If those with black money do not convert all their R500/1,000 notes to new ones for fear of the taxman discovering their hoards, the government could reap a rich bonanza.
Assume that, of the R14 lakh crore worth of R500/1,000 notes, R2 lakh crore are not converted, but are burned. With R2 lakh crore less of currency to redeem, RBI’s currency liabilities will reduce by this amount. This effectively allows the central bank to print a broadly similar amount of fresh money without it affecting anything. This can, theoretically, be parked in a contingency fund and later transferred to the profit and loss account and, over a period of time, given to the government — effectively then, the government can get a windfall to recapitalise banks. This is what the chief economic advisor meant when he said, on Thursday, that the demonetisation could be seen as a transfer of black assets from private individuals to the government — the size of the transfer depends on how much currency is not converted and that, in turn, depends on the size of the black economy.
The accounting operation, of course, is a technical one and involves reducing the asset side of RBI’s balance sheet to match the reduction in the liabilities side — this is done by increasing the ‘net non-monetary liabilities’ which, since they appear on the assets side, will appear with a negative sign (see graphic for details of RBI balance sheet).