It’s that time of the year when the capital’s air turns foul and a dark pall hangs over the city. A darker cloud seems to have settled on Raisina Hill, which houses the offices of Prime Minister Narendra Modi and Union finance minister Arun Jaitley. Media leaks from within those offices seem to indicate battle axes are being sharpened; the rising crescendo of drumbeats also increasingly suggests that 19 November will be a day of reckoning when evil will be vanquished and the world will be set to rights. Increased belligerence has converted what used to be a private, genteel joust into a gladiatorial pastime.

When did a normal (and usually boring) board meeting of the Reserve Bank of India (RBI) turn into a blood-speckled spectacle? The ratcheting of a public and indecorous spat between the fiscal and monetary wings of the economic administration points to a broader and deeper malaise within the system.

One immediate reason for the sparring is the traditional aggression displayed by the political wings before elections, hoping to browbeat the central bank into keeping interest rates low and monetary conditions loose. Money supply, especially currency with the public, usually spikes a few months before elections and then reverts to normal a few months later. The pre-election period also sees political parties exerting enormous pressure through public posturing. US President Ronald Reagan’s war of words with then-Federal Reserve chairman Paul Volcker is now well documented. In India, the RBI’s monetary policy tightening and higher interest rates on the eve of the 1996 elections invited scathing political criticism. With an independent committee now deciding on monetary policy in the RBI, which demonstrated its independence by refusing to attend pre-policy summons by government officers, the government’s bellicose utterances seem peculiarly out of alignment.

Like with demonetisation, the narrative emerging from the government’s front-lines also seems to be changing. Initially, leaked reports seemed to suggest that the government wanted to dip into the central bank’s reserves to meet its budgetary requirements or recapitalize ailing public sector banks. There were reports about how the RBI has excess capital which should be returned to the government. References were also made to the Economic Surveys of 2015-16 and 2016-17 which had argued that the RBI’s excess capital was higher than international standards, and “it would seem to be more productive to redeploy some of this capital in other ways". The two successive Surveys also made the obligatory noises about protecting the central bank’s standing: “It must be done with the full cooperation of the RBI to ensure that the RBI’s independence and credibility are in no way undermined." But no similar cautionary notes were appended on how the bulk of the reserves are actually accounting income, arising from the revaluation, and not real income.

Curiously, the government’s current hawkish stance forgets to mention how the RBI has indeed been transferring surplus capital to the government in the form of dividends over the past three years—at the cost of transfers to its contingency fund—with the surplus transfer in FY18 rising 63% over FY17. In some senses, the RBI has indeed been fostering expectations of higher resources transfer.

The entire debate raises a fundamental issue: what is the correct level of capital for a central bank balance sheet? One refrain stands out among the various discussions on global monetary policy: central bank balance sheets must slim down now that economic recovery in the advanced economies seems sustainable in the medium term. Senior economist from the International Monetary Fund, Manmohan Singh, recently wrote in the Financial Times: “Payment systems in advanced economies in normal times have functioned well with minimal reserves—well below $50 billion, in the case of the US before the financial crisis. For a long time, that was a sufficient amount to iron out any deviations in short-term rates, and to keep the effective Fed funds rate in sync with overnight market rates before Lehman Brothers failed."

As academics and central bankers debate normalization of central bank balance sheets—see the paper presented by the European Central Bank’s Ulrich Bindseil (Evaluating Monetary Policy Operational Frameworks) at the 2016 Jackson Hole economic symposium—to prepare for a post-crisis economic framework, Indian economic administrators seem to have latched on to the idea of slimmer central bank balance sheets.

There are arguments on the other side also which claim that the operating framework of monetary policies in most economies needs a fresh review, given the deep impact of the financial crisis. Whatever be the argument of the day, the Indian central bank’s balance sheet must keep in mind the economy’s peculiarities and vulnerabilities, especially to volatility arising from monetary policy normalization in rich countries.

After its recent belligerence, the government seems to have lowered its decibel levels somewhat. Realization seems to have dawned that dipping into a central bank’s reserves to fill budgetary gaps would be anathema to markets. As of now, it is moot whether the hostilities have truly ceased, but another motivation behind the exercise is becoming clearer: the government needs a fall guy on whom the slowdown emanating from demonetisation and economic mismanagement can be blamed, especially with elections around the corner.

Rajrishi Singhal is consulting editor of Mint. His Twitter handle is @rajrishisinghal.

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