opinion

Updated: Aug 12, 2017 11:56 IST

The Reserve Bank of India’s (RBI) announcement this Thursday to halve its dividend payout to the government has once again put demonetisation under the spotlight.

It was earlier expected that there would be a big windfall for the RBI, from the government’s November 8 decision to scrap currency notes held in denominations of Rs 1,000 and Rs 500. The argument was a sizeable part of these high-value notes, estimated at about Rs 3 lakh crore, were dodgy cash (read as black money) and would not return to the system. The amount could be written off from the liability of the central bank, which could then transfer this ‘windfall gain’ to the government either through higher dividend or some other means. The government, in turn, could use this money to build infrastructure, capitalise banks or invest in other growth catalysts.

This hopeful script, however, has gone horribly wrong. It now appears that most of the cash held in such high-value notes might have returned to the system, although the RBI maintains that it still counting the demonetised notes.

Worse, the RBI’s announcement coincided with the release of a research report by the State Bank of India (SBI) — the country’s largest — that severely undermines the government’s earlier claim that the impact of demonetisation would inevitably subside in a few months and make way for accelerated growth.

According to the SBI report, in the first four months of the current fiscal year, bank credit has shrunk to Rs 1.5 lakh crore, or 2%, compared to the same period a year ago. The SBI report, moreover, has identified the sluggish trend in home loans and personal loans as being even most worrying. Clearly, further indicating that consumer confidence hasn’t yet turned around and India still remains wary of their economic prospects.

What is also alarming is that the informal credit network that otherwise used to fuel India’s cash economy seems to have been profoundly disoriented in the wake of demonetisation. The belief, moreover, that the informal credit network would simply shif to the formal (banking) sector hasn’t happened.

The findings of the SBI report also underscore the structural risks involved in trying to shift a multi-layered and complicated economy such as India’s into the formal economy in a single shot. The latest update on RBI’s finances bear it out.

Let alone a windfall, the RBI has not been able to protect its income, thanks to demonetisation. For 2016-17, it will pay Rs 30,459 crore in dividend to the government, compared to Rs 65,876 crore it paid last year. There are broadly three reasons for the lower payout, directly or indirectly linked to the November 8 2016 decision:

First, the central bank is understood to have spent about Rs 15,000 crore on printing new notes. This money wasn’t budgeted, because the note-ban decision was supposed to be a surprise move.

Second, when people rushed to deposit demonetised notes, banks ended up with huge piles of cash and left the financial system with excess liquidity that could have stoked inflation or triggered other imbalances.

The RBI was forced to conduct reverse repo operations: meaning it had to borrow short-term money from the banks to suck out excess liquidity. Some estimates put the excess liquidity to be as high as Rs 8 lakh crore in early January, which means the RBI must have paid a fair amount in interest charges to the banks.

The last, but the most important, reason for the fall in RBI’s earnings relates to a decline in returns on investment in US treasury bonds, which was aggravated by the rupee’s appreciation against the dollar.

The RBI earns a good part of its income by investing India’s foreign exchange reserves in US treasury bonds. A big spurt in this income through 2015-16, in fact, had helped the central bank make a record dividend payout to the government.

In 2016-17, it was expected to moderate because interest rates in the US were softening. But the blow to the RBI turned out to be harder, thanks to an appreciating rupee that further diminishes the impact of lower dollar earnings. Between July 2016 and June 2017, which is the financial year for the RBI, the rupee has risen nearly 5% against the US dollar, primarily because imports have been sluggish.

Demonetisation has hit exports hard, especially in sectors that are import-intensive. It also dampened consumption spending, keeping imports and demand for foreign exchange subdued and helping the rupee appreciate.

Rajesh Mahapatra is the Chief Content Officer, Hindustan Times.

Follow him on Twitter @RajeshMahapatra