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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

Modi-Jaitley Economy'.

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 bank.

"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.)



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