Demonetisation Will Cut Prices, But GDP Growth Will Take a Hit: Manmohan Singh’s Adviser

The demonetisation drive will help curb inflation and shore up the fiscal deficit but India can kiss bye to the GDP growth target of 8%, a top economic adviser to former Prime Minister Manmohan Singh told News18.

“Finance is like blood in the system and when you drain that much of blood, obviously there will be problems,” M Govinda Rao, who was a member of Manmohan Singh’s Economic Advisory Council and a former Director of the National Institute of Public Finance and Policy (NIPFP), told News18 in an exclusive interview.

Under Rao’s watch, the NIPFP was also tasked with doing a study on India’s black economy.

“The GDP will decelerate and all this talk of 8 percent growth, they will have to revisit that,” he said.

Rao also drew a detailed picture of the exact link between demonetisation and the macro economy.

A unit of money (Rs 10 note, Rs 50 rupee note) is basically an I.O.U. Any bank note carries a signed statement by the governor of the Reserve Bank of India: I promise to pay the bearer the sum of XX Rupees – where XX is the face value of the bank note.

“Money is a liability for the government and by sucking out 85% of the cash government’s liability has been wiped out,” Rao said.

The value of 500 and 1,000 rupee notes constituted 85% of the total value of Indian currency.

The RBI, in turn, will replace the worthless currency with new Rs 500 and Rs 2000 notes. It can also make a profit in the process.

If the face value of the bank note is more than the cost to produce that note then the RBI will make a profit on each new note it introduces into the banking system. On a Rs 2000 note the RBI could potentially make a great profit.

In turn, the RBI pays the government around Rs 65,000 crore each year as dividends. Rao estimates that the RBI will pump in around Rs 5 lakh crore into the system.

“The RBI can give a huge amount of money as profit, which can reduce the government’s fiscal deficit,” he said.

This money will be non-tax revenue, much like the 2G windfall of 2010 or the coal re-auction money.

He said that on the inflation front, there is good news. Inflation is likely to fall, but only because purchasing power and consumer spending have been disrupted. Rao feels that the disruption will continue for at least 3-4 months.

But what about the core issue of black money? Rao is less optimistic.

“The stock of black money will be destroyed, but the flow will not stop. Real estate black money transactions will persist, medical and engineering college seats will be sold, people will take bribes and evade income tax,” he said.

Rao also said that the rural economy will suffer more than the urban economy, the less developed regions will take a bigger hit than developed regions and poor people will suffer more than honest rich people.


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