Govt lost political capital in getting RBI funds but gained very little

In retrospect, the government's move to get more RBI funds for itself has paid it no dividend

What the central board of the Reserve Bank of India (RBI) decided last Monday, based on the recommendations of the Bimal Jalan committee, was disappointing for those in the finance ministry, who had hoped to secure for the exchequer a little more extra money from the central bank’s reserves.

But what has not been appreciated so far is that a bigger disappointment awaits the government when it gets ready to present the next Budget, just five months later in February 2020. Along with that will arise a politically embarrassing question on the Modi government’s governance style. If so little was secured by way of extra capital from the RBI after months of deliberations, growing doubts on the government’s commitment to provide autonomy for the central bank and the souring of relations with an RBI governor, who eventually quit, was the entire exercise counterproductive?

The Jalan committee was set up in December 2018 to suggest a formula for determining the prudent level of reserves that the RBI must keep with itself as part of its economic capital framework. The government had hoped that the new formula would pave the way for the RBI board to transfer more money to the central exchequer to help finance its expenditure programme, which was starved of adequate resources.

But the recommendations of the Jalan committee did not give much leeway to the government for taking advantage of the RBI reserves. It’s true that the total transfer from the RBI to the Centre is estimated at Rs 1.76 trillion in the current year. Of this, Rs 1.23 trillion arose out of the RBI’s net income, thanks largely to the Rs 3 trillion of open market operations it conducted during the July-June period of 2018-19.

The remaining Rs 53,000 crore was transferred following the adoption of the new formula to keep the RBI’s contingency reserve at 5.5 per cent of its balance sheet, which was the lower end of the recommended formula. The Jalan committee had recommended a range of 5.5 to 6.5 per cent of the balance sheet for deciding on the contingency reserve level. Before enforcing the 5.5 per cent formula, the RBI’s contingency reserve was about 6.8 per cent of its balance sheet.

The government’s additional financial bonanza, thus, was only Rs 58,000 crore. That is because the government had already taken credit for Rs 28,000 crore of surplus by way of interim dividend from the RBI in its Budget for 2018-19. An estimated Rs 90,000 crore had already been provided for in its 2019-20 Budget as dividend from the RBI.

So, the actual extra money with the government after this elaborate, and controversial, exercise is only about 0.3 per cent of gross domestic product (GDP). This is neither adequate for meeting the demands for higher expenditure, nor even the revenue shortfall that is being feared.

Worse, the expected income from the RBI during 2020-21 may be significantly less than what was transferred in 2019-20. There will be no scope for any further gain from the contingency reserve of the RBI, since the lowest level of the suggested benchmark has already been reached. Indeed, with the RBI balance sheet expected to grow by 7 to 10 per cent next year, there would be need to transfer from its income more money to the contingency reserve to keep it at 5.5 per cent of the balance sheet. The currency and gold revaluation reserves, estimated at Rs 6.6 trillion, cannot be touched either as the Jalan committee has categorically stated that this money cannot be redistributed to either maintain other funds or meet dividend requirements. A significant fall in the government’s income from the RBI next year will exert more pressure on its finances.

The question that is likely to arise then is whether the government imprudently wasted so much of its goodwill and even political capital to secure higher transfer from the central bank’s reserves. Its demand for more capital transfer from the RBI was first raised in the Economic Survey, presented by the government in February 2016. The argument for transferring RBI’s “excess” capital to the government to help it recapitalise banks and extinguish government debt was raised again in the Economic Survey presented a year later in February 2017. This issue was raised again by finance ministry bureaucrats in the subsequent year, even as the then RBI Governor Urjit Patel made his reservations about such a move known to the government.

Finally, a government advice to the RBI in October 2018, under Section 7 of the RBI Act, seeking consultations on its economic capital framework led to the formation of the Jalan committee. The RBI board decided to form this committee at its November 19, 2018, meeting. Urjit Patel resigned on December 11. The Jalan committee’s deliberations were stormy on occasions, with the government representative on it once refusing to sign the report to show his disagreement with its recommendations. Once the government nominee was changed following his transfer to a different ministry, the committee quickly completed its report and submitted that to the RBI, whose board adopted it on August 26.

But the end result could not have been very satisfying for the government. The entire exercise over deciding afresh the economic capital framework for the RBI and the resignation of Patel worsened the already fraught relationship between the country’s central bank and the government. And now the disappointment will be more since all those moves have not even helped it achieve its primary goal of substantially increasing the funds transfer from the RBI to the central exchequer.