Demonetisation gold pot: Will it all end up as an 'accounting adjustment' for RBI?

Banks will be the biggest beneficiaries with deposits coming in large quantities leading to surplus liquidity in the system.

Madan Sabnavis November 23, 2016 07:39:04 IST
Demonetisation gold pot: Will it all end up as an 'accounting adjustment' for RBI?

The demonetization exercise has led to a barrage of conjectures on the sums of money that will be involved and their possible allocation by the end of December. The magic number is around Rs 14 lakh crore, which is the amount that was in Rs 500 and Rs 1,000 in circulation as of March 2016. As these notes have been taken out of the system, the guesswork is as to how this would be dispersed.

Demonetisation gold pot Will it all end up as an accounting adjustment for RBI

Representational image. Reuters

There are three alternatives here. The first is where the money goes into deposits with banks as savings accounts and probably gets converted into time deposits to the extent that there are no corresponding withdrawals. The second is cash is exchanged for new notes which come back into the system directly, while the last is currency that remains with the holders which is not disclosed and would be the ‘perfect black money’ that the government has been targeting.

The RBI’s latest data on this exercise reveals that as of 18 November, Rs 5.44 lakh crore has been tracked with Rs 5.11 lakh crore going into deposits in cash and another Rs 0.33 lakh crore being exchanged under the one-time scheme permitted by the central bank. Another Rs 1 lakh crore has been withdrawn from the deposits put in giving a ratio of about 15 percent.

How will things pan out in the next 40 days or so is anyone’s guess. Some argue that there will be acceleration in such deposits as the time period moves on, while others view that all those trying to channel their money through dubious means have been checkmated and hence the flows will slow down. The government has officially mentioned that it hopes to get in Rs 10 lakh crore of deposits, and assuming that the ratio of currency to deposits of 20 percent holds good, currency held could be in the region of Rs 2 lakh crore, and the balance Rs 2 lakh crore would get impounded.

Now, banks will be the biggest beneficiaries with deposits coming in large quantities leading to surplus liquidity in the system. Two implications from this outcome are that deposit rates will come down which has already been witnessed and the other is that bank lending rates should reduce. As savings deposits rate are fixed, they would necessarily lower the term deposits rates. This will be good for industry as there has been a clamor for lending rates to be lowered. In fact, the Reserve Bank of India can tarry for a while in lowering the repo rate as banks on their own volition would be lowering rates under the pressure of surplus liquidity. But will this help?

One cannot be sure as one large section of borrowers, i.e. small industry is grappling with liquidity issues with business levels coming down by 50-80 percent due to the currency crunch. Production activity as well as services has come down significantly which may not put them in a position to borrow funds at a time when business is uncertain. This will be so for the third quarter for certain and probably also for Q4 to an extent. The shortage of currency in the market has already put pressure on the farm sector and SMEs which operate fully in cash. Services like transport and hospitality have witnessed irrevocable decline in business as any shortfall in this period will not be made up unlike demand for manufactured goods, which can pick up later when conditions normalize.

Further, consumer spending has come down as there is a cash margin that has to be paid when buying on credit. Also in situations where the cash system is not normal, there is a tendency to become cautious when spending. Therefore, these industries would also witness lower demand leading to less funding requirement. In fact, interestingly, the most vibrant form of credit is mortgages which will witness a setback as households will defer purchases of dwellings leading to decline in home loans. Hence, it will be a mixed bag for banks which may have to deploy the funds in the GSec market.

Will the government gain? It is expected that the IT department will scrutinize closely the Rs 5-10 lakh of deposits that come in which would be liable for taxation. To the extent that the holders cannot defend the source of such money, there would be a tax-cum-penalty imposed. Assuming 10 percent comes under this net and is fined say 50 percent, there could be a gain in tax revenue of around Rs 50,000 crore which will supplement well the money procured from the income declaration scheme of around Rs 30,000 crore. While this will be a one-time effect, the broader gain will be in the coming years, where tax compliance improves dramatically and given that the GST is to be introduced in the next year, the efficacy of the latter will get enhanced.

What about the impounded money? Assuming that Rs 2 lakh crore of currency cannot be declared and does not flow into the banking system as deposits for evident fear of being questioned, the notes have to be burnt or destroyed as it would be paper with no value. This would be the final tally of the black money that has been unearthed even while being concealed as the identity of the persons will never be known.

The disappearance of money from the system will be an accounting positive for the RBI where liabilities come down. However, the positive impact on the government would be only to the extent that the government has issued debt on a fractional basis to the RBI for issuance of currency. To the extent this comes dow n, there would be a benefit on the interest payments of the government and hence fiscal balances. Otherwise, it would be more of an accounting adjustment that will not lead to any financial benefits in concrete terms.

Therefore, the next few weeks will witness considerable volatility where spending and borrowing will be under the lens and the sooner the structures are in place to deliver currency and make ATMs operational, the quicker it will be for the recovery to kick in.

(The author is Chief Economist, CARE ratings. Views are personal)

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