“Instead of seeing it (the demonetisation) as a reduction of wealth, it must be seen as transfer of unaccounted wealth. It should be seen as a transfer of this unaccounted wealth from private sector to government and public sector, which will boost economy,” chief economic advisor Arvind Subramanian said at a press conference on Wednesday.
The following is an attempt to explain the channels of this revenue accretion, translated from accounting in to simple English. We apologise for any exaggerated simplification and to accounting purists for any technical errors. Since RBI issues currency notes and coins, its balance-sheet will be the medium of transfer of the change in currency notes held with depositors (and hence banks) to the government. The accompanying graphic should help understand this narrative.
RBI operations are organised under the banking department and the issue department, the latter being in charge of currency issue. As of October 28, the holdings of high denomination currency notes was R15.1 trillion (lakh crore) in value. Of the total, holders of the old 500- and 1,000-rupee notes have the choice of giving these back at banks and post offices for exchange, either for legitimate, full-value exchange into the new R500 and R2,000 notes, or deposit these, some of which will be subject to tax audit. If tax evasion is detected, it will attract back-taxes, penalties and interest. This part will accrue to the government, although the realisation will probably be after the end of FY17, once the audits are started and completed. This part is straightforward.
Of the rest deposited with the banks, some part will be exchanged for the new notes and will continue to remain as currency in circulation. The notes which are deposited by customers with banks and not exchanged will be added to their respective deposits. This adds to what is technically called the Demand and Time Liabilities of banks, for which banks will deposit increased Cash Reserve Ratio (CRR) balances with RBI.
Now, consider the RBI balance-sheet. Banks will deposit the old notes (which are no longer legal tender) with RBI, which will reduce the currency liability (notes issued) of RBI by an equivalent amount. This, in turn increases the deposits liability of RBI. [The analogy for a bank depositor is as follows. I go to a bank and deposit cash, my deposit account is credited and the balance increases.]
The last bit of the old notes will just go missing and be unaccounted for. After the stipulated close of the exchange window ), either with banks (December 30) or some later date with RBI, these will be deemed to be extinguished and will be shifted from Notes Issued to Other Liabilities and Provisions with RBI. This is essentially a buildup of reserves. Schedule 3 of the RBI balance-sheet shows it might be initially under some some entry of the Other Liabilities and Provisions. After June 30, the year-end closing of RBI accounts, this is likely to be shifted to “Surplus Transferable to Govt of India”.Thereafter, these additional reserves can be transferred to government as dividend (or under some other head).
These transfers will be matched on the Assets side of the RBI balance-sheet, from the Issue Department to the Banking Department. Note that a significant portion of the currency liabilities of RBI are matched by foreign investment assets.
With inputs from Tanay Dalal and Abhay Chavan
The author is senior vice-president and chief economist, Axis Bank. Views are personal