'There is merit in keeping the central bank's balance sheet strong if the government's fiscal balance sheet is weak.'
Anup Roy reports.
Former Reserve Bank of India governor Dr Y V Reddy sharply criticised the government for intervening in the central bank's affairs and asking money from the past reserves.
In a speech delivered at Pune on Friday, February 8, Dr Reddy, who was also chairman of the 14th Finance Commission, endorsed critics stating that the 'automatic monetisation of the pre-reform period' is being replaced with 'coercive monetisation of fiscal needs'.
In the Kale Memorial Lecture, delivered at the Gokhale Institute of Politics and Economics, Dr Reddy said that by taking recourse to unprecedented practice of interim dividend, the government has compromised on the established mechanism of 'ways and means', a temporary loan facility extended to the government by the RBI.
The reserves act as insurance for the future, and needed to be fortified, instead of taken away.
'The immediate fiscal needs seem to take precedence over a renewed assessment of the capital needs of the RBI,' Dr Reddy said.
This is contrary to what the government did in 2013 when it shared the excessive cost of sterilisation so that the central bank balance sheet remains strong and reserves get added.
'There is merit in keeping at least the central bank's balance sheet strong if the government's fiscal balance sheet is weak,' Dr Reddy said.
The government expects Rs 28,000 crore (Rs 280 billion) as interim from the RBI and the finance minister recently said he expected another about an equal amount from past reserves as well.
In 2015, the government decided that the RBI holds more reserves than required and the entire money, therefore, should be transferred. The chief economic adviser had already advocated that the excess money should be used to recapitalise banks.
'There is no doubt that in the ultimate analysis, the government as the owner has a claim over the reserves, but the way it exercises gives signals to the market and influences public opinion,' Dr Reddy said.
There is also the issue of 'Constitutional propriety' of using the reserves directly to fund capital of the banks instead of crediting it to Consolidated Fund of India.
The proposal to invoke Section 7 of the RBI Act, which is used by the government to direct the RBI what to do, was an 'unprecedented move', which, in many ways, raised 'fundamental questions on governance,' Dr Reddy said.
The invocation of the Act 'virtually meant that the channels of normal communication for reaching agreed position between government and governor RBI had broken down', and which ultimately culminated in Dr Urjit R Patel's resignation as RBI governor.
The Centre's demands of relaxing prompt corrective action rules for banks dilutes 'both the autonomy and accountability of the RBI', Dr Reddy said.
Dr Reddy was also against the government's demand to dilute Basel III norms which are perceived to be more stringent in India than the global norms.
According to Dr Reddy, the RBI should be 'concerned at the risk assessment capabilities of public sector giants like LIC and SBI' that allowed the mess at IL&FS even as the former entities were large shareholders in the company.
By encouraging aggressive lending to small and medium enterprises, the government could be jeopardising depositors's interest or inducing systemic instability, and any extra support to this segment should be given from budgetary resources such as what is done in case of farm debt waiver.
The current composition of the central bank's board is appropriate, according to Dr Reddy. The board provides advisory and guidance on policy matters, but the government is trying to revise the role of the board to a more assertive one.