Demonetization of Bank NPA

The demonetization of India's existing stock of 500 and 1,000 rupee notes is a $45 billion bonanza for the government that can be used to recapitalize the country's broken banking system, which needs roughly $90 billion to become whole again.

I have tried to make this blog as easy to understand as possible even if it is read by someone with no financial background

Lets consider Balance sheet of RBI as on June 30,2016.(source Bloomberg)

Since then, notes in circulation have expanded to $264 billion, and deposits at the RBI by commercial banks and the government have increased to $85 billion

If we assume fifth of the current stock of 500 and 1,000 rupee notes is "lost," in the sense that their owners, who have either avoided taxes or earned the money illegally, fail to return them to the banking system  That's 17.2 percent of $264 billion the RBI forgets about it

Let us assume nothing else changes then the RBI Balance Sheet will look like this

Now consider above balance sheet where notes not coming in circulation is shown as Reserves under Liability 

Amount Indian banks received in deposits in first four days

$44.4 billion

This $44 billion of low-cost deposits financial institutions have won in four days will buy risk-free government notes, keeping a lid on yields, even as global bond markets tumble.

There could be a rate cut or two.This will push up Bomd prices and hence  Mark-to-market profit on banks portfolios would go up. This shall help in some way  mending their balance sheets, so long as there isn't a fresh wave of nonperforming loans.

So Indian Bonds will be saved to an extent by  outflow of foreign funds to US in case of Fed rate hike.

My only appeal as in my last blog. Not everyone who is sitting on cash has earned it in illegal way. Some have worked hard for it but may not have declared the same.Few also were scared to declare under VDIS for fear of being harassed .

If Government had given a choice of 0% coupon bonds the above 46$B shown as Demonetization reserve would have replaced Infra bonds. 

Although RBI can always replace this liability with printing of currency of same amount ,few genuine hard work money could have got a chance to get into system.  The same may have avoided long ques to deposit as the collection for Infra Bonds could have been distributed with other Government authorized centers 

The same could have saved lot of post demonetization scrutiny work as old currency notes have  been pushed to Gold,Real Estate, zero account balance bank accounts, Accounts of employees, political party donations, Loan accounts of banks, Revised balance sheets with higher cash in hand and so on

Hope I am able to put across my point supporting issue of Infra Bonds. The post is after my talks with various finance professionals who did not find any flaw in the same. 

Still not too late for this Prime Minister Sir.