Home / News / India /  RBI aligned with govt on economic capital framework: Rakesh Mohan

Mumbai: The Reserve Bank of India (RBI) and the government are in complete agreement on the new economic capital framework (ECF) recommended by the committee headed by former RBI governor Bimal Jalan, said Rakesh Mohan, vice chairman of the committee.

In an email interview, Mohan, also a former RBI deputy governor, said it wouldn’t be a good idea to enter into a formal legal contract with the government on the new ECF.

The committee has fixed the contingency fund level at 5.5-6.5% of the central bank’s balance sheet. Can this be sanctified through a contract with the government, like in the case of inflation targeting, to avoid future misuse?

I don’t think that would be a good idea. As of now, there is complete agreement between both the RBI and the government in accepting the Jalan committee’s recommendations. I am not aware of any reservations on the subject. I don’t think that it is a good idea to introduce such rigidity through legislation into the system. There must be a degree of trust and cooperation between the central bank of the country and the government.

Does the new economic capital framework make the monetary policy subservient to fiscal policy?

No. There is no reason to believe that. That used to be the case when there was automatic monetization of government borrowing: The FRBM Act (Fiscal Responsibility and Budget Management Act, 2003) prohibits that. Profit transfers do not impact the practice of monetary policy. As the government spends the transferred resources, there will be an expansion of liquidity in the system which will be dealt with in the normal fashion through the operation of the RBI’s normal liquidity management.

Does the ECF lead to the RBI being more vulnerable, especially in case of a black swan event?

As you would see in reading the report in some detail, the calculations made to arrive at the desirable magnitude of the contingency risk buffer, and the desirable magnitude of the revaluation reserves, took into account relatively extreme probabilities. Of course, as was seen in Europe and North America in 2008, a real black swan event can certainly be beyond any known unknown. Central banks then have to innovate and operate as necessary. I believe that the RBI has the capacity to cope with such eventualities. As was observed in the North Atlantic financial crisis, central banks and governments worked very closely during that crisis episode. Hence, it is necessary for the central bank and the government to have an appropriate understanding of their respective roles, particularly if a black swan event occurs.

What will be the implications of the transfer of the RBI’s reserves on the monetary policy? Will it impact the RBI’s flexibility in conducting monetary policy?

There are no implications for monetary policy as a consequence of the transfer made by the RBI to the government. The RBI is required to transfer all its surplus to the government every year. So, this is a normal procedure and, hence, there are no implications for monetary policy.

The only difference is that the magnitude of the transfer is much higher this year. And, of course, there is the addition of transfer of excess reserves.

Does this set a precedent for the government to raid the RBI’s balance sheet in future?

With the acceptance of the Jalan report there is no “raid" on the RBI’s balance sheet. Hence, there is no question of any precedent being set in this regard. That would have been the case had the government accepted Arvind Subramanian’s calculation of the RBI’s excess reserves of 4.5-7 trillion.

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