Its been called India's 9/11, surgical srtike on black money. But in reality, demonetisation is India's version of TARP, the post financial crisis (2008) US bank bailout programme. Black money is really a superficial sideshow. How?
Black money - the superficial
Look at the numbers. At a macro level, total currency in circulation (C) in India, per RBI is ~17 lac crores. 500/1000 rupee notes constitute ~85% of this stock, or ~14.5 lac crores (USD 220 billion). Estimates of black money, whether Baba Ramdev (70 lac crores, or USD1.2 trillion), or World Bank (which estimates it to be ~20% of GDP annually, or USD400 billion annually), are a very large multiple of any putative number derived from the stock of currency in circulation. Ergo, the black money discussion is really rhetoric, and only for public consumption.
Bank bailout - its vital, its big
Again, look at the numbers. 14.5 lac crores of demonetised notes can be classified into 3 categories.
X would be tendered back to the banking system, either to exchange back into new notes, or bringing that part of the business in the "cash less" domain. Y too would largely come back into the banking system, either by making it legal (paying penalty/tax) or through various jugaad means.
Z, on the other hand, will be partly converted into alternate stores of value (Gold, Real Estate), but a large chunk will simply be burnt up in the air. Lets assume at least 60% of this, ~2 lac crores, blows up in thin air.
Impact on bank capital/finances
Given the restrictions on withdrawals expected to be in place for some time, bulk of X+Y (10.5 lac crores), say 75%, will lie as bank deposits for at least 6-7 months. At a modest NIM of 4%, that translates to ~16,000 crores of extra profits for the banking system. In the longer run, even if a modest 30% of these deposits (or 3 lac crores) remain in the banking system for good, it generates incremental 12,000 crores of profits for the system. As a comparison, the total budget for recapitalisation of banks this fiscal is 25,000 crores.
Next, Z. The money that is "burnt away"(2 lac crores as estimated above), or doesnt get tendered back into the banking system, extinguishes a concomitant liability in RBI's balance sheet. Extinguishing of the liability without any change in assets means RBI's reserves go up by the same amount. Whether this money can be paid as dividend to the government is up for debate, but there is no doubt that RBI will have a higher reserve that could be deployed. An obvious use could be to recapitalise banks, as CEA Arvind Subramaniam suggested in the last economic survey. Whether as a fiscal boost or as a straight capital injection into banks, the impact is large and meaningful.
Last, bond yields. Demonetisation imparts a deflationary shock to the economy. With 13% of M3 effectively withdrawn for a period, demand for a variety of goods and services will go down, thus reducing prices. Additionally, enhanced liquidity with banks and a fiscal boost for government both impact yields positively (downwards). Biggest beneficiaries of downward trending bond yields are banks, that can make large treasury gains out of their holdings of SLR securities (government bonds, which is ~25% of the total balance sheet of banks). Again, its a positive blow for bank finances.
Net net, whichever way you carve the data or assumptions, this isnt about black money. This is all about a banking system bailout, intended or otherwise. Bankers working hard over the weekend would do well to remember!
Black money - the superficial
Look at the numbers. At a macro level, total currency in circulation (C) in India, per RBI is ~17 lac crores. 500/1000 rupee notes constitute ~85% of this stock, or ~14.5 lac crores (USD 220 billion). Estimates of black money, whether Baba Ramdev (70 lac crores, or USD1.2 trillion), or World Bank (which estimates it to be ~20% of GDP annually, or USD400 billion annually), are a very large multiple of any putative number derived from the stock of currency in circulation. Ergo, the black money discussion is really rhetoric, and only for public consumption.
Bank bailout - its vital, its big
Again, look at the numbers. 14.5 lac crores of demonetised notes can be classified into 3 categories.
- X: Genuine, tax-paid currency in circulation required to grease the wheels of the economy. How much should this be? Currency in circulation constitutes ~13% of total money supply (M3). Comparable economies (China, Malaysia, Indonesia) have a ratio close to half of this. Ergo, lets say that half, ie, ~7 lac crores would be reconverted into new notes in the system.
- Y: Tax-avoided money, but used in legitimate businesses. Typically, there is seamless flow of this liquidity to and from the "white" economy.
- Z: Tax-avoided money, either from illegitimate sources (laundering, corruption, terror etc) or as stores of tax-avoided wealth.
X would be tendered back to the banking system, either to exchange back into new notes, or bringing that part of the business in the "cash less" domain. Y too would largely come back into the banking system, either by making it legal (paying penalty/tax) or through various jugaad means.
Z, on the other hand, will be partly converted into alternate stores of value (Gold, Real Estate), but a large chunk will simply be burnt up in the air. Lets assume at least 60% of this, ~2 lac crores, blows up in thin air.
Impact on bank capital/finances
Given the restrictions on withdrawals expected to be in place for some time, bulk of X+Y (10.5 lac crores), say 75%, will lie as bank deposits for at least 6-7 months. At a modest NIM of 4%, that translates to ~16,000 crores of extra profits for the banking system. In the longer run, even if a modest 30% of these deposits (or 3 lac crores) remain in the banking system for good, it generates incremental 12,000 crores of profits for the system. As a comparison, the total budget for recapitalisation of banks this fiscal is 25,000 crores.
Next, Z. The money that is "burnt away"(2 lac crores as estimated above), or doesnt get tendered back into the banking system, extinguishes a concomitant liability in RBI's balance sheet. Extinguishing of the liability without any change in assets means RBI's reserves go up by the same amount. Whether this money can be paid as dividend to the government is up for debate, but there is no doubt that RBI will have a higher reserve that could be deployed. An obvious use could be to recapitalise banks, as CEA Arvind Subramaniam suggested in the last economic survey. Whether as a fiscal boost or as a straight capital injection into banks, the impact is large and meaningful.
Last, bond yields. Demonetisation imparts a deflationary shock to the economy. With 13% of M3 effectively withdrawn for a period, demand for a variety of goods and services will go down, thus reducing prices. Additionally, enhanced liquidity with banks and a fiscal boost for government both impact yields positively (downwards). Biggest beneficiaries of downward trending bond yields are banks, that can make large treasury gains out of their holdings of SLR securities (government bonds, which is ~25% of the total balance sheet of banks). Again, its a positive blow for bank finances.
Net net, whichever way you carve the data or assumptions, this isnt about black money. This is all about a banking system bailout, intended or otherwise. Bankers working hard over the weekend would do well to remember!
You have not taken into account the agricultural economy of 70% of the population. The revenue as well as capital gains( on sale of agri lands) are exempt from tax. This coupled with welfare injection by govt means a huge cash economy. Have you included this in X ?
ReplyDeleteAgri is only 14% of GDP, so its not a big economic contributor. and its anyways tax-free. so all included in X.
DeleteVery narrow and motivated application of basic macroeconomics concepts. Banks earn by lending our money. This policy of modi will adversely affect the real sector. This uncertainty and reduced demand due to liquidity prob, may actually reduce demand for loan. Banks sitting on huge balances may be forced to reduce interest rate .
ReplyDeleteThere are many more objections.
There's no assumption of fresh loan growth, as credit demand is anyways weak. Refinancing existing higher cost FD with CASA is the source of incremental revenues.
DeleteThe econ impact is complex. I think too early to tell.
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ReplyDeleteThis comment has been removed by the author.
DeleteYup this is not about black money but it is all about bank bailout. What it is also about is the bailout of rich and powerful who defaulted on their loans. Yes the Finance Minister and SBI CEO has assured the public that the bad loans have gone nowhere but it is still under "Accounts under Collection". They must think Indian public are imbecile and do not have guts to speak up against Government sleight of hands.
ReplyDeleteIn essence in case of India, the way I see it is "Crony Capitalism" or "Oligarchic System" at its finest and happening in the very front of wide Indian eyes and in broad daylight. It is really about socializing the losses while privatizing the profits. Clearly the rich and powerful are being bailed out while the aam admi and aurat are being stripped naked and left to hung dry!
TARP never bailed out the rich and powerful! The important goal of TARP was to prevent the banks from being run over. In essence, TARP bailed out the common man and woman!
TARP bailed out sr unsecured bomdholders and equity holders, depositors were anyway bailed out even for WaMu.
ReplyDeleteideology apart, banks are central to modern economies, its a worthy cause to bail them out