Challenge to the Reserve Bank of India’s reserve(s)

There are many issues on which the Reserve Bank of India (RBI) and the Centre disagree but the most significant one is over the treatment of the sizeable reserves in the central bank’s balance sheet.

If the reserves are mouth-watering for the Centre, they’re a source of security for the RBI and not up for bargaining.

The Centre’s views

Let’s look at this from the Centre’s angle first. The outlay for recapitalisation of banks is continuing to grow. After coughing up over Rs. 2.11 lakh crore over the last year, the government finds itself in the unenviable position of having to cough up even more as the skeletons keep tumbling out of bank lockers.

Second, the Centre is still smarting from the return of all the cancelled notes in the demonetisation exercise. Remember, it was banking on a large part of the notes not returning which would have accrued to its account.

Third, throw in the fact that it’s an election year when it would like to push up spending to create a feel-good factor with voters, and the picture is complete. Now you know why the government is salivating over the booty in RBIs vaults.

How RBI sees it

Let’s now look at this from the central bank’s angle. As of June 30, 2018, the RBI had Rs. 10.46 lakh crore in reserves, bulk of it under two heads — currency and gold revaluation reserve (Rs. 6.91 lakh crore) and contingency reserve (Rs. 2.32 lakh crore).

The currency and gold revaluation reserve (CGRA) accounts for 19.11% of total assets and the contingency reserve for another 6.41%. Back in 2004, a committee under Usha Thorat, then Deputy Governor, examined the question of what should be the ideal size of RBIs reserves.

It suggested that the CGRA should be 12.26% of total assets while the contingency reserve should be 5.5%, totalling 17.76% in all. But the RBI Board did not accept the recommendation and preferred to continue with the level set by an earlier committee in 1997. That committee, under V. Subrahmanyam, had set a contingency reserves level of 12% of total assets. The reserves are built through transfers from the annual surpluses in the profit and loss account of RBI. The balance surplus after transfper to reserves is given to the Centre as dividend.

In 2013-14, then governor, Raghuram Rajan, decided to transfer the entire surplus in the RBI’s profit and loss account to the Centre without appropriation to reserves. He was acting on the recommendation of another committee under Y.H. Malegam which said the existing reserves were in excess of the needed buffer and hence no transfers from the profits were necessary.

So, what were the reserves then? The CGRA was 21.81% of total assets and the contingency reserve was 8.44%. The corresponding numbers now (2017-18) are 19.11% and 6.41% respectively. By imputation, it can therefore be concluded that the buffer is now inadequate going by the Malegam Committee’s recommendation.

Aim of keeping reserves

But what’s the object of these reserves? They are fourfold. The CGRA is meant to cover a situation where the rupee appreciates against one or more of the currencies in the basket — and the basket has several currencies ranging from the dollar to the euro and the yen — or if there is a decline in the rupee value of gold.

The level of CGRA now covers about a quarter of the total currency reserves of the RBI.

The contingency reserve is meant to cover depreciation in the value of the RBI’s holdings of government bonds-- domestic and foreign-- if yields rise and their prices fall. The reserve is also meant to cover expenses from extraordinary events such as demonetisation (you could argue that like the tsunami, an exercise like demonetisation hits the country once in several generations), money market operations and currency printing expenses in a year of insufficient income. Most important of all, the contingency reserve supports the mother of all guarantees — the central bank’s role as the lender of the last resort. The reserve is also a cover for the deposit insurance fund given that the Deposit Insurance and the Credit Guarantee Corporation (DICGC) is a wholly-owned subsidiary of the RBI.

The RBI’s position, therefore, is that it would be imprudent to consider sharing any part of the reserve with the Centre. The Centre’s view is that the technocrats in RBI are too conservative and the money belongs to it.

The reserves have been built from higher seigniorage income (the difference between the value of new notes printed by the RBI and the costs of printing and distribution) and interest paid by the Centre to the central bank on the latter’s holdings of government securities.

A committee is in order

So, what’s the solution to this? Simple. When in doubt, set up a committee.

Such a committee should have representatives from government, the central bank, academicians and the market. The committee should go into all aspects of the RBI’s balance sheet, suggest a safe buffer in reserves and set out a fair method of sharing the reserves, if at all they should be.

In his book Advice & Dissent — My life in public service , former Governor Y.V. Reddy narrates the story of the Subramanyam Committee and its recommendation. When he took the issue to then Finance Secretary Montek Singh Ahluwalia, the latter just asked him one question: “If you were in the Finance Ministry in my position, would you agree to this proposal?” When Dr. Reddy nodded, Mr. Ahluwalia immediately gave him the go-ahead.

Dr. Reddy quotes this to show the mutual trust and level of respect that the two had for each other.

Admittedly, the present scenario is a far cry from that. But is it too much to expect for mature individuals to respect each other as professionals and act in the best interests of the nation shedding their egos?