An exceptional year

Govt needs to reduce dependence on RBI

The Reserve Bank of India (RBI) has released its Annual Report for 2018-19, which explains its actions over the past year and outlines expectations for the broader economy. The Annual Report comes shortly after reports that the RBI will transfer a considerable amount, over Rs 1.7 trillion, to the government’s coffers this year. This is thanks to a much larger surplus of Rs 1.23 trillion, with excess provisioning making up the remainder. This followed the recommendations of a high-level committee led by former RBI governor Bimal Jalan. The surplus is high partly due to an acceleration in open market operations (OMOs) by the RBI, particularly in the second half of the year, which saw Rs 2.5 trillion worth of OMOs. Nevertheless, the Annual Report noted that liquidity remained tight and “system liquidity experienced shortages despite injection in durable liquidity of the order of Rs 3 trillion, the highest in any year so far”. Some observers believe that liquidity in the banking system is comfortable. India Ratings argues that this is because the net liquidity injection under the liquidity adjustment facility continued in FY19 and the credit offtake remains weak.

Future views on liquidity in the system are crucial as to whether the higher transfer from the RBI will be a one-time event or sustained under the new framework. As to why the RBI felt the need for liquidity injections on a larger scale, the Annual Report was quite clear on the motives: It was largely because of foreign exchange operations and large currency expansion. 

The RBI also felt that the last vestiges of remonetisation were dealt within 2018-19, taking the currency-GDP ratio from 10.7 per cent to 11.2 per cent. That meant that system liquidity shifted from surplus to deficit during the year. Therefore, the RBI blamed capital outflows and the expansion in currency in circulation for strong action on liquidity. The government, thus, cannot depend upon a permanently higher level of transfers from the RBI and must reduce its dependence thereon.

It is important to note that the RBI, through the Annual Report, signals its continued vigilance about the need for ample precautionary buffers against external crises. These are more important than even in the “taper tantrum” episode of 2013, because the sensitivity of portfolio flows to global spillovers has increased significantly.

In other respects, the Annual Report might be considered to be surprisingly sanguine, such as on the matter of the growth of the general government deficit. While it highlights the lack of growth impulses domestically and the downside risks from the global economy, it also says that India is going through a “soft patch mutating into a cyclical slowdown” rather than facing a structural problem, though it has highlighted structural issues in areas such as labour, agricultural marketing, and land, and they need to be addressed. 

The RBI has also reiterated its stand that reviving consumption demand and private investment is priority in the current year. This means that since inflation is likely to remain under control in the foreseeable future, the central bank will be in a position to bring down the policy rates further.