Former chief economic advisor
(CEA) Arvind Subramanian has made a strong pitch to the
government to claim Rs 4.5-7 trillion in excess capital from
the Reserve Bank of India (RBI).
RBI is an outlier among its peers as it is keeping
close to 28 per cent of its balancesheet in the reserves,
against an 8.4 per cent global average, Subramanian, who was
the CEA from October 2014 to June 2018, writes in a
soon-to-be-published book 'Of Counsel: The Challenges of the
Stating that the swelling captial base of the RBI
needs to be held accountable, he pegs the excess capital that
the apex bank holds from Rs 4.5 trillion from the ratio of
shareholder equity to assets, and at Rs 7 trillion from a
BIS-mandated average based on 1 per cent of risk cover ratio.
"The RBI is an outlier among major central banks. It
holds about 28 per cent in reserve capital, which is the fifth
largest amongst all major central banks Compared to the
typical central bank (8.4 per cent ratio), it has excess
capital of about Rs 7 trillion," he writes.
He goes on to argue that "when looked at the practices
of all the major central banks and the Bank for International
Settlements (BIS), nearly all the other central banks choose
a risk tolerance level of 1 per cent and when we apply this
tolerance level to the risks facing RBI, the formula shows
that RBI has an excess capital amounting to Rs 4.5 trillion".
As per the RBI's annual report for FY18, its balance
sheet stood at Rs 361.75 trillion, up 9.5 per cent from FY17,
boosted by rising foreign investments and growth in foreign
exchange reserves. On June 30, 2017, its balance sheet stood
at Rs 330.4 trillion.
The RBI follows a July-June fiscal year. The note-ban
of November 2016 had shrank the central bank's balancesheet by
close to Rs 15.8 trillion.
Admitting that counting RBI balance from the 1 per
cent risk ratio perspective as a "too crude a way of
calculating it", Subramanian says central banks across the
world are using the analytical framework based on economic
capital framework to arrive at the optimal level of capital,
which essentially involves conducting a value-at-risk analysis
for the various sources of potential risk for a central bank.
The book, to be published on December 7 by Penguin
Random House India, comes at a time when the recent spat
between the government and RBI over a host of issues including
this capital demand, ended up RBI ceding ground and agreeing
to set up a panel to look into the details of a new economic
capital framework for the central bank.
Stating that the range of RBI's actual capital
position reflects an ambiguity, he says the ratio of
shareholder equity to assets "varies from over 40 per cent in
the case of Norway to negative capital in the case of Israel,
Chile and Thailand, with a median holding of 8.4 per cent for
54 major developed and emerging market economies for 2016-17".
But he also underlines that any change in the captial
position of the central bank involves many risk such as market
risk that captures the risks arising out of change in the
value of their assets like forex reserves, gold and government
securities; credit risks in the form of losses arising due to
default by counterparties; operational risk; and contingent
risks among others.
But he also adds that none of these risks can justify
the large capital that RBI sits over as the sovereign's
security is more important and credible than that of its
"Central banks are part of the government, and it is
the broader government balance sheet that matters, not that of
any of its constituents. As long as overall conditions are
reasonable, the stream of profits will eventually make up for
any capital shortfalls because central banks have a unique
ability to generate income," he says.
Subramanian had first proposed this in the Economic
Survey 2017, wherein he had called for redeploying this excess
capital into the cash-starved public sector banks.
On the controversial note-ban of November 8, 2016,
Subramanian, who had supported the move in the Economic survey
2017, sounds very critical of the policy saying this was "a
massive draconian, monetary shock", which accelerated an
already slowing economic engine, pulling down growth to 6.8
per cent in the past seven quarters, against the 8 per cent
prior to the note-ban.
Breaking his silence, Subramanian, in the chapter
titled 'The Two Puzzles of Demonetisation - Political and
Economic', says demonetisation hastened the economic slide
which though was a massive political success as was seen in
the BJP sweep of the UP elections.
"Demonetisation was a massive, draconian, monetary
shock: The real GDP growth was affected by the demonetisation.
Growth had been slowing even before, but after demonetisation,
the slide accelerated," says Subramanian in the book where he
is silent on whether he was consulted on the move.
He also says the executive ceding powers on decision
making to the Supreme Court over the years has come with a
heavy cost. This has resulted in the judiciary acquiring a
greater role in economic policymaking.
"In particular, it's shifted the balance of
institutional power and authority away from the executive and
the legislature. Indeed, it seems at times that the only
legitimate locus of decision making, even on major economic
policies, is the Supreme Court. This situation is certainly
better than a state of indecision. But it is not without
costs," he writes.
He also says the Insolvency and Bankruptcy Code (IBC)
is a work in progress.
Though the IBC has had some success in resolving a few
high-profile cases, at the same time, many of my initial fears
have been realised. In most of the key cases, there have been
prolonged delays. As a result, backlogs have been growing,
resolutions have been receding into the distance, and all the
while costs have been climbing," he argues.
Accordingly, he doubts whether IBC is the effective
way out for resolving the twin balance sheet problem.
"A more radical solution will be necessary to solve
the twin balance sheet problem; government will have to take
bold actions such as changing the Bank Nationalization Act -
one of the holy cows of our socialist past - to allow
privatisation of public sector banks and also setting up a bad
bank funded by the RBI," he says.
(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)