RBI Should Be Sole Judge Of Adequacy Of Reserves, Says Indira Rajaraman
The central bank, which, among other functions, acts as the lender of last resort, should be the sole judge of the amount of reserves that it sees as appropriate, said noted economist Indira Rajaraman. That said, the Reserve Bank of India must be willing to explain and defend its views to the central board if needed, Rajaraman said in a conversation with BloombergQuint.
The amount of reserves held on the central bank balancesheet has become a point of contention between the RBI and the government. The issue is likely to come up for discussion at the board meet on Nov. 19.
Some sections in the government argue that the RBI is holding excess reserves, which should be transferred to the government. There are two material components to RBI’s reserves:
- A Contingency Fund of Rs 2.5 lakh crore
- A Currency and Gold Revaluation Reserve of Rs 6.91 lakh crore
Most economists agree that a transfer from the unrealised gains in the currency and gold revaluation reserve is not possible without a sale of gold or foreign currency assets. Hence, the debate is centered around whether the central bank is holding excess contingency reserves and whether it should transfer any more funds to it in the future.
Rajaraman said the decision should be left to the RBI. But it should be willing to explain its position.
The RBI, according to me, is the sole judge of what is needed for the financial stability of the country and the financial rating of the RBI itself, as an institution in international markets. This is paramount. It has to do its own calculations but be prepared to present those calculations to the board. They have to say - why they think what they think is right.Indira Rajaraman, Economist & Former RBI Central Board Member
The RBI should not become a victim of the Latin Liturgy syndrome, cautioned Rajaraman drawing an analogy to sermons in latin delivered by the church, which were not understood by the people. “It has to be willing present the calculation, defend the level they think is optimal and carry the board with them.”
While the RBI did not transfer any funds to the contingency reserves between 2013-14 and 2015-16, it had made additional transfers in the last two years. This, in turn, has reduced the eventual transfer of surplus to the government. In 2018-19, the RBI transferred Rs 50,000 crore in surplus to the government.
The government’s demand for additional funds from the RBI has come against the backdrop of stretched government finances, even though finance ministry officials have assured the markets that the fiscal deficit targets will be met.
When asked whether fiscal strains should be a deciding factor in the RBI’s decision on reserves, Rajaraman said that would be an “appalling” precedent to set.
If there is a reach into RBI reserves in order to fill a fiscal hole, that would be an appalling precedent to set. It should never be allowed to happen.Indira Rajaraman, Economist & Former RBI Central Board Member
NBFC Strains: Does The RBI Need To Do More?
One of the other issues of debate is whether the RBI needs to do more to help non banking financial companies (NBFCs), which are facing a liquidity squeeze. Here, the RBI may need to review the extent of support it has so far provided, said Rajaraman.
“The RBI has probably been too stringent in terms of its willingness to consider the liquidity needs of the NBFCs. This is a serious financial crisis we are facing right now. It could have a systemic impact,” Rajaraman said.
The central bank infused Rs 36,000 crore in October through open market operations. It will pump in Rs 40,000 crore in November. In addition, the RBI has eased bank exposure norms to NBFCs and allowed for partial credit enhancement. Many feel this may not be enough to help the sector through the current crisis, particularly the smaller NBFCs.
There are multiple ways in which this can be done including a special repo window, she explained while adding that supporting NBFCs will also help reduce incremental strain that may be developing for small and medium enterprises.
NBFCs were the ones meeting the needs of SMEs. They are closest to the ground. They were taking care of last mile liquidity needs of SMEs. I really think that if the liquidity needs are taken care of, to some degree, you would be able to ease the pain that SMEs may be facing.Indira Rajaraman, Economist & Former RBI Central Board Member
Controlling The Damage
The very public dispute between the RBI and government has raised concerns of a possible resignation from RBI governor Urjit Patel or his deputy Viral Acharya. If either of them were to resign, that would be a very big catastrophe, warned Rajaraman.
“It would indicate to the outside world that the government and the RBI have not been able to resolve their differences. Most of all, to the outside world. For a developing economy, which needs outside capital, it is important to show that we can work out our differences in a civilised way.”Indira Rajaraman, Economist & Former RBI Central Board Member
Watch the full interview below: