RBI board meeting: A question that haunts India: can a central bank really go bankrupt?

By Andy Mukherjee


An institution with the power to print money should have no trouble keeping the lights on. But could he continue to act effectively after exhausting his net worth?

The former Bank of England decision-maker, Willem Buiter, asked this question in early 2008; it is currently the biggest challenge facing his long-time research collaborator, Urjit Patel, Governor of the Reserve Bank of India.

Under the pressure of restoring capital surplus to a resource-poor government, Patel should take inspiration from Buiter's paper to argue that very few assets and liabilities of the central bank are really visible. That New Delhi is coveted by accountants, it would be like a ship captain who would decide to fly over a small piece of ocean ice, ignoring the risk of sinking into a submerged iceberg.

First, consider the counter-argument. Chile, Mexico and Israel are examples of central banks that have successfully fulfilled their mandate despite the weakness of their own funds. Similarly, the market does not apply to the excessive finances of the US Federal Reserve, which is currently multiplied by 106 times, nor to the Bank of Japan with a concern similar to the concern it has for commercial banks or excessively extensive hedge funds.

The reason for this indifference, however, should be Patel's first line of defense. The market does not seem to worry because of an invisible part of the central bank's balance sheet. The monetary base of the RBI is $ 363 billion, including outstanding currencies and current account deposits of banks. This "big money" is duly recognized as a responsibility of the RBI. However, its ability to borrow at will at zero interest – by printing money – is a source of profit that is not explicitly accounted for.

Suppose the RBI for any reason (inflation?) Can not print money and has to raise the same amount of $ 363 billion by paying the 3-month cost of borrowing 6.9%. It's already $ 25 billion in one year. Add up the present value of all future profits from not having to pay interest on a $ 363 billion pile growing at the same rate as the economy, and add the $ 25 billion saved this year. If it were to be taken into account, this seignorage profit would easily be the main asset of the Indian central bank's balance sheet. Over time, most of this money would go to the government – the bank's sole shareholder – while gains on Indian and foreign securities would clog up the RBI's purchases and sell them using its cost-of-funds lien. zero.

But there is a danger, exemplified by Venezuela in the 1980s and 1990s. The central bank, pushed towards insolvency because of its support for the Latin American government's industrial policy, relied too much on the power of the government. printing cheap money for profit and turnaround, and lost control of inflation. The weakening of the capital of the Indian central bank could introduce a similar vulnerability. Patel is already under pressure to use the RBI's balance sheet to support the private sector by accepting guarantees provided by ghost banks in need of cash. His successors will not want a situation in which the printing of money would lead to indomitable inflation, which would mean that the central bank would have no benefit to share.

The Indian government may not want to get bogged down in the invisible part of the RBI's balance sheet. Focusing only on $ 498 billion of assets and liabilities documented, one might wonder why Patel needs revaluation reserves of $ 95 billion and an additional $ 32 billion in contingency funds. It's way too much capital, we could say, and so the RBI should give some back. The "excess capital" figure cited by the Indian media is $ 50 billion.

The problem is that the central bank can not reduce one side of the balance sheet without a concomitant reduction of the other. By investing just over half of the $ 95 billion revaluation account in foreign currencies and gold, the RBI would be forced, from a risk management perspective, to sell an identical proportion of the corresponding assets, ie $ 190 billion. of dollars. This would trigger a "cataclysmic deflationary shock" for the economy, as V.K. Sharma, a former central bank executive director, recently pointed to the Business Standard. This is because such a reduction in assets would result in a $ 140 billion reduction in liabilities (monetary base of $ 363 billion), net of $ 50 billion to the government.

If the authorities did not print the new currency quickly, the effect would affect another unsuccessful monetary experiment in India: the November 2016 ban on putting 86% of the currency in circulation. It also reduced the monetary base by 34% in just a quarter, which led to a slowing economy.

Patel was barely engaged for two months when he was forced to execute the ticket ban. He could not resist then. But now he should, with all the arguments at his disposal, including those of Buiter.

(This column does not necessarily reflect the opinion of economictimes.com, Bloomberg LP and its owners)