When Raghuram Rajan was the chief economic adviser to the UPA government, he too demanded the central bank part with a large portion of reserves as it was sitting on a heap. Later, when he moved to the Mint Street, he set up a committee under noted economist Y H Malegam, who opposed the very idea of parting with capital and suggested that only the profit that RBI earns should be given to the government. Rajan adhered to that and gave to the then government the highest of dividend paid in the history of RBI. It paid almost all its surplus to the government.
Times have changed and the governments have become greedier by the day. After 2014 parliamentary elections, Prime Minister Narendra Modi-led government appointed Arvind Subramanian as a new chief economic adviser. He raised the demand for more and said mere dividends were not enough and that Centre should get the excess capital lying with the RBI for decades. He cited examples of central banks around the globe which roughly held, only 14% of their total assets, in reserves. In contrast, RBI’s reserves of over Rs 9.6 lakh crore were equivalent of 28% of its reserves. And hence, a conclusion was drawn on the basis of CEA’s argument that the RBI can part with around Rs 3.5 lakh crore.
The suggestion may look attractive to any government which has, as a sovereign, many obligations to fulfill. But it is not all that easy for the central bank to just part with the money without consequences. One, the reserves of over Rs 9.6 lakh crore is not held by the central bank in cash. It is only on its balance sheet. This, to a layman, may appear that the central bank can print so much currency as and when the government demands. But, in monetary economics, it does not happen that way. The reason – it may lead to excess liquidity in the market, to inflation, to higher interest rates and so on.
How RBI manages funds
What the central bank does when faced with higher demand from the government? It gives the amount but sells government bonds of a similar amount from its balance sheet to withdraw from the market that excess amount it has paid to the government. So, on the net basis, the government does not get any cash in its hand but yes, its market debt gets reduced by a whisker.
Besides, the reserves held by RBI are not meant for spending on social sector programmes as the government has said. The reserves are part of the Contingency Fund held by the central bank. They lend strength to make its balance sheet unimpeachable. And, at a time when the government of India wants to borrow from abroad, a strong RBI with AAA rating comes handy.
In the words of Rajan, “We (India) are ‘Baa’ country. We are barely investment grade. Sometimes, we need to undertake international transactions which require a really high credit rating. For example swap, we did in 2013”. After the famous “taper tantrums” by the US Federal Reserve, when the rupee started depreciating and plunged to a lifetime low in 2013, Rajan as the RBI governor announced that the central bank would offer a special swap window for non-resident Indians and mobilised $34 billion through foreign currency non-resident bank account (FCNR-B) deposits. The move stabilised Indian currency and widened current account and fiscal deficits.
Sometimes, the RBI also uses the Contingency Fund to defend its asset, that is, the foreign exchange reserves, which is held in dollars. Each time the dollar appreciates vis-a-vis the rupee, the value of the central bank’s assets go up. That is a win-win situation. But, sometimes, when the depreciating rupee gets strengthened, the value of assets go down. The reserves are used to defend assets. Of course, the RBI needs only a part of its reserves for this purpose. But here the question arises as to how much should it part with? The government has set up a committee to look into it.
However, Subramanian, the NDA government’s former CEA has a different viewpoint altogether. In a conversation with DH, he said that the central banks do not acquire credibility and reputation based on how much reserves they have but they are rated on how independent they are and how good the job they do. If they have excess reserves and keep that with them and go on conducting a bad monetary policy, they miss out on big loan defaults, then those reserves do not come to preserve their reputation.
But Subramanian also holds a grudge against Rajan. That is, when he advocated RBI should give its excess capital to the government, he came under fire by economists of the likes of Rajan, who told Subramanian he did not have much knowledge of monetary economics. To counter that, Subramanian says when Rajan was in the finance ministry, he too had raised demands for higher capital and only when he moved to RBI, his views were changed.
Central banks, the world over, preserve certain reserves with them for rainy days. The global norm may be 14% of the total asset value of the central bank but former RBI governor Urjit Patel appeared to have indicated that RBI wanted to maintain close to 99% of current reserves to maintain a robust balance sheet and keep the AAA rating.
End of an era
Patel’s era is over. But RBI’s is not. A former bureaucrat and a trained finance ministry hand Shaktikanta Das is at the helm at RBI now. The government’s expectations from him are enormous.
But Das, who has also served under two stalwart chief ministers M Karunanidhi and J Jayalalithaa, is known for taking some tough decisions in the very early days of his career which were far from his political master’s liking. Das has two reputations to save, one of the RBI, the other, his own. Giving away a bulk of RBI’s decade-old, well-preserved capital to a government, which goes spendthrift at the time of elections, can cause more harm than good.
