The war of words between the Centre and the Reserve Bank of India (RBI) is only escalating despite governor Urjit Patel having indicated that all outstanding issues would be discussed in the central bank’s board meeting on November 19.
After this announcement, one had expected that back-channel negotiations would take over and the public spat, largely conducted through the media, would cease.
But things seem to be getting worse. Media reports suggest that the finance ministry wants to bring decisive resolutions at the November board meeting through its nominees in order to force Patel’s hand.
This, unfortunately, indicates a hardening of positions.
Ideally, a mutually satisfactory solution should be found and sealed before November 19. If this is not done, it will be bad for the economy and markets in the longer term. And if the board tries to force decisions on the governor, then it would be the first time in decades that the central bank’s board would have played such an activist role in operational matters.
Urjit Patel’s predecessor, Raghuram Rajan, has already sounded a warning by suggesting it would be a mistake for the RBI board to force specific operational decisions on the governor. What Rajan is implying is the board can go into the broader policy issue of how the RBI should deal with its contingency reserve accumulated via profits from operations.
Despite what current rhetoric may indicate, the central bank’s policy towards contingency reserves has been studied and refined over a decade. And there’s no reason why it can’t be further refined in a mutually accommodative spirit. But the RBI board should not force a specific decision – in this case that the governor transfer Rs 3.5 lakh crore to the finance ministry for recapitalisation of banks and to meet its other fiscal needs. What is also puzzling is that the actual contingency reserves on the RBI’s balance sheet is Rs 2.5 lakh crore, which is roughly 6.5% of the central bank’s assets. So one doesn’t know the origin of the Rs 3.5 lakh crore figure being cited by the finance ministry.
Nevertheless, any ham-fisted move would surely compromise the integrity of the institution in the eyes of the global financial community. And it will then surely invite the wrath of the global markets.
Prime Minister Narendra Modi and finance minister Arun Jaitley must begin by recognising one fundamental reality – in the eyes of the global markets and investors, whose faith in India’s economy and market institutions is manifested in the bulk of the $400 billion of reserves accumulated by RBI – a central bank’s autonomy is an article of faith not to be trifled with.
The prime minister and finance minister must also realise that in an election year, the central bank would carry far greater credibility with global investors than the finance ministry which is seen as constantly cutting fiscal corners. These philosophical debates, especially on how to treat the RBI’s contingency reserves, are best conducted in the first year after coming to power so that basic intentions are not seen as suspect. But then this is a T-20 playing government which thinks up one zany idea every quarter.
At this stage, the PMO and finance ministry would do well not to push the RBI leadership on the question of taking money from the contingency fund. Any resolution brought on this subject will neither be in the “public interest” or “national interest” which Modi and his ventriloquists are so fond of peddling. Just remember, national interest is determined by the outcome of your actions and not by the intentions behind your action. Demonetisation is a classic case in point.
A former RBI governor, respected globally for steering India’s economy and the financial system in the build-up to the 2008 global crisis, told me that there are also macroeconomic consequences of taking large sums of money out of the central bank at once. What he clearly implied was that the RBI handing a few lakh crores to the government would be akin to new money creation, which would then have a ripple impact in terms of rising inflation, expanding the current account deficit and weakening the rupee. This would not be wise, coming at a time when attempts are being made to bring the very same macro indicators under control.
Also it must be stated that the central bank has not been rigid about parting with its contingency reserves over the years. In the late 1990s, deputy governor Y.V. Reddy appointed a committee to go into the question of the minimum contingency fund that the RBI must keep to meet emergency requirements.
This was also the time when the RBI’s balance sheet was being aligned with the balance sheets of central banks of other developed economies. The committee then recommended 12% of the RBI’s assets as the minimum contingency fund accumulated from the central bank’s profits profits from market operations.
Subsequently, under the UPA government, this question was further studied by the Y.H. Malegam committee, which didn’t prescribe a specific minimum requirement but broadly argued that all fresh accretions to the fund can be shared with the Centre. As the Malegam committee’s recommendations started getting implemented in the latter half of UPA-II, the RBI regularly transferred higher profits (Rs 40,000 to Rs 50,000 crore) year after year.
This continued after Rajan took over as RBI governor when the contingency fund was about 8% of RBI’s total assets. This has come down to 6% of the total assets now.
The point one is making is that the contingency fund has come down in an orderly and gradual fashion from 12% of RBI’s assets in 2008 to 6% today. But this has happened through a carefully considered policy review within RBI and therefore carried credibility.
What is being attempted now by an impatient, T-20 oriented government is akin to using a sledgehammer on the RBI’s contingency fund policy. It can only be described as myopic. The RBI’s reserves are the nation’s social wealth and cannot be used arbitrarily citing public interest.
Any resolution forced on the central bank governor by the RBI’s board on November 19 in this regard will have disastrous consequences.