How Much is Not Too Much?

Four economists argue for Arun Jaitley against Urjit Patel on RBI reserves

On October 26, Reserve Bank of India (RBI) deputy governor Viral Acharya had made a passionate speech warning that governments that raid the reserves of their central bank, as Argentina’s once did, can come to a sticky end, with foreign investors fleeing at this sign of gross profligacy. Newspapers highlighted the spat between the finance ministry and RBI on this issue.

New light has been shed by an article in the Economic & Political Weekly, ‘Paranoia or Prudence: How Much Capital is Enough for the RBI?’ (Dec 8,, by four economists — Abhishek Anand, Josh Felman, Navneeraj Sharma and Arvind Subramanian. They claim that RBI has excess reserves of at least ₹5 lakh crore, and maybe ₹7.9 lakh crore, which can be used for better purposes than sitting in RBI vaults.

Money Plant

The finance ministry has long argued that RBI has accumulated enormous reserves from seigniorage (profits from printing money and minting coins), far in excess of legitimate needs. But RBI governor Urjit Patel backed Acharya’s stand that RBI needed its high reserves as a prudential measure.

The RSS member on the RBI board, S Gurumurthy, added fuel to the fire in a speech condemning ‘foreign-trained economists’ who slavishly followed conservative western norms, insensitive to the huge and much-merited needs of credit-starved micro, small and medium enterprises (MSMEs). Ultimately, Urjit Patel had to go.

Alarge transfer of RBI reserves couldhelp the government go on a spending spree in an election year, recapitalise moribund public sector banks (PSBs), and cut its fiscal deficit. Many analysts, including me, fear that the finance ministry’s motives are not just technical, and include the desire to grab RBI money to finance election freebies.

However, RBI reserve adequacy is a highly arcane issue. Ideally, the government and RBI need to talk at a non-political expert level, and agree on norms that will be followed by both in future. A committee is being appointed to examine this issue.

The independence of RBI has definitely been eroded. Yet, the issue is not a simple one of evil politicians against an upright RBI. The EPW article by the four economists — including a former chief economic adviser, Subramanian — strongly supports the finance ministry’s claim that RBI has enormous excess reserves that should be transferred to the government. However, they also warn that the transferred funds should not be misused in a pre-election spending spree.

They start by saying that the question of central bank reserve adequacy has no clear answer in theory or practice. They then compare central bank capital as a proportion of total central bank assets globally. India’s ratio is 27.7%, three times as high as the median ratio of 8.4%. Only four of 54 countries have higher ratios than India’s, and two of these are oil exporters.

The four economists then study the ratio of retained earnings and contingency reserves to assets. Here again, India’s ratio of 8.2% is many times higher than the median ratio of 2.0%. Only five countries have higher ratios than India’s. Perhaps India has special factors requiring higher reserves, say the economists. But even allowing for this, India appears to have excess reserves of over ₹5 lakh crore.

RBI needs reserves in times of international crisis. But being highly profitable, it has never made a cash loss even in the worst crisis years. Its core capital has never declined. Total capital has risen consistently, except in the four years when valuation losses exceeded realised profits.

Reserves Bank

The economists create a model for determining reserve adequacy, taking into account India’s circumstances. They conclude that RBI reserves exceed the minimum needed by at least ₹5 lakh crore, and perhaps by as much as ₹7.9 lakh crore. The 2018 Budget outlay for the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) scheme was ₹55,000 crore. The transfer deemed appropriate by the four economists is more than 10 times higher.

However, they warn that such a transfer must not be used for a spending spree. That would amount to printing money, stoking inflation. The transfer they recommend is only for ‘below the line’ operations. One such operation would be to buy back government bonds, reducing government debt. This would reduce the annual interest outgo of the government by a whopping ₹33,000-45,000 crore.

Another possible operation could be the recapitalisation of moribund PSBs, enabling these financial zombies to start lending again. Shorn of technicalities, this can be seen as little more than abook entry, shifting government money from one category of its assets (RBI reserves) to another (capital of PSBs).

This is by no means the last word on the subject. Viral Acharya and Urjit Patel, who favour the current policy of high reserves, are economists as eminent as the four journal authors. They need to respond to the four authors and carry the debate further in deliberation of a new committee — likely to be headedby former RBI governor Bimal Jalan — that will go into this thorny issue.

Hopefully, it will come out with guidelines that both sides stick to in future, so that the autonomy of RBI is not in doubt, and populism does not erode the fundamental prudence for which RBI is responsible.

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