Debate on transfer of 1.76 lakh crores during a crisis

A businessperson puts a part of his earnings in Fixed Deposits in banks, buys gold or holds it in some other form of “reserves”. These serve as a backstop in adversities. The remaining profits are used for home expenses or investment in the business—new shop or product/service. This division of profits is decided by the businessperson. Similarly, The Reserve Bank of India (RBI) has to decide what share of its profits will be retained as reserves and what share is transferred to the Government as dividend.

The Government being RBI’s sole shareholder, all profits in excess of those plowed in reserves will be transferred to them. Part of these dividends will be consumed in paying salaries to its employees and part for investment such as in making highways. The situation reverses in times of economic crisis. The Reserve Bank draws on the reserves to protect the economy. If in the situation of a war India is not able to earn enough to pay for its imports of oil, the foreign reserves can be used to pay for oil imports. The RBI had been placing part of its profits in reserves every year until 2013. Rs 27000 crores in 2012, Rs 28000 crores in 2013 and none since 2014.

Consider the present controversy. The RBI has earned a profit of Rs 1.76 Lakh Crore in the financial year of 2018-2019. This entire amount has been transferred to the Government, with not a single paise put in the reserves. Furthermore, the RBI formed a Committee under the chair of Bimal Jalan, former Governor of RBI, to recommend what would be a reasonable level of reserves that should be maintained. The Committee recommended that the RBI should hold between 24.5 and 20 per cent of its assets as reserves. 23.3 per cent were held in June 2019—within the range suggested by the Jalan Committee. However, the RBI decided to bring them down to the lower end of the range i.e., 20 per cent. Accordingly, it transferred Rs 52000 Crores out of its reserves to the Government. The RBI has assessed that holding reserves at the most minimum level would be reasonable—a decision that is self-evidently flawed.

The situation is even more serious. The reserves of RBI consist of two types of assets. One is not liquid--US Treasury Bonds, gold, foreign currency. They cannot be sold at will and have geopolitical implications. For example, Trump would not be pleased if the RBI would want to sell its holding of US Treasury Bonds. The second type are domestic such as domestic currency and bonds Issued by the Government of India, which are easily cashable. Until now, the adequacy of reserves was assessed only on the basis of domestic or easily cashable assets. The RBI made a major departure from this policy and considered all assets, including sticky assets like US Treasury Bonds, in assessing the adequacy of its reserves. Thus, the 20 per cent assets that the RBI is overtly maintaining as reserves are not truly reserves.

The RBI has no say in the manner in which the Government may use the dividends just as the Company which pays dividend to its shareholders has no say in its usage. The record of the Government in the last 5 years has not so good. The Government has reduced its fiscal deficit from 7 per cent to 3 per cent. However, most of this reduction has been secured by cutting investments; not consumption. The share of investment in the reduction of the fiscal deficit is about 3 per cent while the share of consumption is only 1 per cent. The Government is unable to cut down its consumption and wants the RBI to give away more moneyto support it. That is exactly opposite of what is required to jumpstart the economy.

The transfer of Rs 1.76 Lakh Crore by the RBI to the Government has imperiled the security of the economy in many ways. One, till 2013, part of the current income of the RBI was being placed in the reserves as a protection against any future economic crisis. Now, these reserves are being spent to support the current expenditures of the Government. The RBI is selling the family silver to have a meal in a 5-star hotel. It is an unsaid admission that we are in a midst of an economic crisis.

The Jalan Committee had recommended holding reserves between 24.5 and 20.0 per cent of the assets. Adopting the lowest level of this range means our safety net has become marginal. Third, the foreign or sticky component of the reserves cannot be easily converted into cash. The RBI may not be able to use these reserves in case of a crisis. By the day, many indicators of an upcoming crisis are becoming evident. Our relationship with Pakistan is on its edge, we are unable to import cheap oil from Iran, the Non-Performing Assets of our banks are not going away, we have succumbed to US pressure to increase imports from that country, the consumption expenditures of the Government are sticky while investment expenditures are fast declining, and our economy has been continually slowing down in the last three years.

We need a higher level of reserves in this situation. The Reserve Bank has unfortunately allowed itself to be persuaded to transfer high amounts to the Government and has placed the economy in peril. The Reserve Bank and the Government are together behaving like the businessperson whose business is running in loss and who is drawing the past reserves to continue to party.

The writer is former professor of Economics at IIM Bangalore.

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