Is India still a liberal democracy on a path of economic consistency?
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Understanding central bank balance sheets are key to interpreting central bank policy actions : the structure of the balance sheet, and changes thereof over time, can then provide significant insights into its goals and their efficacy, and economic consistency, over time. In this furore over the transfer of reserves from RBI to the government, this aspect has been completely ignored.
Else it would have been apparent that, even if RBI did agree to the transfer of unrealized surplus as a special dividend, the move would not help the Government with its fiscal budgets as this would require creating additional permanent reserves (a.k.a printing money) and, thus, to maintain the budgeted levels of money creation in the economy, exactly the same amount of bonds would have to be sold by RBI from its portfolio holdings.
Hence, the effective public sector borrowing requirement will not change and the entire core objective of financing Government spending with this special dividend would not be achieved as Government bond sales to the public will not be reduced!
Furthermore, apart from the fact that distribution of unrealized surplus is not legally permitted, it must also be remembered that the RBI Board has adopted a risk management framework which is consistent with its need for AAA rating for RBI in international markets and, therefore, the appropriate level of equity it needs given the risks it faces is ₹10 lakh crore—the current level of aggregate reserves as per the latest balance sheet ! Hence the battle cry over “excess” reserves is simply inexplicable.
S Gurumurthy, a director on the board will most certainly push his views as he sees them from the lens of his well known perspectives though they will be in stark conflict with those of trained economists. The key will be how the other Board members react. Apart from Dr. Ashok Gulati, none of the other 12 nominated external directors ( including the two government officials) are career economists. This can cut both ways as far as informed support to the Governor is concerned and will indeed be a case study of how conflicting viewpoints are resolved in a liberal democracy. Bravado, or blind support of the government is not the preferred option; economic reasoning is. How truly independent are the nominated directors in their thinking despite the pre-eminence in their respective fields will be known on Monday.
I will end this article with a historical fact. Though quite serious, the Taper Tantrum led 2013 crisis is not remembered in our economic folklore. This is because it was quietly steered and professionally handled by RBI which took some brave calls in consultation with the finance ministry, on the strength of its strong reserves and a highly credible balance sheet.
Despite the perceived difficulties of government finances, the international banking system did not question RBI’S ability to honour the FCNR(B) swaps which formed the basis of a bold rescue plan. The message for decision makers is this : do not mess with the balance sheet and the credibility of the institution built over generations.
The present tussle should not be viewed as a matter of ego, but one of handling difference of opinions in a liberal democracy whose interests are best served by staying on the path of economic consistency.
We shall know by the end of Monday where we stand.