The Reserve Bank of India (RBI) has decided to transfer Rs 28,000 crore to the government as interim dividend. This is the second year running when it is making such a transfer.
In 1989, the RBI had transferred just Rs 250 crore. It had been transferring this sum since 1936.
Since the early 1990s, however, the sum has been growing. From 2014, the RBI has been transferring upward of Rs 60,000 crore annually. The exception was 2017, when, thanks to demonetisation in November 2016, it transferred ‘only’ Rs 30,000 crore.
Is this a good thing or bad? There is no consensus. This is because there are two equally powerful arguments for and against the practice.
The politico-legal argument in favour is that the RBI is owned lock, stock and barrel by the Government of India, which, therefore, has a total and complete right over the former’s surpluses — which accrue of the issuance of currency and the lending to the government.
In any case, goes this argument, if by not transferring whatever the government needs, the result is a higher fiscal deficit, who gains? It is like not paying the large hospital bill when you have idle cash sitting in your safe at home on the grounds that the money is for a different kind of emergency.
But what if the government wants the money to finance consumption and holds out the threat of a higher fiscal deficit to bully the country? Is that not like an alcoholic stealing the money meant for school fees?
The government answer is that it needs this money to pay committed costs like salaries, pensions, interest on past debt and subsidies.
The balance sheet view
In direct opposition to this is the view of central bankers. This was summed up most admirably in a paper called ‘Why central bank balance sheets matter’ by Jaime Caruana of the Bank of International Settlements in Basle (BIS Papers No 66).
After acknowledging the merits of the politico-legal arguments, Caruana sounds a clear warning that while the resources of a central bank can indeed be used, we should be aware of the risks also.
“The increased use of these tools in recent years reminds us that central banks do not need to rely merely on short-term interest rates in order to achieve their policy goals. But the judgement that such and such a policy was the right choice in current exceptional circumstances should not make us complacent about possible medium-term risks arising from such a significant shift in the size and composition of central bank balance sheets.”
His basic point is that the size of a central bank’s balance sheet has implications for the real economy which cannot be shrugged away.
“Let me also remind you,” he says, “about the considerable fiscal risks that many countries face – risks that could at some point confront central banks with extremely difficult choices.”
In India, one of these risks arises out of a large number of banks becoming insolvent at the same time. Who will rescue them if that happens?
One answer to this question lies in saying that private sector banks will, in the final analysis, have to fend for themselves while public sector banks, which are owned by the government, will be bailed out by it, if necessary, by printing the requisite number of notes.
Here, issues of financial stability begin to arise and Caruana’s view is that in importance these far outweigh any short-term considerations that governments may have.
This is exactly the argument that a former governor of the RBI, R N Malhotra, had made between 1986 and 1989 when the then finance secretary, S Venkitaramanan, had demanded more of the RBI’s surpluses. Malhotra had said a firm no but he was succeeded by Venkitaramanan who promptly reversed Malhotra’s policy.
The question history has to answer is if the crisis of 1991 could have been avoided if the RBI had transferred more from its coffers, thus helping to keep down the budget deficit – as it was called then – and preventing the crisis of confidence that led to the outflow of foreign capital.
We will never know because there was more to that crisis than merely the fiscal deficit.
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