Demonetisation, GST and NPAs: Why the government wants to dip into RBI reserves

09 November 2018
Harsha Vadlamani for The Caravan
Harsha Vadlamani for The Caravan

A long-drawn power tussle between the Reserve Bank of India and the central government came to a head in the last week of October. On 26 October, while delivering the AD Shroff Memorial Lecture in Mumbai, Viral Acharya, a deputy governor of the RBI, stated that “governments that do not respect central bank independence will sooner or later incur the wrath of financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution.” Five days later, the government reportedly initiated consultations to invoke Section 7 of the Reserve Bank of India Act, 1935, which empowers it to issue directions to the central bank on key financial matters and has never been used before.

The focal point of conflict between the two institutions is an unprecedented proposal by the central government seeking the transfer of over a third of the central bank’s surplus funds to itself—Rs 3.6 lakh crore of the RBI’s reserves worth Rs 9.59 lakh crore. These reserves are meant to be withdrawn to aid the economy in situations of exceptional distress. Mohan Guruswamy is one among several renowned economists who have criticised the government’s demand. In 1998, Guruswamy was appointed as an economic advisor to the BJP-led central government, though he gave up his position within a year. He is currently the founder and director of Centre for Policy Alternatives, an independent think-tank.

In conversation with Aathira Konikkara, a reporting fellow at The Caravan, Guruswamy explains why he thinks the government’s demand to dip into RBI’s reserves is an attempt to subdue the failure of demonetisation and imposition of the Goods and Services Tax. “With the weak conditions of banks, RBI has to be the guarantor of last resort. If you deplete its capital, you are putting the entire financial system at risk,” he said. “It’s like selling family heirlooms to go and burn crackers at Diwali.”

Aathira Konikkara: When was the last time a government dipped into the reserves of India’s central bank?
Mohan Guruswamy: I recall that in 1962, during the Chinese war, the government asked for reserves under RBI to push some money forward. RBI offered [the government], dip into our reserves if required. I don’t think it was actually taken from the reserves—the war ended soon and the RBI didn’t really have to do anything to exert itself. Even in 1991, when things were really bad, the government sold gold abroad but they didn’t dip into RBI reserves.

The RBI transfers surpluses every year. Last year, they gave Rs 50,000 crore. But this [demanding Rs 3.6 lakh crore] is like reaching into the family silver. With the precarious nature of banks, without RBI being solid by itself, we are putting the country at risk.

Aathira Konikkara is a reporting fellow at The Caravan.

Keywords: Rashtriya Swayamsevak Sangh Non-performing assets Mohan Guruswamy RBI demonetisation GST inflation