Economy under great stress Rescue Measures fail to work

TN Ashok

Desperate situations require desperate measures. That’s a commonly understood expression. More so with the PM Modi led BJP led NDA government, which is virtually fighting a last-ditch battle to rescue the economy, akin to a sinking ship. Even as government announced a massive relief package that included RBI’s historic transfer of Rs 1.76 lakh crore to the government kitty to contain fiscal deficit around 3% besides bridging the gap in tax revenue loss caused by massive GST refunds and the sluggish growth in auto sector and eight other core sectors.

The latest report from Index of Industrial Production (IIP) has for July 2019 shown a 2.1% decline in eight core sectors of the economy. The bad news is that even as government has stretched backwards and forwards with relief measures like withdrawing tax on super rich and some others, the economy is still only chugging.

IIP report shows that growth in July 2019 has slowed down from last year’s 7.1% to much lower levels caused by a contraction in the infrastructure sector caused by less coal production, crude oil and natural gas and refinery products. A private study by an investment banker reveals that India’s manufacturing output in August grew at the slowest rate ever in the last 15 months, a cause for major worry for the government.

The last fortnight saw the Finance Minister announcing a slew of measures in a comprehensive Economic New Deal that ranged from combining state runs banks , reducing 21 of them into just 14 to rescue the weak banks by attaching them to stronger ones with stronger capital base, withdrawing the surcharge or tax called the super-rich tax on portfolio investors. Allowed government departments to buy new vehicles removing the ban so that auto makers could dispose off piled up inventories besides resuming manufacturing and preventing a threatened lay off of about 3.50 lakh employees. Maruti Suzuki that controls 48% of the market share is the worst affected among the automakers.

Economists, policy makers and thinkers and bureaucrats are all seriously concerned about the 5% growth exhibited by the economy the current years three months ending June, considered the slowest in six years. Actually, there is a small silver lining in the cloud is that the IIP figures of 2.1% growth in July is slightly higher than the 0.7% growth in June. Construction sector in limbo since the last five years could take cold comfort in the fact that production of cement and steel has shown some modest growth in July. While fertilizer production has remained more or less static over the year, electricity generation has shown a modest increase in July this year. Rating agencies claim that while Q1 growth in FY 2019-20 may have fallen, but post budget government expenditure could perhaps help push up growth of the cement and steel sector.

Now, lets see what the government actually seeks to achieve with the historic transfer of Rs 1.76 lakh crore as surplus reserve to the government as per recommendations of the Bimal Jalan committee. This is actually a dividend transfer from the federal bank to the government treasury against the originally approved 900 billion rupees under the then RBI Government Urjit Patel who subsequently along with his deputy Viral Acharya following monetary management policies with the government and the finance minister asserting it was the exclusive preserve of the federal bank.

Subsequent change in leadership with the appointment of former revenue secretary Shakti Kanta Das as the RBI government has led to a change in thinking of the federal bank which has announced repo rate cuts four times this year and now the bonanza of dividend transfer of Rs 1.76 trillion. Is it really a bonanza? As said earlier, desperate situations demand desperate measures. This is one such. Many economists have termed the move as a “lifeline” for the government.

Focus in now on how the government uses this amount amidst an economic slowdown, leading economic dailies report. The Bimal Jalan led expert committee appointed by the government, which was set up to decide the size of capital reserves that the central bank should hold. As the committee approved the huge money transfer — a sum of Rs 1,23,414 crore of surplus for the year 2018-19 and Rs 52,637 crore of excess provisions identified as per the revised Economic Capital Framework (ECF), which was adopted at the meeting of the central bank.

While most economists and think tanks believe over the table the RBI lifeline for the government is to boost economic growth amid a period of sluggish consumer demand and weak investments. While this may be government’s main aim, the priority it is addressing how to contain fiscal deficit around the budgeted 3.2% and bridge the yawning gap in tax revenues caused by a massive GST refund to traders and manufacturers following a restructuring of the slabs that pushed down many items from the higher slabs to lower slabs of around 18% from 24%. Tax revenues have not been buoyant this year as last year, and the lingering effect of demonetization has also led to sluggish growth in the MSME sector accounting for the tax fall out, that is no goods to pay tax on, because they were not produced.

Before the RBI’s announcement, the government had budgeted Rs 90,000 crore or Rs 900 billion as surplus and dividend transfers from RBI for the current fiscal. However, it will now get Rs 86,000 crore or Rs 860 billion more, nearly treble the estimated amount of the budget.

Media reports claim It is almost three times (2.7 times) more than what RBI governor Shaktikanta Das’s predecessors ever managed–something that the government had been seeking desperately since Urjit Patel was at the helm.While some opposition leaders and economic experts including Raghuram Rajan and former RBI governor Urjit Patel raised doubts over the development, the excess surplus reserve transfer gives the government a handful of options to stabilize dwindling economic growth.

It is common knowledge that RBI’s balance sheet includes reserves comprising assets and earnings, which offers a cushion in times of an economic crisis. The Federal banks accounting is very different from that of a normal company due to its high liabilities (which has been considerably reduced by saving on paper and printing cost by introduction of the high value Rs 2,000 and Rs 200 notes), there is another large share which represents the reserves.

Much of this preserved through gold reserves and foreign exchange assets, which collectively constitute the Currency and Gold Revaluation Reserve Account. The RBI also stores a Contingency Fund (CF), which is another provision for tackling unexpected emergencies. When it comes to surplus funds, it is the amount RBI transfers to the government after meeting its own expenses. This surplus is basically RBI’s income which it earns through interest on securities it holds or profit it makes from investing the monies it holds. A good portion of its earnings is transferred to the CF. The Bimal Jalan committee was essentially constituted to decide on the issue of extent to which the RBI needs to hold reserves and whether it was holding reserves beyond adequate limits.

The math behind the new surplus transfer rule, a leading journal published from the capital explains as:The revised Economic Capital Framework (ECF) suggested by the expert panel indicated that the RBI currently has more capital than what it needs as a contingency. Therefore, a surplus capital 52,637 crore worth excess provisions have been transferred to the government under the revised ECF guidelines.

The committee had recommended a new surplus distribution policy, which looks at the level of Realized Equity (RE) to be maintained by the RBI within the overall level of its economic capital, which is a combination of realized equity and revaluation reserves. RBI’s realized equity–a form of CF built up from its retained earnings–stood at 6.8 per cent of the central bank’s balance sheet, but the expert panel led by Bimal Jalan recommended it to be in the range of 6.5-5.5 per cent.

Taking these recommendations into account, the central bank has opted for the lower bound of the realized equity level at 5.5 per cent of the balance sheet and transferred remaining excess reserves worth Rs 52,637 crore to the government, the report claims. “Given that the available realized equity stood at 6.8 per cent of balance sheet, while the requirement recommended by the Committee was 6.5 per cent to 5.5 per cent of balance sheet, there was excess of risk provisioning to the extent of Rs 11,608 crore at the upper bound of Contingent Risk Buffer (6.5%) and Rs 52,637 crore (5.5%) at the lower bound of CRB. The Central Board decided to maintain the realized equity level at 5.5 per cent of balance sheet and the resultant excess risk provisions of Rs 52,637 crore were written back,” said the RBI in a statement.

Under the revised framework, the central board of the RBI also decided to set the economic capital levels (ECL) containing the contingency fund and revaluation reserves as on June 30 within the range of 24.5-20 per cent of the balance sheet.

As mentioned earlier, the surplus transfers would depend solely on the RBI’s earnings-if the contingency fund falls below 5.5 per cent of the central bank’s assets, the surplus transfer amount the government would be restrained. What do Economists feel about this transfer of huge amount? The move is expected to help the government at a time when India is going through a period of economic slowdown, triggered by slower consumption demand and weaker investment.However, economists differ over the new surplus transfer policy. Some of them had expected the RBI to make staggered payments to the government treasury and not making it at one go.

Some economists have welcomed the move as it will help the government counter the shortfall in revenue and tax collection. Since inflationary pressure is low, economists believe that the move will not have a negative impact in the long run. Another group of economists which include the likes of Raghuram Rajan and former RBI governor Urjit Patel said earlier that the move could put RBI in a vulnerable position apart from diminishing its autonomy.

While Former chief statistician of India Pronab Sen told the business daily Livemint that keeping the RBI at a “rock-bottom” level is not a good idea, adding that this could become the norm from now onwards, Former RBI deputy governor Rakesh Mohan, who was the vice-chairman of the expert panel on ECF, clarified that the transfer of surplus reserves is not a raid on the RBI’s balance sheet.

Mohan further added that it was not a raid as the decision was based on the ECF committee’s report, which was agreed upon unanimously and signed by all the members including the government representative, Finance Secretary Rajiv Kumar. RBI now has to closely monitor the market situation in the country and abroad, following which it could take a call on whether to maintain the upper bound or lower bound of the contingency reserve in future.

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