Bank of America Merrill Lynch’s economist Indranil Sen Gupta expects the government to raise additional income-tax to the tune of 0.7 per cent of GDP from the black money that converts into bank deposits.
This should allow the Finance Minister to meet the fiscal deficit target of 3 per cent of GDP of FY18. The added revenue should enable him to recapitalise public sector banks without cutting public investments or delaying the full payment of the Seventh Pay Commission award, he said in a report.
A lower fiscal deficit also supports their call for lending rate cuts of 75 basis points by September 2017, he said.
He expects the RBI will likely have to do open market operations of ₹1.6 lakh crore to clear the money market. This, he expected, should generate excess demand in the goverment securities market.
Sen Gupta also said that they expect the RBI to cut down OMO (open market operations) as it should be able to meet the cash demand by a smaller expansion of the balance sheet/reserve money rather than extinguish liability and booking net profits to pass on to the government.
Saying the market was erring in expecting the RBI to book profits, he pointed out that the situation was different with the RBI as a creator of money. He explained that while a company raises a liability (say a loan), to create an asset, and if the bank closed down, the loan converts to net worth.
But with the RBI, which is a creator of money, it creates an asset in order to incur a liability. For example, it bought G-Secs/Fx to meet public demand for cash. So, if the public no longer needs the cash, the RBI will extinguish the asset backing it. There is, therefore, no case to transfer the demonetised portion to the fisc as profit, he said. That would simply tantamount to monetising the fiscal deficit.