A man puts a new Rs 2,000 note into a wallet that has the old Rs 1,000 note as its cover design. Photo: Rahul Pattom/OnmanoramaRevenue secretary Hasmukh Adhia has been reported as saying (which he has subsequently denied) that he expects the entire stock of Rs 500-1,000 notes in circulation to return to the banking system. Some commentators have said that it amounts to an admission by the government that the demonetization policy has failed. But the RBI deputy governor R. Gandhi has said that close to Rs 12 lakh crore in value of old currency has come back to the banking system leaving Rs 2 lakh crore still missing.
Consider the scenario in which the remaining money does not come back to banks or only a part does. In that case, the missing money is a liability of the RBI that they do not have to honor. This is what many had called a windfall gain for the government. But if the revenue secretary is proved right, then this windfall gain will not happen since the remaining Rs 2 lakh crore will also find its way into banks within the deadline of December 30.
I believe that this talk of windfall gain is pure speculation since even if the missing money never comes back, it will continue to be treated as currency in circulation on the RBI's balance sheet but will not be legal tender. RBI governor Urjit Patel has recently confirmed this.
However, if the government amends the necessary laws then the RBI may still be able to 'retire' the missing currency from its balance sheet and transfer equivalent amount of fresh currency to the government in the form of dividend on profit earned. But I do not think that the government will pursue this option as it would amount to profiting from ordinary citizens' misery caused by the demonetization and will go against the stated objectives of the policy. Even if the money goes to some kind of poverty reduction fund, it would have come from the RBI's profit after all.
What will happen if the missing money comes back to banks? The government has amended the Income Tax act to charge 50 percent tax and penalty on undisclosed income and deposit another 25 percent in a zero-interest four-year scheme that is in the nature of a poor people's welfare fund. So the government will actually enjoy real windfall gain if the missing money does come back!
The government will be hoping that the entire money comes back as it can show the collections in the welfare fund as proof that its midnight surgical strike on black money that has caused innocent people great difficulties has ended up benefiting the poor of the country. The prime minister would be keen to showcase this as a great success for the demonetization policy.
Notice that this type of windfall gain accrues from taxes and not from profit. Also, the tax is not from a voluntary disclosure scheme but an involuntary disclosure i.e. either disclose or let your money turn into worthless paper.
And two things must happen for this kind of success to be achieved. First, the black money hoarders in cash form must believe that it is better to deposit their cash with banks and pay the penalty instead of burning it. Even for the economy, black money that becomes white after paying penalty is better than destroyed money. Second, the government must actually use the welfare fund for the poor people. One way to do this would be to transfer a part of the collection to the needy through direct cash transfer. This would be some kind of a onetime universal basic income that is globally being talked about as an effective welfare policy. The government must do this to make the difficulties and economic damages caused by demonetization seem worthwhile in the end.
(The writer is a professor at IIM Kozhikode)
