Modi-fying India's central bank

Try as one might, cricket analogies, are hard to avoid when covering India. So, when the then Reserve Bank of India (RBI) deputy governor Viral Acharya said in October last year brought up different formats of cricket to explain the difference between the roles of the central bank and the government, we sighed.

The bank, he said, plays a 5-day test match while the government plays T20 — the shortest form of cricket — driven by short-term political considerations. "The central bank aims to win each session, but, importantly, also survive it to have a chance to win the next session, and so on." 

So, when the central bank recently approved a 1.76 trillion rupees ($24.4 billion, €22.1 billion) payout to the government the bank's role was turned upside down: the bank was now a short-term slogger not an elegant play-maker, if we use the same cricket analogy.

Read more: Why India's central banker is a matter of hot political debate

The transfer came three days after Finance Minister Nirmala Sitharaman announced plans to give India's stuttering economy a boost. The timing was not a coincidence, critics say.

The issue of how to finance social programs, while boosting growth and balancing the books, is one that bedevils all and all would be populist regimes. The issue has underpinned months of bickering after the resignation of the  bank's former governor, Urjit Patel, late last year after clashes with the government over using central bank reserves to boost growth. 

All eyes will now be on how the money is used.

Scraping the barrel

Prime Minister Narendra Modi has been under pressure to boost growth since his Hindu nationalist Bharatiya Janata Party (BJP) was reelected in May, in part by playing up his welfare credentials. The problem is his government hasn't quite worked out yet how to increase tax revenues to pay for all the programs.

During his previous term, Modi tried demonetization to increase the tax base. The move failed to deliver the desired results. He then introduced a complicated Goods and Services Tax (GST) tax regime, but its unrealistically high tax rates put the brakes on demand, and it also has, so far, failed to live upto its potential. The government then more recently unveiled tax breaks for start-ups and an injection of 700 billion rupees into state-run banks, plus an easing of the rules governing foreign investment, potentially opening up the coal sector entirely.

New Delhi was seen by critics to have pressured the central bank into cutting interest rates in February, a pre-election calculation, they suggested. Some also see this political interference manifest in the government pressing the RBI to loosen restrictions on new lending by some of the weakest state-controlled banks. The limits had been placed to head off worsening of the country's bad loan crisis.

Economy in turmoil

Something had to be done, after all. The rupeewas Asia's worst performing currency in August after Chinese yuan, falling nearly 4%. The unemployment rate is at its highest level since the 1970s and GDP growth fell to a six-year low of 5% in the second quarter of 2019.

"It is definitely a slowdown," said Anuradha Saha, a professor of economics at Ashoka University, describing the situation as "grave."

Modi's spending urges

In such circumstances, the government has now decided to take RBI's excess fund that is known as Contingency Risk Buffer (CRB). The Modi government says the RBI's capital has risen to an "excess" level and could be more usefully used.

In an article published in December, Arvind Subramanian, the government's former chief economic adviser, argued that of the RBI's total capital of 10.5 trillion rupees, between 5.3 trillion rupees and 7.3 trillion rupees was "excess" and that some of it could be transferred to the government coffers.

Supporters like RSS-affiliated Swadeshi Jagran Manch's leader Ashwani Mahajan say the RBI governor should work with the government or quit. "This entire talk of central bank independence is a Western concept. It is not acceptable and feasible here. India is a developing country our main priority is employment and growth of small-scale industries. RBI should stand with government on these issues," he said.

Critics abound

"Nowhere in the world does a central bank give away its CRB to the government," Saha says.

"Governments that do not respect central bank's independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution," she added.

The RBI earns profits on its bond holdings and on currency movements and some of this is transferred each year to the government as dividends while some is retained by the bank as protection against contingencies.

Over the last five years, the RBI has transferred 100% of its profits to the government, compared to an average pay out of only 46.5% during the previous government. Not a single rupee has been added to the central bank's contingency reserves over the past five years, as a result of which RBI reserves today are lower than when the Modi government took over in 2014, Saha says.

The Basel norms suggest contingency reserves of around 8% of assets and for countries with more volatile currencies, reserves need to be around 12%. The RBI's internal research suggests contingency reserves should be maintained between 9% and 12% of assets. The Jalan committee, set up by the RBI in 2018  to examine the issue of reserve transfers to the government, suggested a number between 5.5% and 6.5%. The RBI maintained a reserve ratio of around 10% until 2013, which has now declined to 5.34%.

The previous two RBI governors, Raghuram Rajan and Urijit Patel, had refused to transfer the bank's excess reserves to the government, but that has changed with the appointment of Shaktikanta Das as RBI chief. 

Mixed interpretations

"There are perhaps two caricatured folklore narratives about this increased transfer of RBI surplus," says Partha Ray, professor of economics at the Indian Institute of Management Calcutta.

"The first one is: the government, facing a resource crunch, has arm-twisted the RBI to transfer some of its reserves, which is almost in the nature of family silver. This is not good for the economy. As when and if the economy faces a crisis, the RBI may not have adequate money to protect it. Also it denotes an erosion of the RBI's independence.

"The second, on the contrary, is: the central bank is a unique institution; it is backed by the faith reposed on it by the central government, and therefore, a huge amount of reserves with the central bank is in the nature of idle cash which could have been utilized more productively in the economy. This year, the central government has done precisely this."