The Reserve Bank of India (RBI) Governor, Urjit Patel, is said to have told the Parliamentary Standing Committee on Finance that its capital reserves are meant “to be used during periods of stress, and not for meeting normal needs.” One does not know if this attribution is authentic, since proceedings in the committee often get reported through the anonymous statements of participants, but two points need to be made, assuming the thrust of the statement is correct.

First, Patel is correct to emphasise that the RBI’s reserves, currently in the region of just under Rs 10 lakh crore, and equivalent to around 28 per cent of its assets, are not meant to be used by governments for normal expenditures. If the money, say, is used for financing freebies in an election year, clearly Patel is within his rights to say no.

Second, the question Patel needs to ask himself is this: what if the money is not going to be used for political ends? And what if this period of financial stress warrants the use of the reserves for achieving something more important like systemic stability?

The second question is important because despite high gross domestic product (GDP) growth, the financial sector is under stress, and this stress could worsen if several other sectors threaten to go under.

For example, the public sector banking industry is far from out of the woods. Non-bank financial companies (NBFCs) are starved of liquidity. The micro, small and medium enterprises (MSMEs) are struggling for credit, impacted by the goods and services tax (GST) pressure to formalise and become more tax-complaint. The telecom sector is tottering, and at least one company has hinted at a spectrum payment default. Real estate and aviation finances are also in a mess. Many private power players are edging towards insolvency, and the RBI is pushing them towards it. If these sectors start imploding, the financial sector would be up the creek without a paddle.

The RBI is clearly fooling nobody by claiming that there is no stress, when most of the stress is financial in nature.

The logical way out for the RBI and the Finance Ministry is a simple one: it is not about handing over the central bank’s excess reserves to the government to spend on freebies, but link this directly to financial sector stability.

A few such ideas could include the following:

One, let’s assume the government recapitalises public sector banks to the hefty tune of Rs 1 lakh crore over and above the Rs 2.11 lakh crore it is already committed to doing. At current yields, the additional recap bonds would cost the government Rs 7,500-8,000 crore annually. The RBI could offer to finance this by hiking dividends by this amount over normal levels, if the government calls for it.

Two, since the RBI has 28 per cent capital adequacy, it can easily expand its balance-sheet by buying good quality assets from the banking and NBFC sectors. This will not only provide liquidity, but also enable the central bank to hawk these assets at a later date for a profit, assuming most of these assets are good. This can be done indirectly by financing banks to buy these assets from NBFCs or other banks. The liquidity crunch is going to get worse next month, as GST and advance tax payments are made by 15 December.

Three, the RBI and the government can float a holding company for the government’s excess shareholdings in public sector banks (holdings above 51 per cent), and jointly appoint a fund manager to generate surpluses by hawking the shares when the markets are fizzier, and buying the shares back when they are not. The borrowings made possible through the underlying assets with this company can be used to recapitalise some of the weaker banks, or finance their voluntary retirement schemes and/or mergers with stronger ones.

Recapitalising banks is not something that the RBI can wish away as merely the government’s job, especially when the losses of banks are going to come from sending many of their bad loan cases to bankruptcy courts.

Moreover, when the RBI has put 11 public sector banks under PCA (prompt corrective action), it has essentially allowed them to raise liabilities (deposits, or costs) while strangling their assets growth (incomes). How will banks finance rising deposits without raising credit or capital? Again, the RBI could help any which way it can to recapitalise these banks.

What the RBI cannot deny is stress in the financial system. It is a cause worth financing using the RBI’s own strong balance sheet. The money need not go to the government for election-eve spending, and the Finance Ministry has anyway said that it is on target for meeting the fiscal deficit target for the year.

Acting cussed on its reserves is not what is expected of the RBI right now.

Strong Balance Sheet

Get Swarajya in your inbox.