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 These reserves are meant to be withdrawn to aid the economy in situations of exceptional distress.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.
Taking out Rs 3.6 lakh crore in one shot will also stoke off inflation. In a money supply, money has to be created by work—not by taking from here and there. It’s like selling family heirlooms to go and burn crackers at Diwali. Therefore, RBI is reluctant to give it. RBI is entrusted with this money to secure the nation’s financial integrity, not to give in to the whims of politicians.
AK: The RBI was set up by the British in 1935. During the Second World War, there was dire need for liquidity. Is there any evidence of the British government dipping into the RBI reserves?
MG: No, nobody has dipped into the RBI. They dipped into government of India money but nobody weakened the RBI. It is like taking away money meant for the child’s education to throw a party. RBI governor and all should resign rather than bow to this government.
AK: Why do you think the current government wants to dip into RBI reserves?
MG: This is a desperate move because GST collections are slow. The increased growth that was anticipated did not happen. Then there is slowdown of demonetisation. At that time, they were saying that we will get Rs 3 lakh crore, as [that black] money which will not be put back [into circulation]. But all 19 lakh crores came back.
The government wants the Rs 3 lakh crore somehow because [it] is not able to do anything—it is not able to reduce subsidies; it is not able to control its borrowing or reduce its interest; it is not able to raise taxes. If the RBI loses its reserve, it will never get it back. They have lost Rs 3 lakh crore in demonetisation. Now they want to waste the RBI’s Rs 3.6 lakh crore also. This is a terrible state of affairs.
Elections are coming in six months. The NBFC [non-banking financial companies] sector has lent money recklessly. They want to put the money in banks so their NPA [non-performing assets] accounts are all cleared.
This money will disappear—it won’t be used to build a single road; it won’t be used to build a single school. In effect, the money given to banks to recapitalise them is being put to retiring the debts of Mr Ruia and Mr Ambani and Mr Adani. You don’t want to ask them to retire their debts. Can Modi ask Anil Ambani to retire his debts? He is indebted to Anil Ambani.
AK: The former chief economic advisor Arvind Subramanian's Economic Survey 2016 stated that the RBI is “already exceptionally highly capitalised” and that Rs 4 lakh crore can be used to recapitalise banks.
MG: You do it in times of buoyancy when there is growth. When it is a desperate act, it creates a different atmosphere. RBI also has to look after its own financial health. It can't say tomorrow that it doesn't have the money to back up because it is the ultimate guarantor.
AK: The Malegam committee, a technical committee constituted by the RBI, said in its 2013 report said that the RBI has reserves and buffers in excess of its requirements. How do you respond to that?
MG: When things are good, you are growing at 10 percent and you want some funds to build infrastructure, you can get [help from] RBI and even reduce the foreign reserves by 40-50 billion. Under those circumstances, when foreign trade and current account deficit look optimistic, you can reduce the reserves somewhat. Right now, the current account deficit is increasing. The trade deficit is also narrow.
AK: How will the government justify such a demand?
MG: They can’t justify. It is just a bad government and they are trying to appear good—if you bring Rs 3.6 lakh crore [into circulation], GDP will grow because that much money has come in.
But taking RBI reserves means that you have not run your economy well. If you put Rs 3.6 lakh crore into the economy in one day, there will be inflation. Prices will go through the roof because once you retire all the debts, the banks will be free to lend money; banks exist to lend money. They [the government] don’t want the RBI’s money for asset creation—they want it to retire debts of NPAs. People who have taken money from banks are not paying it back. So that’s why the banks are not looking good. The banks are required to crackdown on the fellows who are not returning the money. They want to prevent that.
Who is advising the government? Swadeshi Jagran Manch, Gurumurthy—[SJM is the economic wing of the Rashtriya Swayamsevak Sangh and S Gurumurthy is its former co-convenor, who was appointed to the RBI’s central board in August this year]—all fellows who know nothing of finance.
AK: Could you give an example of any other country where the transfer of the reserves of the central bank was justified?
MG: It is never justified. It is done only in the most disastrous of conditions. Argentina did it last year because it’s facing an economic disaster, Guatemala has done it in the recent past, some African countries do it—these are countries on the verge of bankruptcy. Britain has never done that. America has never dipped into Fed [Federal Reserve System]. China has never done it. Russia has never done it.
I think a better idea is to restructure the banks—merge them together, strengthen them. Do all the hard work. If you have a broken leg, you must either operate the leg or put it in a cast. But instead of doing that, you are giving morphine, so you won’t feel the pain.
AK: The RBI has an economic capital framework that defines the terms and conditions under which reserves can be transferred to the government.
MG: Reserves can be taken. [The government] can give directions under Section 7. But RBI’s job is to advise the government on fiscal prudence. If the government does not listen to its advisors on fiscal prudence, the governor of the RBI [and] the deputy governors should throw their resignation, and walk away unless Gurumurthy runs the RBI. The government can do anything. But it cannot do anything [just] because it can do it. It is supposed to exercise restraint at all times.
Given the state of the economy and the precariousness of the banks, RBI has the responsibility to keep money in hand to do a rescue job. Total NPAs are 11 lakh crores [approximately]. If you take Rs 3.6 lakh crore, you will need money again.
AK: But aren’t there any rules on paper that ensure transparency and explain the process of transferring funds to the government?
MG: That is a judgment the RBI has to make. RBI has to act as the guarantor of last resort. After all, on a 100-rupee note, it is the governor of the RBI who signs. [The] 100-rupee note is a promissory note; 10-rupee note is a promissory note. So the RBI is an institution whose credibility is sacrosanct. You have already diminished [its] credibility by demonetising.
AK: Do you foresee action on the government’s part against the RBI if they refuse the demand?
MG: I think the mentality of Modi and Jaitley is that we are the bosses, we can do what we want.
RBI has to be endowed with credibility at all times. If you sack the RBI governor, if you sack the deputy governor, there will be chaos in the market. Nobody in the world will lend you money after that, or trust you after that. It is the RBI’s credibility which keeps us, financially, head above the water in the world market.
This interview has been edited and condensed.