The Centre’s move to demonetise ₹500 and ₹1,000 notes is no doubt a crackdown on black money. But can the Centre also earn a windfall gain by such a move, so much so that the fiscal deficit halves?
The beauty of Modi’s demonetisation move lies in the fact that aside from requiring people to exchange these notes for other denominations or depositing money in banks, it has cancelled the existing notes as legal tender.
This leaves hoarders with two options. Either disclosing their unaccounted cash holdings and run the risk of being asked to shell out tax, plus a heavy penalty.
But given the steep penalty and also the possibility of prosecution, in all likelihood, significant portion of this hoarded cash will not be tendered for exchange. What happens then? Let us work with some numbers. The current currency in circulation ,according to the RBI is about ₹17.5 lakh crore. Of this, around 86 per cent in value or ₹15 lakh crore is in ₹500 and ₹1000 notes. If we assume that about 10 per cent (an indicative figure) or close to ₹1.5-2 lakh crore of notes don’t come back into circulation, the Reserve Bank of India would have made a handsome profit. How?
The about ₹2-lakh-crore worth of notes which continue to be stocked away, become useless come December 30, the last day for exchange or deposit of old notes. On the RBI’s balance sheet, liability in the form of ‘notes issued’, extinguishes to that extent.
According to the RBI’s annual report, in 2015-16, notes issued formed around ₹17 lakh crore of its liability. This will now reduce by ₹2 lakh crore as the RBI is not liable to pay this amount any more.
An equivalent amount (around ₹2 lakh crore) can move into reserves, through the profit and loss account. Since 2013-14, the entire surplus in the RBI’s coffers has been transferred to the Centre. If one assumes that close to ₹2 lakh crore gets transferred to the Centre, then its total receipts gets a boost and fiscal deficit falls substantially.
According to Budget estimates, the fiscal deficit for 2016-17 is projected at about ₹5.33 lakh crore or 3.5 per cent of GDP. If the Centre’s coffers fill up by over ₹2 lakh crore, the fiscal deficit number that ends up in the upcoming Budget this time may well be a shocker 1.5-2 per cent.
This could mean a fall in government borrowing rates, and hence lower rates for the economy as a whole.
The Centre may well have delivered on its objective to bring down rates, despite the RBI’s tardiness.