The Reserve Bank of India (RBI) board has accepted Dr Bimal Jalan committee's proposed economic capital framework in totality resulting in surplus transfer of Rs1.76 lakh core for FY18-19. With this, the fiercely fought intellectual battel which started with a reference in Economic Survey 2016 & 2017 and further carried forward in study by Anand et al in the EPW (Vol 53 (48), 2018) has come to an end.
Quite surprisingly, the discourse on the subject had been reduced to a monologue and the finer shades of the complex relationship (both historical and current) between the government and RBI were lost. The vantage point from which the debate originated had some obvious infirmities, namely, the lack of grounding in cardinal principles of central banking; a choice of empirical framework that did not capture the full dynamics of the RBI’s balance sheet.
However, RBI's press release has set the record straight by drawing a distinction between the ‘realised equity’ and ‘revaluation balances’. Furthermore, “there was only a one-way fungibility between them which implies that while a shortfall, if any, in revaluation balances vis-à-vis market risk provisioning requirements could be met through increased risk provisioning from net income;” the reverse was not permitted.
Then something else was also missed out. What played in the Indian theatre was a general trend seen across countries. The post-crisis period has been marked by strained sovereign-central bank relationship in many countries such as the US, Turkey, Italy, etc, and, now, India. This tension was clearly visible during the last US election campaign when Federal Reserve’s hawkish policy was under attack and there were demands for audit of Federal Reserve.
Thus, as politics and economics adjust to new realities of Indo-Pacific region, the reordering of sovereign-central bank relationship was in the making. What is perhaps not appreciated is the way this tension has been resolved in India, in striking contrast to styles elsewhere. The Jalan Committee proposals have ensured that a principled approach overrides emotions and, in the process, what has emerged is a transparent rule-based framework for distribution of RBI surplus with some flexibility for the RBI board and non-tax revenue certainty for the government.
The framework proposed is a two-step approach and links the surplus distribution to both realised equity and economic capital (= realised equity + revaluation balances). As on the date of finalization of account the size of the realised equity must be between 5.5%-6.5% of the balance sheet. Furthermore, any shortfall in revaluation balances vis-à-vis the market risk tolerance limit would add to the requirement for realised equity. The total economic capital must be between 20%-25.5% of the balance sheet. The revaluation balances will be calculated using an expected shortfall methodology at 99.5% confidence which is more conservative than previous method used by RBI or by any other central bank. Once this is ensured, the available net income can be transferred to government.
The application of this framework has resulted in large surplus transfer to the government for FY18-19 (July-June). Although RBI's balance sheet for FY18-19 grew by 11.6%, the net disposable income registered a growth of over 146% over that in the previous year. This was largely due to persistent liquidity deficit during the whole year resulting in RBI being net lender to system. Furthermore, revaluation balances for gold, which is the largest component under revaluation balances, must see an accretion of 9.5%, the change in London price of gold between July-June. As a result, the overall economic capital was in comfortable position at 23% permitting larger transfer of surplus this year.
In conclusion, the Jalan Committee report has put to rest perception of strain between the RBI and government. It is quite possible that full contents of this report may never be made public as was the case with previous such reports. This prevents a more detailed examination of the recommendations. Notably, the proposed level of realised equity at 5.5%-6.5% was last seen during 1998 (at 5.1%). Then, optimal economic capital for the central bank, which is essentially an inter-temporal optimisation of risk, can be determined using two approaches—the asset only approach and the asset-liability approach. The Basel approach falls in former category and RBI approach mimics this approach. It may be pertinent to explore an asset-liability approach also as it is more closely aligned to dynamic evolution of RBIs seigniorage. Absence of the full report may keep the curiosity alive for a later date.
(The author is an economist in the banking sector. Views are personal)