Decoding Bimal Jalan panel proposals on RBI surplus capital transfer to government: The good, bad and ugly

Logically, the Bimal Jalan-led expert panel set up to decide the formula for RBI’s surplus capital transfer to the government had a tough job at hand. For long, there were two sides on the issue with powerful arguments for and against the idea of tapping central bank’s surplus capital, beyond what is already done, to meet government’s fiscal expenditure needs. The debate between the RBI top brass and government on this matter turned into to a full-fledged public spat when former deputy governor Viral Acharya raised this issue in public in 2018 and government countered, eventually leading to the governor, Urjt Patel’s early exit. Government’s stance was very clear—the RBI didn’t need to hoard so much extra capital, it can be used to support the government’s fiscal operations. The RBI top brass, at that point, made a counter-argument saying it isn’t wise to use RBI reserves for government’s expenditure needs; this money, it was said, is a cushion for times of financial catastrophe. Bimal Jalan panel was formed with the idea of a consensus-building. Government and RBI called a truce post Patel’s exit and a wait and watch approach was taken by both sides. [caption id=“attachment_5129811” align=“alignleft” width=“380”] Representational image. Reuters.[/caption] One of the main points of Jalan Panel’s recommendations was that RBI should maintain a band of 5.5 percent to 6.5 percent with respect to its realized equity–5.5 to 4.5 percent for monetary and financial stability risks and 1 percent for credit and operational risks as against the present level of 6.8 percent. The other part, defined as revaluation reserves, wasn’t considered for transfer as gains/losses here are not realized. These are RBI’s investments in gold and securities in India and abroad, the value of which keep varying time to time and will be used as risk buffers against market risks. Post the Jalan panel recommendations, the RBI chose the lower band of 5.5 percent and agreed to transfer a total of Rs1,76,051 crore to the government. This amount, comprising Rs 1,23,414 crore of surplus for the year 2018-19 and Rs 52,637 crore of excess provisions identified as per the revised Economic Capital Framework (ECF). Jalan panel has recommended reviewing the agreed economic capital framework every five years. Now, what are the likely consequences of the Jalan committee report on all stakeholders? As always, there are different ways to look at it. The good news, logically, is for the government. It is getting an additional leeway to use some extra money to manage its fiscal arithmetic. For instance, the government can use the windfall gain from the RBI either to cut its off-budget borrowings or to use for spending boost likely in the infrastructure sector. If that happens, it will be good news for the economy because this will be nothing short of a stimulus. But, finance minister Nirmala Sitharaman has hinted that the government is yet to decide about the use of RBI money. That means it could be even used for meeting an expected revenue shortfall and cut off budget borrowing. In that case, there won’t be much of an instant benefit for the economy from the RBI bonanza. Whichever way, the government stands to gain as fiscal pressure eases a bit. The bad side is that RBI’s reserves earned over decades will deplete quicker than before. This money is reserved for times of financial catastrophe that may arise on account of extraordinary events. RBI’s ability to offer cushion for extreme economic situations take a hit. The Jalan panel has suggested a range of 5.5 percent to 6.5 percent. The RBI chose 5.5 percent probably to raise a meaningful transfer to the government. Governments always need capital and this will likely set a bad precedent. Future governments may also stick to the lower band, keeping the RBI’s reserve position at a bare minimum. This will not be a problem on a normal day, but could impact the RBI’s ability to cushion a catastrophic financial event should such a scenario arises. That’s the bad news–also the reason why Rakesh Mohan who was a member of the Jalan panel said that it would have been better to take a higher risk reserve of at least 6 percent instead of 5.5 percent. But, one good thing is that the Jalan committee has left a room to review the ECF framework every five years. To sum up, the world over, central banks’ surplus is used by governments. This has been the case in India too. Every year, the government has been getting RBI dividends. Tapping the excess reserves will help the economy if it is used for investments. On the contrary, if the government chooses to use it for bridging the revenue shortfall alone, it is doubtful how much of this exercise will help. Jalan panel has walked a tightrope on fixing the formula for capital transfer. According to an estimate by the former chief economic advisor, Arvind Subramanian, the government can claim up to Rs 7 lakh crore from the RBI reserves. Jalan panel got both parties to appreciate a consensus figure of Rs 52,637 crore in the first year and, as mentioned above, embedded a clause to review the framework every five years. The real test for this arrangement will come in the event of a major financial crisis of global scale impacting domestic economy deeply. That will be the ugly side of having a weak central bank if the formula proves wrong.