Demonetisation: BJP’s theory busted

In the article, http://newsclick.in/demonetisation-basis-fiscal-stimulus, Prabhat Patnaik tries to clear the air around a popular argument that has been advocated by BJP spokespersons while defending the failure of the widely criticised demonetisation. The rumour goes: Rs 500 and Rs 1000 notes which have become worthless paper, will help to reduce RBI’s liabilities, since the currency in circulation is RBI’s liability. However, the assets remain unaffected. This would create a kind of surplus situation for RBI. The government has a stake (RBI dividends) in all the profits earned by RBI. Thus, in the medium term, government can use this money to inject a ‘fiscal stimulus’ or reduce fiscal deficit.

At the beginning, he suggests that the government cannot call ‘fiscal stimulus’ as the basis for demonetisation but merely a by-product, if at all their theory is true. This is because cash transfers to public or investment in infrastructure could have been made earlier too without such a radical move and without fearing inflationary pressures. However, he establishes the government’s proposed argument to counter this: making such investments and transfers without using the disabled money would require an increase in tax revenue otherwise it would adversely affect fiscal deficit. But such a huge fiscal deficit would put off global investor sentiment in India as they would consider it ‘fiscal irresponsibility’. Hence, using the ‘veil’ of demonetisation, BJP is trying deal with the tradeoff, between public welfare and investor sentiment.

Subsequently, he explains, for this theory of government to work, two requirements need to be fulfilled. Firstly, the government needs to change the current accounting practices to ensure that a reduction in liabilities is treated as an immediate ‘windfall gain’ for RBI. Under the current scenario, the decline in liabilities is rather offset by increasing the Reserve fund so there is no case of RBI earning a profit/surplus due to asset-liability mismatch. But changing the accounting practice would have disastrous implications for the NPA issue of nationalised banks. Secondly, government should be ready to face the risk of ‘loss of confidence’ by globalised finance. This seems to counter the purpose of all those foreign visits by NaMo to attract investors to India.

In his interview with The Wire, http://thewire.in/850…/demonetisation-arun-kumar-discussion/, Prof. Arun Kumar from JNU, author of the book ‘The Black Economy in India’, states 2 reasons in line with Patnaik’s views. Firstly, most of the ‘disabled cash’ would make its way back into the banking system through the exchange of old notes with the new notes, because a very small proportion of black money is kept in form of cash per se. So this would be from ordinary public deposits who are holding white money. This means that the liability reduction argument is flawed. Secondly, since people are hoarding cash in small denominations, RBI would actually need to print more currency than was made defunct through this move, to restore the economy to its former state. This means, let alone a reduction, there would actually be an increase in liabilities.

 

 *The post was originally published on FISCUL LSR facebook page
Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s