Wednesday, November 16th, 2016

Demonetisation: Government gains at RBI’s cost

MK Shukla | November 16, 2016 10:55 am Print
According to official statistics, it cost RBI a little over Rs 3 to produce the demonetized Rs1,000 note, the lowest in terms of printing costs as a proportion of value. Printing notes of smaller denominations is relatively costly.

An internal research, conducted by the State Bank of India, shows that while demonetisation may provide the government with a fiscal benefit of Rs2.5-lakh crore or more, the RBI may suffer a net loss of seigniorage of Rs 2,800 crore. Seigniorage is the difference between the value of money and the cost to produce and distribute it.

The research bases its study on the experience of the 1978 demonetisation exercise to state that there may be a cash payout against the extra notes printed by the RBI to the government. As the RBI will issue notes only against the old ones, there has to be a decline of an equivalent amount from the RBI’s asset side/cash payouts.

According to official statistics, it cost RBI a little over Rs 3 to produce the demonetized Rs1,000 note, the lowest in terms of printing costs as a proportion of value. Printing notes of smaller denominations is relatively costly.

Further, the notes issued by the RBI appear as liability on its balance sheet. It creates a corresponding entry on the asset side by investing in foreign currency assets abroad (in US treasuries) in lieu of such currency holdings. The investment income generated in turn is transferred back to the government through dividend income, among others. The RBI is expected to transfer this windfall to the government over time. The study said that “Such amount may be at least Rs 2.5-lakh crore, but with a significant upward bias.”

There is a possibility of about 25-50 per cent of the existing notes not being exchanged at all as people are resorting to various ways to get rid of stashed cash.

In March 2016, the total value of Rs500 and Rs1,000 denomination notes in circulation stood at Rs 14.18-lakh crore, of which Rs 2.5-lakh crore or more may flow back into the system, says the study.
It is estimated that anywhere from 25-50 percent of this cash of Rs 14 lakh crore in circulation is unaccounted money, hoarders are extremely reluctant to go to the bank and deposit the cash. “Hence, burning them is the quickest way to get rid of these notes and the process has reportedly begun in Uttar Pradesh,” the study said.

MK Shukla
MK Shukla
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