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Are the RBI's reserves in imminent danger of depletion?

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The latest edition of EPW (December 8) carries a research paper titled “Paranoia or Prudence: How Much Capital Is Enough for RBI” authored by former CEA Arvind Subramanian along with Abhishek Anand, Josh Felman and Naveenraj Sharma. The article explains in detail how RBI may have excess capital to the tune of Rs 4.5 lakh crores which can be used to capitalise banks. The authors say at the outset they all “worked in or were associated with the Ministry of Finance when the bulk of this paper was written.”

Are the RBI's reserves in imminent danger of depletion?
The latest edition of EPW (December 8) carries a research paper titled “Paranoia or Prudence: How Much Capital Is Enough for RBI” authored by former CEA Arvind Subramanian along with Abhishek Anand, Josh Felman and Naveenraj Sharma. The article explains in detail how RBI may have excess capital to the tune of Rs 4.5 lakh crores which can be used to capitalise banks. The authors say at the outset they all “worked in or were associated with the Ministry of Finance when the bulk of this paper was written.”
Can one connect the publication of this article to other events that happened last week?
  1. Since all the authors worked with the finance ministry when bulk of the data was gathered and the paper written, it may be safe to assume that the Ministry of Finance owns this data and will likely rely on it while discussing the issue of RBI’s capital framework. Since some of this was published in the Economic Survey of 2015-16, what is the reason to re-publish it at this juncture? Is it to rekindle this argument as the basis of a new capital framework calculation that should be adopted by the soon-to-be-appointed committee on RBI’s capital and reserves?
  2. On Tuesday, the ruling BJP lost the state assembly elections in three key states and failed to make a mark in the two other.
  3. Three days ago news agency Reuters carried a story saying the government could be looking to waive Rs 4 lakh crore of farm loans. ”Prime Minister Narendra Modi's government is likely to announce loan waivers worth billions of dollars to woo millions of farmers ahead of a general election, government sources said, after his ruling party suffered a rural drubbing in state polls,” the agency reported. "The plan could see as much as Rs 4 lakh crore ($56.5 billion) in loans written off, the government sources and analysts said”. This report was published by several English and vernacular newspapers. So much so that Shiv Sena MP Bhavana Gawali Patil raised the question in Parliament and the Union Minister of State for Agriculture Parshottam Rupala said in a written reply that “the Union government at present is not considering any loan waiver scheme for farmers.”
  4. For the first time in over 3 decades a Reserve Bank of India governor resigned last Monday citing personal reasons. But the backdrop of the resignation is littered with several differences of opinion between the RBI and the government: the government invoking the never used Section 7 of the RBI Act which allows it to give directions to RBI, the RBI’s governance being brought under board control etc. Was the real reason for the resignation the government’s threat to use Section 7 to direct the RBI to transfer Rs 4 lakh cry of its capital to the RBI and did governor Patel resign to avoid this.
  5. That all these seminal events happened within a week could point to a very distinct possibility that despite denials, the government is possibly planning to use the RBI’s reserves to capitalize PSU banks, after which these banks could be asked to write off loans below a certain level, say Rs 10 lakhs or Rs 25 lakhs, which could total to Rs 4 lakh crores of write offs.
    Technically this is not a loan waiver by the government, it’s a write-off by the banks and hence the minister was factually correct in his written reply to the Shivsena MP.
    Here are a few issues to think about if this is indeed the government’s idea:
    1. If the idea is to capitalize banks, why isn’t the government using the more simple method of issuing recap bonds like Manmohan Singh did as finance minister in 1994. That was what the government promised in November 2017, when it announced the bank recap plan. Why appear to “raid” the RBI at a time when its credibility already stands tarnished by recent events.
    2. Entities like the IMF and the World Bank have already frowned upon the lack of independence for the RBI. The Financial Sector Assessment Program of India conducted by the IMF-World Bank in 2017, says that the central bank’s independence is at the moment defacto and not de jure and its independence needs to strengthened by changing the RBI Act so the governor’s appointment and dismissal requires parliamentary approval.  If the RBI’s reserves are indeed taken within months of the governor resigning it will be impossible not to connect the two events. Under the circumstances further adverse reaction from international agencies such as the IMF as also from rating agencies and investors cannot be ruled out.
    3. It is also important to discuss what the recapitalization is going to be used for. Is the new capital only going to be used to write off small loans or will the capital be so gigantic that banks can write off some loans and also have enough growth capital to give more loans. This can set off a huge and destabilizing loan growth. More importantly it rewards the minority shareholders of PSU banks at the expense of the RBI and the exchequer and will probably trigger a stock market boom conveniently before the polls.
    4. The new governor’s stress test may well be how he responds to the demand from the government, if any, for the reserves. While governor Patel failed to resist the demand for demonetization, probably because he could not gather public support given the way the event rolled out, Governor Das can force a public debate on the matter of the central bank’s reserves. He will probably also have to bear in mind that there is at least a 10% chance that in the next six months he could be faced with a different government.
    5. In all fairness, if indeed the soon-to-be-appointed committee agrees that RBI can do with lesser capital, the committee must also suggest a plan to return this capital to the government over time. These are reserves accumulated over the last two or three decades and in the interest of fairness and stability it should be transferred to government over a period of years and not in one shot to a government that has only a few months to go to polls.
    6. And finally, it may well be that the committee on RBI reserves takes more than three months to give its report, in which case there will be ample time to debate the issue during the polls and thereafter.
    7. Market Movers

      CompanyPriceChng%Chng
      Maruti Suzuki6,993.50 -171.55 -2.39
      Power Grid Corp167.40 -3.68 -2.15
      ITC206.05 -3.05 -1.46
      Bajaj Auto3,763.75 -54.75 -1.43
      Coal India142.15 -1.90 -1.32
      CompanyPriceChng%Chng
      Maruti Suzuki6,991.90 -158.30 -2.21
      Power Grid Corp167.40 -3.65 -2.13
      Bajaj Auto3,762.80 -57.70 -1.51
      ITC206.00 -3.15 -1.51
      Dr Reddys Labs4,671.05 -59.15 -1.25
      CompanyPriceChng%Chng
      Maruti Suzuki6,993.50 -171.55 -2.39
      Power Grid Corp167.40 -3.68 -2.15
      ITC206.05 -3.05 -1.46
      Bajaj Auto3,763.75 -54.75 -1.43
      Coal India142.15 -1.90 -1.32
      CompanyPriceChng%Chng
      Maruti Suzuki6,991.90 -158.30 -2.21
      Power Grid Corp167.40 -3.65 -2.13
      Bajaj Auto3,762.80 -57.70 -1.51
      ITC206.00 -3.15 -1.51
      Dr Reddys Labs4,671.05 -59.15 -1.25

      Currency

      CompanyPriceChng%Chng
      Dollar-Rupee74.2850-0.0900-0.12
      Euro-Rupee88.25700.04600.05
      Pound-Rupee103.81500.28900.28
      Rupee-100 Yen0.67750.00090.13