There's only one big story for the day and it's on the RBI's decision to transfer a whopping Rs. 1.76 Lakh crore to the government.
So it seems to me everybody is convinced that the RBI has extra reserves in its kitty and it's best if it parts with it already. But that does not do any justice to the overwhelming complications inherent in the subject matter. To fully appreciate this story, we must go back in time.
A few months back, there was widespread speculation that the government was going to force the RBI to part with its reserves unilaterally by invoking an obscure clause in the RBI act. This obviously did not go down well with most people because it was a direct attack on the autonomy and independence of the Reserve Bank.
The Famous Dissent
In his now-famous speech titled — “On the Importance of Independent Regulatory Institutions — The Case of the Central Bank”, Viral Acharya, former RBI Deputy Governor expounds on the dangers☠️ of undermining the authority of the RBI and quotes the case of Mr Martin Redrado, chief of Argentina’s central bank who had to resign following a face-off with the country’s president over his refusal to transfer reserves from the bank to the government’s coffers.
Within a few hours, panic hit the streets of Argentina and investors across the globe started fleeing🏃♂️ the country for fears of a total economic collapse. Mr Viral Acharya was invoking this unpleasant episode to remind the public of the importance of an independent Central Bank.
Put Together a Committee
Long story short, that plan never came to fruition. Instead, the government switched gears. It instituted a panel to determine whether the Reserve Bank was, in fact, sitting on needless cash and said it would act only based on the recommendations of the panel.
The government’s side of the argument in all this was simple.
The RBI must act in the interest of the people. If we are heading towards a total economic collapse, this money could be used to help propel🛩️ the economy. The RBI must stick to its mandate of promoting growth and it must part with the reserves now.
But this argument has a problem.
As Duvvuri Subbarao the former RBI governor notes, the RBI interprets its mandate as not just promoting any growth, but ‘long-term’ growth. This requires taking a long-term view even if the path to stability might entail significant short-term pains.
The ruling party, whose future rests on more short-term accomplishments might show little sympathy for such considerations.
However, that doesn’t mean an impartial assessment can’t be made. After all, if an independent committee, the kind instituted by the government can look into this matter of "surplus reserves" impartially, one would presume that would help further the discourse.
Unfortunately, since the recommendations of the panel have been made public, the critics and the provocateurs have been portraying this episode as a blasphemous raid on RBIs reserves that might somehow push India beyond the point of no return😟.
This raiding argument is moot because the RBI routinely transfers extra reserves back to the government anyway. The point of contention is usually what is deemed extra?
This time the consultation on the matter seems to have proceeded with the help of an external committee headed by Bimal Jalan, a former RBI governor.
So despite people saying that the government is perpetuating a massive fraud here, I would presume that the former governor and his colleagues aren’t exactly planning on throwing this country to the wolves.
The second question is about the total quantum of the reserves.
Rs. 1.76 Lakh Crores😲
How on earth did the RBI end up with that much money in the first place?
One possibility is that the RBI made a lot of money last year.
Sooo. the Reserve Bank prints money and it lets banks borrow from it in return for some interest income. It's possible that with the whole NBFC crisis panning out the way it did, there was a lot of demand for that RBI money. So yeah, more interest income perhaps?
Second, the committee actually evaluated the rainy day fund i.e. part of the reserves RBI would need, just in case things go wrong and found that it had enough of it anyway. And it’s not like they used wonky math to prove this.
The Committee had recommended the adoption of Expected Shortfall (ES) methodology under stressed conditions (in place of the extant Stressed-Value at Risk). Believe it or not, there’s actual academic evidence pointing that the new model (method) is better at handling completely unexpected outcomes during troubled times. So stop with your conspiracy theories already✋.
The final question is about execution? How will the potential transfer be executed?
Well for one, it won’t be the RBI just handing over the cash to the government in a suitcase or should I say Bahi-Khata. At least we hope not.
Instead, a lot of the money the government borrowed from the RBI will probably be now considered “maaf” and this will allow the government to borrow some more and use it elsewhere. Most notably help out the banks with some extra money, pay back some of its debt and you know, other stuff.
However, the larger implication of this spending is something that’s still a touchy subject. Will this money go into productive outlets or will this be subsumed into a black hole never to see the light of day again. That my friends is a discussion worth having.
Know someone who might be interested in this? Share on WhatsApp or may be forward this email :)
Until tomorrow then ....