An issue being debated related to the demonetisation saga is the benefits accruing to the government. Much has been said about how RBI will gain and how, if this happens, the collateral benefit will accrue to the government through transfers of surpluses. Neither RBI nor the government has claimed this to be the logical conclusion, though there have been statements made that there will be a transfer of money from the private to the public sector. Evidently, there is merit in this argument though the transmission chain is unclear.
One way of resolving this issue is to go back to the accounts of RBI and see how the balance-sheet and income-expenditure statements would look like once money gets impounded. This is interesting because there would be a mix of balance-sheet items with income-expenditure entries. While the overall impact on the government balances would be positive with more income that can be taxed being revealed, the singular impact of currency being made ‘useless’ can be addressed through a partial equilibrium analysis where ceteris paribus conditions are made for other factors not changing. For FY16, the broad picture is shown in the accompanying graphic.
The RBI accounts are different from the corporate balance-sheet as, in the latter, one can find links between, say, long-term borrowings and fixed assets. But here, the assets are independent of the items in the liabilities listing. Forex investments are based on the reserves invested by RBI. The domestic investments are holdings of securities that are used for managing OMOs. Now when, say, R4,000 billion of currency disappears from the system (assuming this quantum is not revealed in either exchange of old notes or deposits during this 50-day window), the liabilities would come down to R28,429 billion. It looks unlikely that any of the assets can be reduced as they are held by distinct entities. Hence, government debt per se can’t come down. The adjustment has to be in the reserves which will go up as per the accounting standards followed by RBI. The other liabilities, the second-largest component including the currency and gold revaluation account (CGRA), is where unrealised gains from valuation of gold is capitalised rather than booked as income.
Therefore, the conclusion drawn here is that the balance-sheet per se may not really undergo a change in structure. A special reserve will have to be created to make the liabilities match with assets.
The other thought is whether the RBI surplus will increase on this score. To comprehend this impact, we need to look at the income and expenditure statement, which is provided in the accompanying graphic.
The income-expenditure statement reveals that the overall size of the income flows in FY16 is around Rs 808 billion, with income coming mainly from interest, which is on the investments made in domestic and foreign securities. Other income is mainly from exchange on forex transactions (R38 billion) and commission (R15 billion). None of these components could change because of impounding of currency as these investments and transactions are exogenous to this process.
The expenditure side is interesting. Out of the total expenditure of around R150 billion, establishment, agency charges (commission paid to banks for dealing with GSecs as well as underwriting fees) and printing charges account for 85%. Some of these may increase on account of printing of new notes, but will not come down. Hence, it is hard to conceive of a situation where the RBI surplus will increase on account of currency disappearing from the system as it is a cost already incurred. Any changes on account of a decline in currency holdings will be more of an accounting entry if it enters the income-expenditure statement and can’t be in the nature of money that can be used by the government to fund, say, a new road or bridge.
However, the future gains for the government would be better as more money comes into the tax fold. In fact, even within the current scheme, there could be several income tax notices sent which will result in a tax as well as penalty being imposed on the amounts deposited with banks. Further, by almost forcing households to migrate to alternative channels of payment at one stroke, future monitoring and tracking costs would come down and tax evasion to a large extent would be checked. Hence, administrative costs on tax collection would come down substantially with this move as compliance levels increase progressively. Better tax collections will have an indirect but positive impact on the fiscal deficit in future, another major gain to be had.
Hence, while the overall act of demonetisation will be positive for government finances, the precise phenomenon of disappearance of currency may not, on its own, be able to directly improve them, except in the accounting sense. The economic fabric will be cleaned up for sure, which is required given the depth to which the black economy has spread. This will also make it easier to run the administration and implement the GST next year when the major housekeeping exercise is accomplished.
The author is chief economist, CARE Ratings.
Views are personal