Going through the interview of the ex-Governor of the BoM in l’express, I got the impression that we have been taken for a ride ; instead of straight answers to straight questions , we had to go through a verbose analysis which merely grazes the swirl of current events ...
and only illuminates us on some of background subtleties and nuances but fails in pursuing the big picture and it even side-tracks us into some of the stellar credentials of our celebrity. An articulate display of delightfully colourful but otherwise unimpressive fireworks for the general reader with a fluid prose at times even pompous in its unmistakable cadence –“ that I passionately read and discuss with friends in the International Affairs of some Universities “ - that however fails to keep the narrative on track . Our vaunted think thank tiptoes around many of the issues raised and with talented trickery returns back the question to us unanswered, with such a papery grace . Indeed, the interview had everything except straight answers to the straight questions.
On the question of RBI dipping into its capital reserves for budgetary purposes, like what we did, our ex-Governor is totally off track and his advice that we have recourse to S.Raghavan book “Dialogue of the Deaf: The Government and the RBI” or to “The monetary approach to the BoP” is not of much help.
What is this the main issue of the transfers from the Reserve Fund ?
You recall the proposed transfer of Rs 18 billion from the Bank’s Special Reserve Fund for debt repayment. The original Rs60 bn grant to Govt in Padayachy's original plan was to come from the SRF. Later, the Governor of BoM tried to fool us with his so-called attempt to raise the money from the market. If we have a look at the rate of rupee depreciation and the target SRF, we would note a strong correlation. The SRF has been mostly replenished through valuation gains, engineered by BOM interventions to depreciate the rupee.
The IMF was against this and as the money had already been allocated, it provided the authorities with a face-saving compromise- that an amount of Rs 32 billion be written off from the Special Reserve Fund and the remaining balance of Rs 28 billion to be treated as advance against future profits distributable to Govt. This was accompanied by a severe warning that such policies should be discontinued and the BoM law be amended to prevent such exceptional transfers in future.
What was wrong with these exceptional transfers ?
The amendment to the BOM Act authorized the BoM to print money by distributing its capital reserves to Government, for the purpose of debt reduction. The exceptional circumstances that the BoM Board can invoke to approve SRF financing to Government were left totally unspecified, and no limits were prescribed for such exceptional financing. The proposed BoM Amendment could thus be misused and potentially open the floodgates to excessive money financing to Government. The sizeable money creation for Government to finance a higher budget deficit will eventually hurt growth prospects, through adverse effects on the external balance, the exchange rate and inflation.
As pointed out by a top economist in his article “Busting the Bank" on 22 July 2019, "a one-off money financing of moderate size by the BoM and for appropriate use by Government could be considered acceptable….It should only be approved on clear and well-founded grounds, and within strict limits. A capital adequacy and risk provisioning assessment of the BoM is essential for determining its capital needs, and the extent to which surplus reserves are distributable to Government. “
How different was RBI‘s transfers from its capital reserves ?
The Government of India , like here, had been pressing RBI, its central bank, to transfer its reserves to the government. The government has been seeking the transfer of a substantial chunk of RBI’s reserves built up over the years. In the year 2019, the Bimal Jalan Committee was appointed by the government to have a proper model for transfer of funds to the government by the RBI on a regular basis.
The Jalan committee recommended that RBI maintains equity (or retained earnings) at 5.5-6.5 percent of its total assets. It also requires RBI to maintain total economic capital (retained earnings plus revaluation reserves) at 20.8-25.4 percent of total assets. The RBI had kept reserves to the tune of 6.8%. Thus part of the the excess surplus was paid back to the government.
That meant a more transparent and rule-based payout as in many other central banks.
But even such transfers had become contentious. The RBI has been criticised lately for resorting to the infamous gimmick of turning up a higher dividend to the government by carrying out a whole lot of sell-buy swaps- with the huge forex reserves in its wallet, it sold dollars spot & buy dollars forward. When you sell dollars now (spot), the dollar becomes weak, and then, you buy it later (forward) with lesser rupees, thus earning the spread as your profit- The figures show that both the dollars purchased and sold this year had more than doubled in comparison to the previous year. Also, without any other significant influence, this activity had gained traction over the previous three months. The RBI was doing this to make a profit and meet the higher demand for dividends.
Many commentators and analysts disapproved of this gimmick and saw it as “poor messaging on the part of a central bank that had, over the years, built up a formidable reputation for its professional independence.” It was also seen as a case of the RBI doing the bidding of the ruling political establishment which was seriously hamstrung by a burgeoning budget deficit and falling tax revenues and didn’t mind twisting an arm to secure some extra funding. They were also apprehensive that the benefits of this bonanza outweigh the risk of inflation as a result of its monetisation.
On the question of our stock of foreign reserves that has remained more or less unchanged, even the little boy in Felicia Hemans “Casablanca” would have found it much simpler to explain it by referring to the sizeable external financing during 2020 and in 2021 which have boosted the gross official foreign exchange reserves. They have thus remained at around USD 7.4 bn between end Dec 2019 and end April 2021. The rupee value of reserves increased by Rs19 bn over 2020, largely due to a depreciation of the effective exchange rate of the rupee by 11.8%, and a further 1.8% between Dec 19 and April 21. The rupee weakened by 8.6% against the U.S. Dollar between Dec 19 and Dec 20 and a further 2% until April 21.
On the geopolitics in our midst and the outlandish conspiracy theories of our 200 acres of strategically located land being used as an outpost by China, it may bring about some bouts of snickering from our readers but also some signs of encouragement to the many who participate on the online forums -the armchair sleuths-and who resonate with such wide conspiracy theories and will be eager to join the conversation. They gamify the process of truth-seeking, interpreting it and offering their own gloss to it …..and spreading the word . At least, one can say that the interview would have served some purpose.
