Demonetisation will serve two purposes

RADHIKA MERWIN | Updated on January 15, 2018 Published on November 11, 2016



It not only sends out a stern message to hoarders, but could also significantly rein in the fiscal deficit

Prime Minister Narendra Modi’s sudden move to crack down hard on black money has triggered resentment. The aam aadmi has been running from pillar to post, to make good his hard cash. The debate now is centred around whether the scuffle and panic on the street was really worth the while — would it make any dent on the black economy which is pegged at a whopping ₹ 30 lakh crore by various reports?

But what if the scheme is just the tip of the iceberg? What if the Centre can boost its coffers without requiring hoarders to come clean? BusinessLine was the first to report this line of thought (‘Will the govt move reduce fiscal deficit?’ November 10).

A windfall gain, a substantial one at that, could then be used by the Centre to up its spending, in turn benefiting the common man and the economy at large. Modi’s swift surgical strike could achieve far more than what other tax amnesty schemes managed to accomplish in recent past.

Little success

The Centre’s Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 came as a big disappointment raking in only about ₹2,400 crore in taxes. The latest Income Declaration Scheme (IDS) too grossly fell short of expectations adding about ₹30,000 crore to the Centre’s kitty. In hindsight, black money holders would be cursing themselves for not coming clean under the Centre’s one time IDS scheme. But that’s water under the bridge.

Now hoarders are left with two options. One, they can disclose unaccounted cash holdings and run the risk of not only shelling out tax, plus a heavy penalty, but also facing likely prosecution. Two, they can chose not to tender their undisclosed cash for exchange or deposit.

With the Government dangling the stick and issuing warnings that cash deposits of above ₹2.5 lakh could attract tax plus a 200 per cent penalty, in case of income mismatch, there is no wiggle room left for hoarders. In all likelihood, significant portion of hoarded cash will not be tendered for exchange.

Overnight, cash holdings of black money holders has turned worthless. But the Centre’s aim of this mammoth exercise is not merely to send a strong message to tax evaders. Rather, it is to ensure that the exchequer benefits by more than a few thousand crore this time around.

The current currency in circulation is about ₹17.5 lakh crore. Of this, around 86 per cent in value or ₹15 lakh crore is in ₹500 and ₹1,000 notes. If we assume that about 20 per cent (an indicative figure) of this is black then close to ₹3 lakh crore worth of notes may not come back into circulation. So how does the Centre make its buck?

No liability

The ₹3-odd lakh crore worth of notes which continue to be stocked away become useless come December 30, the last day for exchange or deposit of old notes. On the RBI’s balance sheet, liability in the form of ‘notes issued’, gets extinguished to that extent. According to the RBI’s annual report, in 2015-16, notes issued formed around ₹17 lakh crore of its liability. This will now reduce by ₹3 lakh crore as the RBI is not liable to pay this amount any more. The reduction in liabilities will be offset by an increase in net worth or reserves of the RBI, which then can be transferred to the government in the form of dividends. Since 2013-14, the entire surplus in the RBI’s coffers has been transferred to the Centre. If one assumes that close to ₹2-3 lakh crore gets transferred by way of dividends to the Centre, then total receipts of the government will shoot up sharply and the fiscal deficit can fall substantially.

As per Budget estimates, the fiscal deficit for 2016-17 is projected at about ₹5.33 lakh crore. If the Centre’s coffers fill up by even ₹2 lakh crore, (after taking into account the cost of printing new notes), the fiscal deficit could be a turn out to be a huge surprise.

Don’t plug fiscal deficit

But this is where the Centre will have to get its math right. Rather than use this windfall gain to plug fiscal deficit, it needs to spend this money to boost demand. After all demonetisation while leading to a sharp rise in bank liquidity will certainly lead to a squeeze across businesses and sectors impacting demand in the near term. It is hence very important that the Centre spends its bounty, either directly or indirectly to trigger consumption. The Centre can also take this opportunity to reward bonafide tax payers by announcing huge tax breaks in the upcoming Budget to spur demand. Robbing Peter to pay Paul may not be such a bad idea.

Interest rates which are expected to come down substantially post the demonetisation scheme, will also be a shot in the arm for the economy. A measured fall in fiscal deficit can lead to lower government borrowing and hence lower G-Sec yields. The banking system which will be flush with liquidity in the near term can set off a notable fall in lending rates. With the benefits of the demonetisation scheme trickling down to the aam aadmi and black money holders feeling the heat, the Centre would have killed two birds with one stone!

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Published on November 11, 2016
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