Narendra Modi’s government dips into central-bank reserves

MOST CENTRAL banks occupy impressive premises in expensive parts of town. Few begrudge them this perk. Nice digs seem only fitting for the guardians of the nation’s currency, giving them a reassuring air of gravitas and permanence. But is grand architecture necessary for central banks to perform their functions? Is there any economic justification for it? The honest answer is no.

What is true of central-bank architecture is also true of central-bank capital. Most such institutions have reassuring balance-sheets. Their assets, which usually comprise safe government securities, comfortably exceed their liabilities, which are chiefly the banknotes they issue and the deposits held with them by commercial banks. The assets of the Reserve Bank of India (RBI), for example, exceed its liabilities by over 9trn rupees ($ 125bn), of which about 2.7trn rupees is ready to hand.

This balance-sheet is a source of pride, allowing the institution to feel financially independent. Thus when Narendra Modi’s government began to argue that it was too lavishly capitalised, the RBI was displeased. And when the finance ministry concluded last year that it should give some of its excess capital to the government, which was keen to shore up public-sector commercial banks, the RBI resisted. The tussle was one reason why Urjit Patel, then its governor, resigned.

The central bank asked Bimal Jalan, a former governor, to consider the issue further. This week his committee recommended that the RBI reduce its risk buffer to 5.5-6.5% of its balance-sheet. Now under more pliant leadership, it promptly reduced the buffer to the bottom of that range, enabling it to hand over 526bn rupees in addition to a bumper dividend of over 1.2trn rupees. Rahul Gandhi, an opposition leader, accused the government of stealing from the RBI. A former minister said the institution had been left no room to intervene in a crisis. Another critic said Mr Modi had “converted the R in RBI from ‘Reserve’ to ‘Ravaged’”.

Lost amid this political controversy was the deeper economic question of whether central banks need capital at all. They cannot go bust. Their liabilities are the money they issue. But that money is simply a promise to pay money. Their creditors already hold the thing they are owed. Central banks’ assets are also peculiar. The principal one is their licence to print money that people will accept in exchange for real resources. This right to earn seigniorage, as it is called, is worth a lot, even if their money-printing is constrained by the need to keep inflation in check.

Mr Jalan’s committee argues that central banks do need strong financial positions to carry out their business. But its justifications mostly boil down to perceptions: central-bank capital matters because people think it does. That can include central bankers. If a central bank fears negative equity, it may sacrifice other macroeconomic goals to protect its financial position. But if this phobia distorts their work, perhaps they should work harder to shed their fear.

Several central banks have functioned well for years with liabilities that greatly exceed their assets. Often they have accumulated large stocks of foreign-exchange reserves, which fall in value relative to their domestic currency when it appreciates. In these cases, then, the central bank suffers capital losses because of growing, not diminishing, confidence in its money. Take the Bank of Thailand (BOT). It says emphatically in its financial statements that its “accumulated loss has no impact on the continued operation of the BOT”. And indeed inflation in Thailand is less than 1%. Perhaps it helps that the BOT’s handsome premises are valued at over $ 200m.■