Govt can claim up to Rs 7 tn from RBI's excess capital: Arvind Subramanian

Former chief economic advisor (CEA) Arvind Subramanian has made a strong pitch to the government to claim Rs 4.5-7 trillion in excess capital from the Reserve Bank of India (RBI).

RBI is an outlier among its peers as it is keeping close to 28 per cent of its balancesheet in the reserves, against an 8.4 per cent global average, Subramanian, who was the CEA from October 2014 to June 2018, writes in a soon-to-be-published book 'Of Counsel: The Challenges of the Modi-Jaitley Economy'.

Stating that the swelling captial base of the RBI needs to be held accountable, he pegs the excess capital that the apex bank holds from Rs 4.5 trillion from the ratio of shareholder equity to assets, and at Rs 7 trillion from a BIS-mandated average based on 1 per cent of risk cover ratio.

"The RBI is an outlier among major central banks. It holds about 28 per cent in reserve capital, which is the fifth largest amongst all major central banks Compared to the typical central bank (8.4 per cent ratio), it has excess capital of about Rs 7 trillion," he writes.

He goes on to argue that "when looked at the practices of all the major central banks and the Bank for International Settlements (BIS), nearly all the other central banks choose a risk tolerance level of 1 per cent and when we apply this tolerance level to the risks facing RBI, the formula shows that RBI has an excess capital amounting to Rs 4.5 trillion".

As per the RBI's annual report for FY18, its balance sheet stood at Rs 361.75 trillion, up 9.5 per cent from FY17, boosted by rising foreign investments and growth in foreign exchange reserves. On June 30, 2017, its balance sheet stood at Rs 330.4 trillion.

The RBI follows a July-June fiscal year. The note-ban of November 2016 had shrank the central bank's balancesheet by close to Rs 15.8 trillion.

Admitting that counting RBI balance from the 1 per cent risk ratio perspective as a "too crude a way of calculating it", Subramanian says central banks across the world are using the analytical framework based on economic capital framework to arrive at the optimal level of capital, which essentially involves conducting a value-at-risk analysis for the various sources of potential risk for a central bank.

The book, to be published on December 7 by Penguin Random House India, comes at a time when the recent spat between the government and RBI over a host of issues including this capital demand, ended up RBI ceding ground and agreeing to set up a panel to look into the details of a new economic capital framework for the central bank.

Stating that the range of RBI's actual capital position reflects an ambiguity, he says the ratio of shareholder equity to assets "varies from over 40 per cent in the case of Norway to negative capital in the case of Israel, Chile and Thailand, with a median holding of 8.4 per cent for 54 major developed and emerging market economies for 2016-17".

But he also underlines that any change in the captial position of the central bank involves many risk such as market risk that captures the risks arising out of change in the value of their assets like forex reserves, gold and government securities; credit risks in the form of losses arising due to default by counterparties; operational risk; and contingent risks among others.

But he also adds that none of these risks can justify the large capital that RBI sits over as the sovereign's security is more important and credible than that of its central bank.

"Central banks are part of the government, and it is the broader government balance sheet that matters, not that of any of its constituents. As long as overall conditions are reasonable, the stream of profits will eventually make up for any capital shortfalls because central banks have a unique ability to generate income," he says.

Subramanian had first proposed this in the Economic Survey 2017, wherein he had called for redeploying this excess capital into the cash-starved public sector banks.

On the controversial note-ban of November 8, 2016, Subramanian, who had supported the move in the Economic survey 2017, sounds very critical of the policy saying this was "a massive draconian, monetary shock", which accelerated an already slowing economic engine, pulling down growth to 6.8 per cent in the past seven quarters, against the 8 per cent prior to the note-ban.

Breaking his silence, Subramanian, in the chapter titled 'The Two Puzzles of Demonetisation - Political and Economic', says demonetisation hastened the economic slide which though was a massive political success as was seen in the BJP sweep of the UP elections.

"Demonetisation was a massive, draconian, monetary shock: The real GDP growth was affected by the demonetisation. Growth had been slowing even before, but after demonetisation, the slide accelerated," says Subramanian in the book where he is silent on whether he was consulted on the move.

He also says the executive ceding powers on decision making to the Supreme Court over the years has come with a heavy cost. This has resulted in the judiciary acquiring a greater role in economic policymaking.

"In particular, it's shifted the balance of institutional power and authority away from the executive and the legislature. Indeed, it seems at times that the only legitimate locus of decision making, even on major economic policies, is the Supreme Court. This situation is certainly better than a state of indecision. But it is not without costs," he writes.

He also says the Insolvency and Bankruptcy Code (IBC) is a work in progress.

Though the IBC has had some success in resolving a few high-profile cases, at the same time, many of my initial fears have been realised. In most of the key cases, there have been prolonged delays. As a result, backlogs have been growing, resolutions have been receding into the distance, and all the while costs have been climbing," he argues.

Accordingly, he doubts whether IBC is the effective way out for resolving the twin balance sheet problem.

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"A more radical solution will be necessary to solve the twin balance sheet problem; government will have to take bold actions such as changing the Bank Nationalization Act - one of the holy cows of our socialist past - to allow privatisation of public sector banks and also setting up a bad bank funded by the RBI," he says.