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Demonetization shock weighed heavily on RBI’S financials

Share Written By
Mr.Dhananjay Sinha

Head of Research, Economist & Strategist

31 Aug 2017

 Preliminary data released by RBI indicates that nearly 98% of the banned notes were received by the central bank and only a minuscule amount of fake notes were detected. This demolishes the widely held expectation of a substantial windfall for RBI from the demonetization process. On the contrary, RBI’s financial statement indicates considerable deterioration owing to the demonetization fallout. For instance, RBI’s surplus declined by over 53% in FY17. Apart from the impact on RBI’s financials, the wider implications of demonetization in the form of a slowing economy and shocks to informal & farm sectors amplify the cost of demonetization, far more than the potential benefits envisaged

Based on the interim calculations, the RBI in its Annual Report 2016-17 has stated that of the total Rs15.7tn worth of Rs500 & Rs1000 notes (specified bank notes or SBNs) that were demonetized on Nov. 8, 2016, nearly 98% or Rs15.28tn were deposited. Hence, the widely held expectation that a large sum of currency held as black money will not reach RBI, resulting in a windfall gains for RBI, has been completely shattered.

 In addition, the RBI Annual Report also shows that the counterfeit currencies held in old Rs500 and Rs1000 notes and detected incrementally rose by Rs141mn (FY17 over FY16, March ending). Importantly, RBI’s statement also indicates that counterfeit currency of new currency notes of Rs500 and Rs2000 have also been detected in small amounts.

The RBI Annual Report indicates a sharp drop in RBI’s earnings and rise in costs, largely as a fallout of the demonetization operations.

  1.  a.) RBI’s balance sheet expanded by a marginal 1.9% in FY17 (June ending). While its  total income decreased by 23.6%, the expenditure increased by 107.8%. As a result, RBI’s surplus declined by 53% to Rs306.6bn in FY17 compared to Rs658.8bn in FY16.

  2. b.) Provisions of Rs131.40bn transferred to Contingency Fund (CF) are adjustments for unforeseen losses on financial assets etc. 

  3.  c.) Consequently, surplus transferred to the Central Government declined to a five-year low of Rs306.6bn (Rs658.8bn).

  4.  d.) Importantly, RBI incurred a cost of Rs174.3bn on account of interest paid under LAP on SBN deposited by banks in the demonetization process. Hence, overall net interest income from domestic assets declined to Rs375.4bn from Rs441.2bn (a 15% decline).

  5.  e.) RBI also incurred a loss of Rs51.2bn on forex transactions.

In the remonetisation process, RBI has employed two modes: a) printing of new Rs500 and Rs2000 notes and b) release of small notes of Rs50 and Rs100 withdrawn in earlier years.

During Nov’16 to Mar’17 period, RBI printed 9.2bn of new Rs500 and Rs2000 notes or 1.8bn notes per month. This is lower than the peak average monthly level of 2bn new notes supplied by RBI in FY15. In value terms, printing of new notes is around Rs9.5tn. Secondly, the release of old small denomination notes (Rs50 and Rs100) is around 12.7bn pieces amounting to Rs1.1tn. This portion of supply was unanticipated when demonetization was announced and it helped ease the supply shortfall of currency. Hence, nearly 58% of volume of total notes released by RBI in remonetisation was in the form of old small notes withdrawn by RBI in earlier years. The old notes released amounted to around Rs1.1tn or 10.5% of the total Rs10.6tn pushed into circulation (Rs9.5tn of new notes + Rs 1.1tn of old notes).

The fact that the total currency in circulation at Rs15.7tn (as on Aug 18, 2017) is still short of the Rs17.3tn total supply of currency that existed before demonetization was announced in Nov’16 shows that despite the expediency shown by the central bank, the remonetisation process is incomplete even after 10 months of the demonetization shock.

The impact on the wider economy has been stark and has lingered on for more than 10 months. It reflects in GDP growth deceleration to an average of 6.2% in Q4FY17-Q1FY18E from an average 7.7% in H1FY17 (prior to demonetization announcement). Credit growth slumped to a 6-decade low near 4.6% in Mar’17, Consumer Durables growth has been in negative since Dec’16 and shock to the Agriculture sector has culminated in widespread farm loan waivers. This scenario has emerged despite high amount of government spending to pump-prime the sluggish state of Indian economy. With remonetisation and the continued reflationary approach of the government, we might witness improvement in the real economy from H2FY18 onwards.

 Table 1: Trends in Income, Expenditure and Net Disposable Income
 (Rs bn)


 a) Income743.58646.17792.56808.70618.18
 b) Transfers to CF and ADF (i+ii)287.940.
 (i) Contingency Fund (CF)262.470.
 (ii) Asset Development Fund (ADF)125.470.
 c) Net Income (a-b)455.63646.17792.56808.70618.18
 d) Total Expenditure125.49119.34133.562149.903311.554
 e) Net Disposable Income (c-d)330.14526.83659.00658.80306.63
 f) Transfer to funds50.
 g) Surplus transferred to the Government (e-f)330.10526.79658.96658.76306.59

Source: RBI’s Annual Report 2016-17, Emkay Research

 Table 2: Remonetisation process (Nov'16-Mar'17)
 Printing of new notesVolume (bn) Value (Rs bn)
 Rs 2000 notes3.285 6,571 
 Rs 500 notes5.882 2,941 
 Total new notes9.167 9,512 
 Average printing per month1.8 1,902 
 Estimated release of old small notes (based on abnormal rise in supply)   
 Rs 100 notes9.502 950 
 Rs 50 notes3.223 161 
 Total old notes12.725 1,111 
 Total notes released to neutralize demonetisation21.892 10,623 
 Release of old withdrawn notes to total notes released58.1 10.5 

Source: RBI’s Annual Report 2016-17, Emkay Research

Relevant pages from RBI’s annual report:

Please refer to Emkay Research post demonetisation strategy note (Nov 30, 2016) Click Here