A Dummies guide to demonetisation:
In order to understand demonetisation, first you need to understand how bank functions. Bank is like a company which borrows money at either zero interest rate (Current Account), a lower interest (Savings Account, 4%) or a moderate interest rate (Term Deposits) and then lends it to its borrowers at a higher interest rate.
About 80-90% of banks funds are generated from the deposits of its customers (in Current, Savings or Fixed Deposits). Of these, about 50% is in CASA (Current Account-Savings Account). Rest of the money comes from paid up capital and borrowings from Central Bank, Interbank Market and International Financial Institution.
A high CASA ratio is favourable for a bank, since it is getting money at low cost. Other means of money comes at higher interest rate for the Bank, and so not favourable.
How does a Bank do its business?
It does by lending the money (deposited to it) at higher interest rates. However, it cannot lend its total money to borrowers; else the deposit customers would be shown a thenga (Y) when they want to withdraw their own money 😉
The banks are required to keep a certain percentage of deposits with RBI which is called CRR, and also maintain a stipulated proportion of their deposits in form of liquid assets like cash, gold or securities. This is called SLR (Statutory Liquidity Ratio). Most banks currently keep an SLR higher than required (>26%) due to lack of credible lending options
The rest of the money is lent out by the banks, and is called CDR (Credit Deposit Ratio). It is the ratio of how much a bank lends out of the deposits it has mobilised. It indicates how much of a bank’s core funds are being used for lending, the main banking activity. A credit-deposit ratio of over 70 per cent indicates pressure on resources as they have to set aside funds to maintain a cash reserve ratio of 4 per cent and a statutory liquidity ratio of 21 per cent.
A very high CDR is considered alarming because, in addition to indicating pressure on resources, it may also hint at capital adequacy issues, forcing banks to raise more capital. Moreover, the balance sheet would also be unhealthy with asset-liability mismatches.
Understood the basics? Now let’s move to the Real Game:
PSU banks account for nearly 70% of the financial market. Corporate take money (loan) from the banks and do not return it back. A loan is tagged an NPA if interest and/or installment repayments do not take place in 90 days. Once a company is tagged under NPA, it becomes difficult for it to get loans from the same bank or other banks.
However, Banks normally used to pushed loans into the restructured loan basket whenever they saw the first signs of trouble, and retained them as standard assets. This was a technical adjustment that they used to make which suited the cronies, as well as the banks. This adjustment enabled the cronies to borrow more, either from the same bank or nay other bank.
But why did the banks do such?
The readjustments suited both the borrower as well as the banks. Banks hide bad loans and show a healthier than real balance sheet to the investor. Which company (bank) would like to show its stressed assets which would erode confidence of the depositor and trigger withdrawals, leading to bankruptcy?
Moreover, the state also arm twists the banks to give loans to companies which don’t have a healthy reputation with respect to repayments of loans earlier disbursed to them. That’s how crony capitalism works. These companies fund the political campaigns of parties, and when the party comes to power, it returns the favours in forms of largesse, given to them in form of loans.
But this is not the end, the government also write-offs the loans disbursed to them earlier. Twenty-nine state-owned banks wrote off a total of Rs 1.14 lakh crore of bad debts between financial years 2013 and 2015, much more than they had done in the preceding nine years. Who arm twisted them for write-offs? The government of course.
Nah, there is more. The government also write offs the taxes payable by these cronies (in form of corporate income tax, customs and excise duties) every year. How much?? 7 crore every hour or Rs 168 crore everyday in write-offs on just direct income tax alone. No, no these are not my figures, these are government figures which are tabled every year in the budget document, however it is placed at such a position that it doesn’t catch the attention of the general public.
It is tucked away at the very rear part of the budget document, a seemingly innocuous annexure- “Statement of Revenue Foregone” or which the government has now surreptitiously changed the title to “Revenue Impact of Tax Incentives”. As per the budget document, a total of 5.32 lakh crore of corporate tax (corporate income tax, as well as customs and duties) was written off by the government in 2013-14. Well, this was when UPA was ruling.
Then came the party with a difference. Difference? Really? More than 30,000 crore was spent by different political parties in 16th Lok Sabha elections. The BJP spent the most, and eventually came to the winning spot. Where did this money come from? Mr. Modi was often seen flying in Adani aircraft.
BJP carried this legacy of crony capitalism from the Congress. However, it committed a mistake. And that mistake was the brazenness in which this crony capitalism was now being promoted, that it caught the attention of public. Congress, a 130 year party had expertise in this. Cronies benefited under its regime, and were not visible to the masses.
The cronies are benefiting under BJP, and it is visible now; courtesy the brazen form in which the party is trying to promote the interests of its benefactors. Experience matters.
When the BJP came to power, the corporate tax write-off increased to 5.89 lakh crore in 2014-15. If you add up the total write-offs to corporate in the past 10 years (most of which comes under UPA rule) it nears Rs 42 lakh crores- which means Rs 1,110 crore, everyday.
Yes that’s the amount the corporate loots everyday, while you struggle for your subsistence daily, paying taxes and queuing up outside banks to take your OWN hard earned money- with a present withdrawal limit of Rs. 2500. With this money the government can fund the Mahatma Gandhi National Rural Employment Guarantee Scheme for 125 years, at present levels!!!
The coming of Raghuram Rajan:
When Raghuram Rajan was appointed the governor of RBI, he gauged the problem of bad loans early and forced a clean-up exercise of bank balance sheets. It was then that truckloads of skeletons tumbled out of the closet.
About 2 lakh crore of Gross Non Performing Assets (GNPA) was declared in just one quarter (January-March 2016), thus taking the GNPA of banks to 5,94,929 crore at end of March 2016. That means 6 lakh crores of bad loans!!!
Over 90% of this is on the books of Public Sector Banks (PSBs). Such grave was the situation that if timely remedy was not provided, they could translate into significant capital implications for the government that owns majority of these lenders. Rajan gave March, 2017 as the target to banks to clean up their balance sheets and disclose the entire stock of bad loans. If the problem of NPA was left unattended, it had the potential to drive Indian economy to ebb.
Rajan understood that the problem was at two ends- the propensity of the banks to dilly-dally on the situation, by making technical adjustments and pushing NPAs to restructured loan basket, and on the other hand the arm twisting of the PSBs by political masters to give loans to the cronies who have funded their election campaigns.
Addressing the second problem was outside the purview and authority of Rajan, so he addressed the first problem and made it mandatory for banks to make provisions on restructured loans at par with bad loans and forcing them to set aside 15 percent of the loan amount as provisions if they chose to go for fresh restructuring.
Earlier, banks used to conveniently push many stressed loans, especially in the infrastructure segment, to the restructured loan category to prevent them from slipping into the NPA category. But, with Rajan at helm, this was no longer possible. This irked the cronies, and they wanted him out of the establishment. The man who could have addressed to the situation was shown the door. That’s the power these cronies command.
Due to initiatives of Rajan, NPAs started to tumble out in truckloads. This scenario led to a crisis situation in banking sector, that if banks are unable to find sufficient capital to fill their coffers, they might go bankrupt. Banks needed trillions of rupees, if one includes the money needed to provide for bad loans, meet the Basel-III capital norms and fund their credit expansion plans. Banks, due to their fractured balance sheets were unlikely to draw investor interest even if they hit the market with bond issues.
So where would the money come from? Gathering capital for the banks was the biggest problem for Narendra Modi government, since the govt owns 70% of the banking industry. Moreover, the problem was also their (the government present and before) own creation. In its desperation to address to the capital problem of the ailing banks, the government committed a blunder, which the media is reporting as a “masterstroke”. It went ahead with demonetisation policy, triggering a panic among the masses. Deposits to banks have swelled and 3 lakh crore have been deposited within 4 days of the demonetisation.
However, the demonetisation policy is ill-conceived one, which purports to provide a short term solution to banks, the problem of which is deep rooted. The deposits being made in banks will go in CASA category, which is demand deposit and have to be given back to the depositor on demand. The government is tackling the situation with withdrawal restrictions on depositors, which is likely to continue for few months.
Else people would withdraw their money, and banks would again be back to square one. But the pertinent question is- for how long will the government impose withdrawal restrictions? Would it not trigger deflation? Will it not lead to an economic crisis, since if people have few money in hand, they would obviously purchase their monthly ration of groceries, vegetables and eatables and not mobiles, TV, cars or any other manufactured goods?
Will not the manufacturing sector be badly hit by this imprudent decision carried out in haste and without logical planning? Would it not lead to increase in unemployment, with most pink slips coming from the manufacturing sector?
The government says that the situation would settle down in 50 days. How? As per data furnished by the Finance Ministry, Rs 17,50,000 crore worth of currency notes were in circulation in October-end.
The government, through its demonetization of old 500Rs and 1000Rs note made 14.5 lakh crore rupee (84%) invalid in the market, leading to a currency crisis. As per FinMin, Rs. 50,000 crore dispensed to customers in first 4 days (10-13 Nov). However, there is still a currency deficit of 14 lakh crore.
In India, most of the transactions carried out are in cash. As per an estimate (carried out by Fletcher School at the Tufts University in 2012) 86.6% of transactions carried out in India were in cash. The economy is going to take a big hit, with 84% of the cash being made illegal due to demonetisation.
Printing of new currency began in August-September, and by October 2016, the RBI printed 480 million of Rs. 2000 denomination notes and an equal number of new 500 denomination notes. Total value of these new notes= 96,000 crore (1000 notes) + 24,000 crore (500 notes) = 1.2 lakh crore. Time taken (between August-October) = 50 days approx. (guess estimate).
So, it took 50 days to print money of value 1.2 lakh crore. Going by this, it would take approx. 500 days (One and a half year) to print the remaining 12.8 lakh crore needed to bring back the economy to its pre 8th Nov. state.
And the govt. wants to make you believe that in next 50 days it would print 14 lakh crore, to make up for the present Currency Deficit?
If timely ameliorative measures are not taken, we are headed towards an economic recession.
(The views expressed here are solely the author’s own. The facts and opinions appearing in the article do not reflect the views of Janta Ka Reporter and Janta Ka Reporter does not assume any responsibility or liability for the same)