The decision of the Reserve Bank of India (RBI) board to give the union government Rs 1.76 lakh crore (which is more than the Rs-90,000 crore the government had put in its budget numbers) created a lot of noise. Detractors of the government have castigated the central bank for bowing under pressure. They point out that various former RBI governors have not been in favour of such transfers. They have laboured on the dangers of leaving the RBI with too little cash to fight a crisis in the financial markets, if one were to crop up.
Two issues are worth pondering. First, former RBI governor Bimal Jalan-headed committee had recommended the contingency fund to fall in the band of 5.5-6.5 per cent of the balance sheet. The current level is 6.8 per cent. The RBI board accepted the lower band of 5.5 per cent. This is questionable. They should have considered the highest (6.5 per cent) or mid (6 per cent) point. Second, the just released RBI annual report has an item 'provision no longer required and miscellaneous income' at a staggering Rs 57,056 crore. This is what helped the dividend and surplus go up substantially in 2018/19.
The supporters of the government have been equally stout in their defence. They say that after all a committee headed by a well-regarded former RBI governor has recommended it. They also argue that there is no point in RBI accumulating excess surplus and then doing nothing with it when the government can use it to boost the economy. Finally, one columnist even pointed out helpfully that it is hardly the first time the government has raided the RBI reserves - Rajiv Gandhi had done it during his term as Prime Minister.
The last is a silly argument because Rajiv Gandhi left the economy and the central bank in a pretty bad state. Decisions like these are what led India to go to the IMF with a begging bowl. (Of course, that also led to the economic reforms so perhaps there were long-term benefits though in the short term, it wrecked the economy).
The fact is that calculating how much reserves a central bank should keep is not exact science. And exactly how much the central bank should transfer from its balance sheet to the government can also be debated endlessly.
The more pertinent questions in my mind are two. One, what signal is it sending out about the state of the government's finances? And two, will the government spend this money prudently?
The first question is easy enough to answer. The transfer gives a fair idea that the government finances are probably in a worse shape than most people suspected. And that it had little idea about how to go about raising revenues. Over the past five years, it has raised taxes and cesses, but its tax revenue projections in the last budget have seemed rather unrealistic. And already, the numbers revealed by the government so far suggests that tax collections have been far lower than what the government optimistically put in its budget papers.
The instances of forcing the public sector enterprises (PSEs) to give more money to the government to spend are also coming down. Over the last five years, the government has used PSE balance sheets as its private piggy bank and now the PSEs are in a rather bad shape. The government has also tried to raise cash through any means it could to keep spending - including spectrum auctions. But all those avenues are now showing the classic signs of the law of diminishing returns.
The government cannot stop or slow down spending - the economy is already losing steam with exports, private consumption and private sector investment slowing down. If the government spending also goes down, it will hit an already beleaguered economy. It needs the money and the RBI is living up to its role as the lender of last resort - except that this is not a loan, and the government is not a bank, which needs a lender of last resort.
The second question is tougher to answer simply because even the government seems to have little clue currently about how to spend this largesse. Finance Minister Nirmala Sitharaman, when queried, said in a press conference that they had not yet decided how to spend this money.
My fear is that the government is not going to be particularly prudent with this largesse. Yes it might actually use some of the cash to recapitalise the ailing public sector banks and thus improve liquidity in the market. But quite a lot of it would be wasteful expenditure I fear. It could end up helping Food Corporation procure more grains that it cannot store, or keep the ailing PSEs such as Air India, BSNL and MTNL burning cash or be spent on populist measures instead of building useful assets. And that is why the RBI perhaps should not have been keen on forking out money it had put aside for a rainy day.