THE BILLION DOLLAR QUESTION:HOW TO TRANSFER RBI RESERVES?

The Bimal Jalan Committee on Economic Capital Framework met on July 17, 2019, and has suggested that surplus reserves of the RBI should be transferred to the government in phases

over 3-5 years. The final report to be presented before RBI Governor in 15 days has proposed a formula for the ‘nominal transfer’ of the RBI surplus reserves. The issue of transfer of RBI reserves has been a contentious one, with many experts expressing their views on the issue vociferously. The report of the Committee gets the Govt. one step closer to obtaining the RBI reserves and using it for its own purpose.

This article explores ways of how the RBI reserves can be used to achieve maximum gains of an exercise. In this backdrop, four options are being explored in this article.

Option A: Monetize the assets of RBI and utilise the

proceeds to pay the Government

The assets of RBI are primarily foreign currency, gold and government bonds. Selling foreign currency or gold is not a viable alternative and it is likely that the RBI will sell its investments in Govt bonds.

The sale of Govt bonds will have an effect similar to open market operations and will reduce money supply in the market, leading to lower inflation in the short term. Post monetization, the RBI can

transfer the amount to the Central Government. Assuming that the Central Govt. ploughs back the money into the Indian economy, the money supply will be restored to the original level.

Option B: Book Adjustment for Transfer of Reserves

Instead of monetizing the Govt bonds, the RBI can transfer its reserves to the Central Govt by means of a book entry. This could be done in two ways: The government could buy back its bonds at Nil value or the liability of government bonds could be extinguished by RBI. This would lead to a reduction in the future borrowings of the government which it would have had to take for the redemption of its bonds. Since this transfer doesn’t lead to an increase in the money supply, it wouldn’t create an inflationary pressure on the economy.

The two options explored so far envisage a transfer of funds to the government. It is pertinent to note that the Government needs to take populist choices into consideration in the decision making which need not be economically prudent. In case the government utilizes the reserves to launch ambitious welfare programmes and continues to borrow, that would lead to an increase in money supply which can result in inflationary pressures on the economy without positively impacting the fiscal position of the economy. In contrast, RBI is known for its governance standards and the ability to take tough decisions while maintaining economic stability . Hence, the government could look at collaborating with RBI for some of its initiatives and reaping benefits from the brains at RBI in their area of expertise.

Option C: Use bonds to recapitalize the Public

sector banks

The public sector banks are grappling with multiple issues including bad debts crisis, delay in a resolution under the bankruptcy code and liquidity crisis. RBI could step up and allocate its bond investments to the PSBs. The increased availability of the surplus funds would serve as an impetus to revive the economy. However, as per the Narasimham panel recommendations, the RBI cannot own the entities which are regulated by it. Hence, a feasible alternative could be to transfer the bonds to a new independent body, consisting of banking experts to handle the recapitalization exercise. RBI can

mentor the body and can monitor its functioning in the initial stages. It is pertinent to note that the new body will have a role in the day to day decision making as in its role as a provider of capital. From a monetary point of view, the effect would remain the same as Option A, as the public sector banks will sell the Govt bonds to raise capital.

Option D: Use RBI bonds to set up the Public Asset

Rehabilitation Agency (PARA)

India holds the dubious distinction of having one of the highest NPA ratios in the world. With the advent of the Insolvency & Bankruptcy Code, the resolution framework has been institutionalized and

provides an opportunity to turn around non-performing assets. This is the opportune moment for utilizing the Govt bonds held by RBI to set up PARA envisaged by the Economic Survey 2016-17. This would help in creating India’s bad bank, with an exclusive focus on turning around bad assets. The setting up of PARA becomes necessary in order to ensure that capital intensive companies are given a new lease of life and provided support until private players are ready to operate it themselves. From a monetary point of view, the effect would remain the same as Option A, as the RBI's bonds used to create PARA will be sold to raise capital. While the decision to utilise the RBI reserves for the greater good is a valid argument, it needs to be ensured that the money is genuinely used for the public interest. Earmarking the funds for specific purposes would help achieve this objective. The Central Govt. and RBI need to engage productively in order to arrive at a solution which achieves the Govt’s fiscal targets, without compromising the RBI’s autonomy. Having the RBI mentor new bodies would enable the creation of new independent bodies with specific mandates and also replicate the strong governance standards which RBI is known for. It is in the best interests of the nation for the Centre and RBI to view this conflict as a constructive one and an opportunity to get India back on the growth track.

#Economics #RBI #Reserves