When the rbi governor and so many former ones are arguing against a lowering of reserves, surely this should count for something?
First, RBI deputy governor Viral Acharya delivered a speech warning the government that asking the central bank to part with its reserves would have market consequences. Thereafter, Indian Express reported the government was pressing RBI to pay a whopping Rs 3.6 trillion out of its total Rs 9.6 trillion reserves. Then the government clarified it wasn’t asking for Rs 3.6 trillion but only proposing to fix an appropriate economic capital framework of RBI. But the “intent” is now quite clear—the government wants to lay its hands on a large chunk of reserves that it thinks is “surplus capital”. At stake are two questions: One, can the government, as the owner of the central bank, force the Governor to pay out its reserves? Many expert opinions have jumped in support that the sovereign has every right to invoke Section 7 of the RBI Act and direct the central bank to pay up, implying it can withdraw as much capital as it wants—maybe even leave just a bare minimum of Rs5 crore original capital contribution as per RBI Act 1934! That is certainly not the intent however, which leads us to the second question, by how much? This is what the government is alluding to—fix an appropriate economic capital framework, and thus estimate the surplus that it could lay its hands on.
But who should decide on a sensitive issue that has far reaching macro-stability consequences as former Governor Raghuram Rajan recently explained in several interviews? Press reports indicate this could be discussed at the forthcoming board meeting scheduled for November 19. Can RBI board members, outside RBI, with hardly any expertise or experience in macro-stability policymaking, delve into such an issue? If they do and force RBI to pay up, it would be setting a dangerous precedent. Any future government could follow suit, asking for more!
RBI’s current policy of paying dividend to the government is already based on recommendations given by Malegam Technical Committee-II with domain knowledge. Accordingly, it transferred 100% profits for three years beginning FY14. The present government wanted more; the Economic Survey 2015-16 made the case that RBI had significant excess reserves that could be used to recapitalise public sector banks [Box 1.6: Addressing the Twin Balance Sheet Challenge, page 19: Economic Survey, 2015-16]. The government could have set up another expert committee then itself to examine an “appropriate economic capital framework of RBI” for recommendations. Why is it rushing towards this hara-kiri just before a general election?
We don’t claim to have any expert knowledge on what is an adequate reserve or capital level for a central bank but would trust RBI more. If the present and former governors with expert domain knowledge are publicly making a case against such a capital transfer, the government ought to have respected such opinions. But, instead, it seems it is sticking to the view expressed in the Economic Survey—that RBI holds significant surplus capital relative to the 16% median value of a sample of 37 countries. Now, it is well known that relying on such a statistical measure can be dangerous for justifying policy actions as it does not reflect country-specific concerns. Specifically, nearly 72% of RBI’s capital is composed of “currency and gold revaluation reserves” which have risen faster because of a weakening currency over the last decade or so. But then, we are also the fastest-growing economy in the world with rising per capita income and stable inflation; so the medium- to long-run trend would be that of sustained currency appreciation that could erode these reserves at an equally rapid pace! More importantly, and as Rajan explained, the transfer mechanism of any such surplus could be illusory with potential long-run consequences on money supply and macroeconomic stability.
Assume hypothetically that RBI’s board does fix a new capital framework at say, 16% of total assets. This could release 10% surplus capital which is about `3.8 trillion. Also, presume that, because of concerns expressed by RBI, the government agrees to just `1 trillion and not the entire amount. Some opinions seem to be veering to this end, reasoning that long-run consequences could be manageable given the central bank is currently a net seller in the currency market. But, imagine that six months down the line, a newly elected coalition government presents a white paper on continued financial sector distress and fiscal strains left over by the previous government and asks for another `2 trillion in ‘public interest’! How would RBI say no?
Then, again, if for some reason, median reserves fall significantly below 16% in the future across economies, nothing stops a future government from revisiting the capital framework of RBI again in that case! This is precisely the kind of slippery slope that democracies are prone to. If non-experts are allowed to set frameworks that could test even the most skilled expert, we would be laying the road to unmitigated uncertainties. We are only too familiar with how one-time loan waivers for genuine farmers’ concerns degenerated into a political instrument. One hopes the government would not push our most valued institution down that path.
The current urgency seems to be of recapitalisation of public sector banks who can then resume lending as early signs of economic activity seem to be tapering off. In this regard, and fairly so, the government needs to be asked more pertinent questions than it has been so far. Why has it been reluctant to infuse more capital from its own budgetary resources? The only amount it committed was Rs 0.7 trillion in August 2015 stretched over four years under the Indradhanush plan. In January 2018, it decided to issue Rs 1.35 trillion recapitalisation bonds whose interest cost would accrue to the budget. The government could have easily proactively contributed much more considering the significant oil tax revenues it had gained. Or, if the government had other expenditure priorities, then it should have moved on the reform path to privatise some of the insolvent public sector banks, instead of eying RBI’s balance sheet and extend artificial life-support to these entities; the sales proceeds could have been used as capital support for the financially sustainable ones. When the government is rightly credited with enacting and operationalising the Insolvency and Bankruptcy Code (IBC), that is forcing ownership changes of defaulting firms, it should also have looked within and applied the same yardstick to the banks it owned. Had it done that, it wouldn’t now be pressing RBI to relax PCA norms as it is reported doing so by invoking Section 7, thereby raising serious questions about RBI’s autonomy.
The government may be right in blaming the previous government and RBI for letting banks lend to unviable projects. But the public display of lack of trust in the central bank, even to judge the liquidity situation facing NBFCs, is not the way forward. Just as it failed in the November 2016 demonetisation to find `3-4 trillion of black money, the government should not again be disheartened if experts such as Malegam point out that the RBI Act 1934 (section 47) simply does not have a provision to transfer past reserves. This is not the first time the banking system has high NPA levels—a resolute government should let RBI function to the best of its capability without constraining its operational freedom.