Demonetisation: RBI could get Rs 3 lakh crore richer, as could the government

New Delhi, India Dec 05, 2016, 09.33 AM(IST)

Decline in interests on bank fixed deposits and other small savings schemes has also been observed in the recent past. Photograph:( AFP )

By Saurabh Goenka

How would you feel if a friend whom you owed money never took it back? Let's say Rs 10,000. 

Now, how would you feel if that amount were Rs 3 lakh crore? 

That could happen to the Reserve Bank of India on December 30, the last date to deposit old Rs 500 and 1,000 notes. According to the RBI, before demonetisation, the now-old Rs 500 and 1,000 notes added up to a total of Rs 14 lakh crore. Till November 28, only Rs 8 lakh crore in old notes were deposited in banks. It is further expected that not more than another Rs 3 lakh crore in old notes will be deposited by December 30, the last date to do so. 

That leaves Rs 3 lakh crore worth of old notes that might never be exchanged for new.  

Should that happen, the RBI will become richer by Rs 3 lakh crore, since it will then not be obliged to pay the persons holding the old notes. 

Before moving on to an example, let’s check the definition of a currency note. 

A currency note is a "promissory" note or bill issued by a country's central bank. Promissory means implying a promise. The currency we use as money then is basically a piece of paper, but backed by the RBI with the promise of paying the person holding the note the value of the note. (Bear with me.) 

Now the example:

Let's say Mohan goes to his friend Sohan’s shop and picks up a cellphone for Rs 2,000. 

But he currently does not have the money to pay for it. Sohan agrees to take the Rs 2,000 from him two months later and makes Mohan write on a piece of paper that he will pay anybody who holds the paper Rs 2,000 after two months. 

A few days later, Sohan has to pay the wholesaler Mr Mukesh Rs 10,000. Sohan pays him Rs 8,000 in cash and hands over the paper signed by Mohan (promising Rs 2,000). Mukesh can now take this "promissory note" and collect Rs 2,000 from Mohan on the specified date (two months later) or use it to further "pay" someone else.

In the Indian economy, the RBI undertakes this "promise". 

Take out any note from your wallet and check for yourself. For example, take out a 100-rupee note and read what is written on it above the RBI governor’s signature. It says: "I promise to pay the bearer the sum of one hundred rupees". 

Now say Sohan does not use the paper signed by Mohan, nor does he pass it on to anybody else. In that case, in two months, Mohan becomes richer by Rs 2,000. 

Exactly the same thing -- albeit on a much, much larger case -- could happen with the RBI and the old currency notes. The Rs 3 lakh crore that might not be deposited with the banks will no longer have to be backed up by the RBI, making it richer by that much. 

A Rs 3 lakh crore windfall! 

What will happen with all this money?

The RBI will transfer it to the government of India in the form of dividend. This will in turn reduce the government’s budgetary deficits; in simple terms, the government could use the money to pay for public expenditure, ie build roads and hospitals, add to its rail network, etc etc.

Would the public benefit from this?

Yes of course. Greater government expenditure on public infrastructure would mean better facilities for the public. Plus, the actual building and running of this infrastructure would create more jobs -- possibly offsetting any loss of jobs and recessionary trends witnessed in the immediate aftermath of the demonetisation. All this potential infrastructure building will require raw material to feed it, which would mean more production, which in turn could mean a possibly higher GDP.