Opinion | It’s a brouhaha over one pocket swapping money with the other

 (Mint file)

Desperate times leading to desperate measures” has been the tone of the many messages that have greeted the transfer of 1.76 trillion from the Reserve Bank of India (RBI) to the government of India.

The central bank in any country, developed or developing, is an extended arm of the government. It is one consolidated account. The separation was done to ensure the credibility of the government’s—or the king’s in olden days—promise to repay creditors who financed its territorial conquests or defence. A link to a metallic standard was a reinforcement of this promise.

As a concept, central bank independence became fashionable in the 1980s after a decade-long episode of inflation in the industrialised world. This was a confluence of many factors. However, elites used it intelligently to wrest power from politicians and give it to a bunch of unelected technocrats (drawn from their own social milieu). It also marked a transfer of power from the working class to capitalists. Central banks, now independent of the pressures of re-election that politicians had to contend with, were freer to take a long-term view and aim for medium-to-long-run price stability in the interest of the economy.

So went the fable. We all know what happened to that fable in the last 30 years.

This backdrop and context were necessary to establish that the transfer of excess reserves by RBI to the government was no assault on central bank independence. Reserves are accumulated profits, and profits belong to shareholders, and the only shareholder of RBI is the government of India. So, it is a transfer from the left pocket to the right pocket, or vice-versa.

The move does represent fiscal desperation on the part of the government, though. What signals desperation? An expert committee had recommended that the RBI Board make a decision to keep the bank’s contingency risk buffer (CRB) within a range of 5.5% to 6.5% and transfer the excess to the government. The RBI Board decided that CRB would be 5.5% of the balance sheet size. That is, it chose the lowest end of the band.

One of the members of the committee had expressed the view that it might have been better for the board to have kept the CRB at 6%, rather than move to the lowest end of the recommended band. In an interview, he made the subtle point that central banks can always show a higher “surplus” by printing money to buy government debt, as the RBI had done in 2018-19.

Srinivas Thiruvadanthai, research director at the Levy Forecasting Institute in New York, has made the following perceptive observation: “More thoughts on the RBI transferring excess capital: Among other things, the public’s portfolio consists of government liabilities ranging from zero maturity (currency) to bonds. Fiscal policy—deficits—results in an increase in public holding of government liabilities .” Further, in Thiruvadanthai’s words: “Monetary policy results in changing the composition of those liabilities. So, when we say monetising the deficit, what we really mean is that the composition of public holding of government liabilities has been shifted toward cash. However, that is exactly what monetary easing does.”

Thiruvadanthai is right. Monetizing the deficit shifts the public holding of government liabilities towards cash indirectly through the government. Monetary easing is more direct. That said, it cannot be recommended in all contexts as an alternative to monetary accommodation. It depends on magnitudes (how far interest rates are from the zero bound is an example of the “magnitude” dimension), the inflationary impact (not just in goods and services but also on asset prices), the impact on private sector leverage (which one contributes the most?), and on whether animal spirits are alive or missing in the private sector (if it is the latter, monetizing the deficit may be better, but how does one ensure that the money lent to the government directly has a multiplier effect on the economy and is not wasted?).

One of the senior members of the cabinet said that he thought there was more money to be had from the central bank. This is as unfortunate, as it is wrong. Arvind Subramanian, former chief economic adviser, had suggested the use of RBI’s “excess capital” to recapitalize public sector banks. A committee was appointed. It gave its report, which the central bank accepted. A government nominee was on the committee and he did not sign any dissent note. The board of the central bank had fully transferred the “excess” CRB to the government. It will be foolhardy to arm-twist the central bank further or stretch the logic of excess capital by dipping into revaluation reserves. Such a move may prove counterproductive.

In mature organizations, team members do not pull down their fellow team members in public as it undermines cohesion and public messaging.

One of the important lessons of the current slowdown for the government is that it is always easier for a government to hurt and even halt economic activity than to revive it.