Ever wondered what made the central government ask the Reserve Bank of India (RBI) to set aside a bigger share of its reserves for meeting the government's funding requirements? Former chief economic advisor Arvind Subramanian has given us ample hints in the Economic Survey 2016-17 on the 'excess capital' that remains with the RBI and the possible ways to make best use of the money. The survey is prophetic when it comes to the possible objections that could be raised by the RBI against such a move and provides responses to hypothetical situations.
In the Survey, Subramanian argues that there is no particular reason for RBI to retain excess capital within itself. He points out that even at current levels, the RBI is already exceptionally highly capitalised. "In fact, it is one of the most highly capitalised central banks in the world. So, it would seem to be more productive to redeploy some of this capital in other ways," the survey says.
The Survey asks a very pertinent question and goes on to give the answer. "Assuming that the RBI returns Rs 4 lakh crore of capital to the government, what are the uses to which this capital can be put?," it asks.
The answer is as follows:
First, for recapitalising the banks and/or recapitalising a Public Sector Asset Rehabilitation Agency (PARA)
Second, for extinguishing debt to demonstrate that the government is serious about a strong public sector fiscal position.
Subramanian is very clear that the transfer of funds should happen with the full cooperation of the RBI to ensure that the RBI's independence and credibility are in no way undermined.
What are the possible economic objections to such a strategy? He asks, and goes on to list them.
First, would there be adequate buffers after such a reduction in the RBI's capital?
Second, likelihood of capital losses. What kind and magnitude of exchange rate change could undermine the capital position of the RBI? The survey estimates that the exchange rate would need to appreciate by 16.3 per cent to wipe out the RBI's capital.
Third, feasibility of averting losses, where the Survey believes RBI has enough headroom.
Finally, it asks that supposing the excess capital were redeployed toward recapitalising the banks, would redeployment of RBI's reserves amount to the regulator holding a stake in its regulatees- the commercial banks?
The survey goes on to analyse each of these situations and provide its views.
It also ends the section by highlighting some international precedents:
The US Federal Reserve gave $19 billion from its surplus capital to finance transportation projects in 2015.
In 2004, the Bundesbank, extinguished its old deutsche mark currency and counted it as income in the profit and loss account because it was deemed highly unlikely that these would ever be exchanged for euros.
The Bank of Israel recorded a gain of ILS 220 million in its 2010 financial statements (about $62 million at the time) for the face value of notes that had passed the legal date for exchange and were no longer valid for use.