinions over this issue. Till now 8.44 lakh crore rupees has come and it will be visible in the subsequent year as how much gain is actually incurred. Government has also brought in a Bill for unaccounted money. The objective behind this exercise was to curb black money but the premise seems to be flawed because a very small proportion of black economy is held in cash. There is still a lot of cash that will get into the system in the coming days along with the withdrawals now. There will be one major advantage that the shadow economy will merge with the real economy.

If we look at the slowing down of economy by even 1%, it is equivalent to 2 lakh crore rupees. If the economy loses generation of this amount of money, there is a need to see then how much of the black money will come into the system plus how much money would come to the Government’s kitty apart from RBI because it has contingent liability which it has to provide for and only some amount might come to the government in the form of dividend by RBI. We have to look whether 1% of GDP loss which is definite is worthwhile or not. Gains will have to be deployed in a calibrated manner.

Demonetization seems to be more of politics than economics. Taking out informal sector out of the system which thrives on jobless growth and cash economy will not help in future. It would have huge repercussions on liquidity if money is sucked from one market and put it into another. This is like creating space for capitalists and all of them have welcomed this move as well. In 2016, this has been an executive decision. There was no ordinance based on which the demonetization was made unlike in 1946 and 1978. There is some truth in the words said by Dr. Manmohan Singh that the preparation that should have been done to minimize the discomfort to the people as well as economy. Even while maintaining the secrecy, better preparations could have been there to save the GDP loss.

Conclusion:

Government will be able to gain through this move by way of taxation, utilizing the money in infrastructure development, capital infusion for banks and by decreased consumption in the economy. RBI might keep some of the unclaimed legal tender to infuse in money markets. The gains to the government will be gradual and staggered keeping in view the implications on market.