There is some confusion on how the note derecognition issue will result in a huge bonanza for the government. The idea is :
- Rs. 500/1000 notes are no longer exchangeable after March 2017
- The “black money” that did not convert to the new notes will be “invalidated”
- So they are no longer a “liability” of the RBI
- Thus the RBI makes a profit! (We’ll come to this)
- And then RBI will pay that profit to the government as dividend
- For the express purpose of recapitalizing banks
First, The Accounting
Look, RBI is the only entity in India which has rupees as a liability – every rupee printed is something that says “I promise to pay the bearer a sum of X rupees”. The liability is on the RBI. You can’t have liabilities without assets. So the RBI prints rupees and uses those rupees to buy things – such as Gold, Indian Government Bonds, Foreign Currency Bonds etc.
Every rupee is backed with one of these assets. Every printed rupee, that is. The stuff in your bank is not backed by anything (only 4% of it is, and Rs. 1 lakh as insurance by RBI), but that’s a different story.
So how does the RBI earn money?
It gets interest from Indian govt bonds and foreign bonds. It gets interest in the repo operations. It profits when it sells bonds or forex. These are realized profits (or losses) that it makes every year. And this profit is what is used for running the operations of the RBI. However, it spends very little and gives out more than 99% of this income back to the government as a dividend.
Now, there is a lot of “unstated” profit. Like if they printed Rs. 60 and bought 1 USD at Rs. 60. Asset side is 60, liability side is Rs. 60 note printed.
If the USD goes up to 67, then the asset side is 67, but they haven’t printed more notes! What to do?
The answer is that the “adjustment” goes into a special “non monetary liabilities”. This is just an account that sits in the balance sheet – and the profits/losses do not flow into the profit and loss statement of the RBI. (Note: this is not possible for most other Indian organization to do without auditors busting a blood vessel, but please understand that the RBI is different)
To give you an idea: here’s the RBI Balance Sheet. They earned about 80,000 cr. (800 billion) in interest and fees. They spent about 15,000 cr. , and paid the remaining 66,000 cr. to the government as a dividend.
However if you look at the “revaluation accounts”, you’ll see that the Currency and Gold revaluations, plus other bond revaluations have increased the balance sheet size by another Rs. 80,000 cr. This could have been a “profit” but it’s not – and it has not been used, ever (as far as I can see) to pay a dividend to the government.
The Demonetization Accounting
We already know there are about Rs 15 lakh crore worth of Rs. 500/1000 notes in circulation. We will make the (possibly incorrect) assumption that some of them won’t come back. Let’s assume about Rs. 400,000 Crore worth notes do not return.
Then, what happens? RBI’s liabilities of currency come down by a whopping Rs. 400,000 Crore (it’s balance sheet size is Rs. 32,00,000 Crore so it’s “whopping” as a percentage).
Because now the assets haven’t changed – the RBI has sold no Gold or Forex or anything else – the liability side will decrease. Since this is new, we don’t know where it will go; it’s not an “earned” profit like interest, so it can only be a revaluation liability. Or it can be a “one time” profit, which can be paid out. We don’t know what it will be.
But, and here’s the crux, I don’t think it will matter. The RBI won’t make that much money from it.
All The Money Will Come Back
Think of a person who has Rs. 1 Crore of cash, in these notes. What’s he going to do?
The answer: something, anything. He will deposit a little bit in his family accounts – perhaps four people, 2.5 lakh each.
He will buy some gold, perhaps. And eventually ask if the jeweller will give him new notes for the old notes – which the jeweller will probably say, ok, at 40% discount. Political parties can take upto Rs. 20,000 per person anonymously in cash – they will be used to launder this money, and eventually pay out as part of some rally expense that no one can monitor.
Temples can be given cash and they can give you a loan. Eventually if that loan is written off, no one will know. Maids are already being given cash to deposit and return at a 20% discount.
Yet others will just take the risk, deposit the money and pay 30% tax and hope for the best.
This architecture will be fine tuned over the next few weeks, and everyone who has black money will have to take a hit but get money back. Whatever he does, he will take a discount and convert into new notes or move into his bank account.
In essence, all the notes are coming back to the RBI. All of them or nearly all. Some will be lost and others with people who can’t come for geographical limitations etc).
This means the RBI gets no really meaningful “one time” profit for writing off the unreturned 500 rupee notes, because most notes are returned. No big one-time profit means no big dividend either. And the RBI will spend a lot more money on the collection and printing of new notes.
The Government Will Benefit – Some Tax, But After Some Time.
Unrelated to the RBI dividend – which may not be a big deal – the government is likely to get some tax going forward. People who put more money into their account will pay some. But the collection will take time, since tax notices will only go next year and by the time the tax is in, it could be another year.
The Overall View: Popular
Forget the inconvenience. Forget that all channels are showing hardships. Forget that this thing might not load to an RBI profit or greater tax in the short term. The scheme is incredibly popular because it hurts people who have black money (Who will lose money – they will take a big discount on that money).
That alone is enough to make this look successful. Whether this feeling remains popular if these issues result in other complications like shortage of supplies, loss of jobs and increased retail bank NPAs (because of lack of proper cash flow) – remains to be seen. At this time, though, it’s a very popular thing to do. We’re just putting the statistics out there.
