RBI capital reserve: Is Rs 52,000 crore worth so much fuss?

For those who don’t care about technical issues like RBI’s reserves, here is a backgrounder: The RBI, like companies, makes profits and by law has to transfer the year’s profits to its owner, the government, after providing for contingencies. Over the past 25 years, the RBI had collected a kitty of about Rs 3 lakh crore as its contingency reserves.

Separately, it has revaluation reserves. What are these? The RBI often buys dollars from the market, in times of huge inflows (which can suddenly make the rupee strong and hence make our exports uncompetitive); it buys gold (like all central banks do, so that other countries trust that the RBI has some real assets in a crisis) and it also buys Indian government bonds sometimes to push more rupees into the economy. Now every year, like all banks and companies, RBI accountants compare the current price of these assets versus the price at which they were purchased and the excess, if any, is accounted in a “revaluation” reserve.

In February 2016, when Arvind Subramanian was accusing the RBI of excess reserves in his survey, the RBI’s Rs 10 lakh crore reserve comprised of Rs 3 lakh crore in contingency reserves and Rs 7 lakh crore of revaluation reserves (all numbers are approximate). Former governors of RBI and eminent economists argued against Subramanian saying revaluation reserves are not realized reserves and hence should not be used to say the RBI is over capitalised.

The balance of Rs 3 lakh crore as contingency reserves amounted to about 8 percent of the RBI’s balance sheet and these are needed during financial crises, for lender-of-the-last resort responsibilities, and for use in case of, say, cybersecurity or other operational risks.

The government was not convinced and, in 2018, upped its ante on demanding excess reserves from the RBI. Deputy governor Viral Acharya publicly decried this demand as an attack on the RBI’s autonomy. Many former RBI governors and economists agreed with him while the government did not. It issued directions to the RBI governor under the never-used Section 7 of the RBI demanding to know why RBI should not transfer excess reserves. For these and other reasons, governor Urjit Patel resigned. The image of both RBI and the government took a beating in the national and international markets.

Finally, in a bid to soothe tempers and repair the ravaged reputation, the government appointed a panel headed by former RBI governor Bimal Jalan. The panel also comprised of former RBI deputy governor Rakesh Mohan (vice-chairman of the committee), the RBI's board directors Bharat Doshi (an acclaimed chartered accountant), Sudhir Mankad (retired IAS officer), serving deputy governor N S Vishwanathan and the then finance secretary S C Garg.

After overcoming some dissent from one member (SC Garg), the Jalan panel submitted a “unanimous” report last week, since Garg had ceased to be both finance secretary and hence a member of the panel.

The Jalan committee rejected the old Subramanian argument that revaluation reserves should be included while calculating a central bank’s balance sheet. As per Jalan panel, at about Rs 3 lakh crore, RBI’s contingency reserves are only 6.8 percent of its balance sheet of about Rs 40 lakh crore. The panel recommended that keeping in mind international standards, it would like the RBI’s contingency reserves to be 5.5-6.5 percent of its balance sheet.

RBI’s research wing CAFRAL had published a research paper earlier this year which found that globally central banks keep an average 6.5 percent as a contingency reserve. Emerging market central banks are found to have an average contingency reserve of 6.86 percent.

The RBI board accepted Jalan panel’s recommendations on Monday and decided that for now 5.5 percent reserves will do. Consequently the excess (6.8% - 5.5% = 1.3% of balance sheet) was considered excess and transferred to the government. This worked out to an amount of Rs 52,637 crores.

The independence of the committee certainly deserves praise. Faced with the slowdown and pressured by election promises, the government would have liked a larger transfer. But the RBI board members and former governors kept their head down, worked out the international standard and stuck to it. Kudos also to the government for accepting that a manna of Rs 4 lakh crore, as promised by the former CEA, not being acceptable to the six wise men in the committee.

In the end, it may have just have been a face-saving formula. The RBI Board didn’t want the government to lose face and hence agreed to accept the lower end of the band recommended by the panel so that at least some money can be transferred. Nor did the panel want RBI’s actual or perceived autonomy to be diminished.

Also, all transfer of dividend from RBI is actually just printing of notes, and printing a large amount of notes (say Rs 4 lakh crore) would have amounted to monetisation of the deficit, would have been inflationary and attracted suspicion and criticism from international markets and rating agencies.

The paltry amount of Rs 52,637 crores satisfied all sides and arguments and has also left the bond and equity markets a trifle happy since the government has a little more money to spend.

As Shakespeare would say, “all’s well that ends well” but in this hour of happiness, it is worth remembering the stout defence of RBI as an institution put up by the former RBI governor and his deputy governor.