Demonetisation money must not be used to cushion the deficit ... Financial Express December 13, 2016

Money, it’s a crime Share it fairly but don’t take a slice of my pie Money, so they say Is the root of all evil today’- Pink Floyd, ‘Money

The demonetisation plan has three dimensions, with each one superseding the other with time. It started as being a part of the crusade against black money and counterfeit currency. This could be termed as the ‘adagio’ of the musical piece. It was followed by the ‘andante’ or the quest for changing the way in which we transact business where the elegance of digital transactions was extolled. As we end with the ‘allegro’ the questions now are centred on what do we do with the goodies that are collected?

The scheme, it was assumed, would at the end of the day catch the black money holders and put them in a spot.

The first stage was to ensure that a strong due diligence process was followed when taking in cash as deposits with banks. This would, finally, leave those who could not justify the same with currency that was worthless. Once out of the system, RBI could reassess its balance sheet. When currency disappears, then the size of the liabilities contracts and this could be interpreted as a transfer of a surplus to the government. The pundits had argued that amount, Rs 3-4 lakh crore, that would be left can give the government ammunition to fight various battles of development. The purists (including ex-RBI Governors) were against this move, even though the government made no such potential claim on these amounts. It was, hence, more of an intellectual speculation.

The party has apparently been dented by two factors. First, the pace of conversion of old notes to deposits has been very brisk and it appears that there may, after all, not be much left for balance sheet adjustments. Second, RBI, in its recent post-policy press meet, has made it clear that these amounts will not leave the balance sheet though they would cease to be legal tender. This, sort of, puts to rest the controversy over what happens to money left in the system.

The other route of getting money for the government is in questioning, investigating and penalising what enters the banking system. This was not a part of the original plan, as the demonetisation measure was taken just after the formal income declaration scheme came to an end. But once it was noticed that people were gaming the system by backdating bills on jewellery or transferring funds to other peoples’ Jan-Dhan accounts by giving them a part of the money in exchange, the government has thought of ways of identifying and taxing them with a fine.

This Robin Hood scenario would be played out in two ways. The first is to encourage people whose accounts have been used not to return the money to those who have deposited their money, which will be poetic justice.

The second is to tax the deposits that cannot be ‘justified’. This is done by first giving a chance for voluntary disclosure where one pays 50%. If one does not declare the same, but gets caught subsequently when the IT/Intelligence department catches them then the punitive charges could go up to 90% with possible penal action. The calculators are out in guessing the collections and estimates range from Rs 50,000 crore to Rs 150,000 crore. Assuming the final number is somewhere in between, what can be done?
One option is to transfer all this money to the Jan-Dhan accounts, which was a promise made by the government when talking of black money. But with over 25 crore such accounts in operation, an amount of Rs 6,000 per account would be very small. Also, it will not be possible to sift through the misused accounts and the regular ones to lower the targeted group. But this is an option.

The second would be to be fair and compensate all account holders who deposited cash in their accounts with clean money, meaning thereby those that have not been taxed. The sum total could be transferred equally into these accounts which is a way of compensating the country for the trouble they have been through for no fault of theirs. This will be a fair way out much in the Rawlsian spirit.

Both these options should be seriously considered as government’s stance on the November 8, was that this exercise was a nod to transfer funds from the ‘criminal rich’ to the poor.

Yet another route is to transfer the funds to the budget and then use them for spending on specific purposes like roads, rural electricity, urban infrastructure, health, education. This will indirectly add to the welfare of the people in the medium run. But at any rate the money should not be used to cushion the deficit to 3.5% this year, and make up for failure in disinvestment or any other collections.

Another alternative is to use these funds to fully recapitalise public sector banks which are short of funds. The proceeds of demonetisation could be used for compensating banks for the trouble they have taken—though the non-PSBs would be left out.

Which is a better way of using this money? Using it for projects which includes bank capitalisation looks more appealing and logical and would be looked at positively by the global community, especially the rating agencies. Transferring funds to the bank accounts of the masses may be problematic as it looks like bestowing largess and is analogous to ‘subsides’ and ‘waivers’ of loans. But a call has to be taken on whether or not the government considers this transfer as being a commitment made earlier to the people. A more serious impediment would be to address the concerns of the Election Commission which will observe such transfers as being done to curry favour in the upcoming elections.

It would definitely be prudent for the plan to be cast right away to decide on the use of the additional revenue garnered from this scheme. Besides improving transparency it would also clearly spell out the stance of the government on sharing the proceeds with the people of India.