Government should not tamper with balance sheet of RBI: Former RBI governor D Subbarao

D Subbarao's book Just a Mercenary delves into several unknown chapters of India’s economic policy making.
 Former RBI governor D Subbarao
Former RBI governor D Subbarao

In his new book -- Just a Mercenary – former RBI governor D Subbarao details his journey from a Sainik School to Mint Road in Mumbai. The book delves into several unknown chapters of India’s economic policy making.

In an interaction with Dipak Mondal of the New Indian Express, the former RBI governor shares his view on many economic and financial issues facing the country.

You are among a long list of IAS officers who ended up heading the RBI. Do you think bureaucrats make good RBI governors?

The RBI over the last 90 years has been served by 25 governors, and they came from different backgrounds. Some were economists, some came from academia, while some were civil servants like Dr (YV) Reddy and me. I don’t think you can find a correlation between the background of the governor and his performance if the governor responds to the macroeconomic situation of his time, and delivers the service. Whenever the governor’s position falls vacant, I think the government must draw from the entire available pool and choose the best person, not necessarily driven by a particular background.

There have been references in your book about the tussle between the government and the RBI on policy issues. Do you think central bank of a country can function completely free from government intervention?

It should, in theory, function free of interference. And, even if there is interference each of its decision and action should not be influenced by it. The RBI consults all stakeholders in determining its monetary policy. It consults banks, non-banks, financial institutions, financial markets, economists, farmer bodies, microfinance institutions, and takes view of their suggestions and concerns. Similarly, the RBI also consults the Centre because the government is a big stakeholder.

The RBI should listen to all stakeholders, including the government, with an open mind, but I believe it should act in its best judgment. Now, there are attempts to interfere, influence or criticise the central bank, but that is not unique to India. It happened in other countries as well -- it happened in Japan, the UK, the US, Brazil, Turkey, and many other countries. But in countries where institutions are not very mature, these tensions or alleged interference might create some problems.

The government has been criticised for asking very high dividends from RBI’s reserves. What are your views on this issue?

Putting pressure on the RBI for allowing a part of the foreign exchange reserves to be used for infrastructure financing is quite different from the dividend issue.

The issue of use of forex reserves for infrastructure came up when I was the finance secretary and Dr Reddy was the (RBI) governor. There was a suggestion that RBI is holding a large forex reserve, which was getting very low returns. On the other hand, private companies were borrowing huge amounts of foreign capital at a high rate for building infrastructure. So, the government of that time wanted the RBI to lend a part of the reserve to corporates for infrastructure projects at lower rates. However, there is a hidden cost. If the country is seen tampering with those forex reserves or diverting them for other purposes, the credibility of the country might get eroded.

The government should not be tampering with the balance sheet of the central bank, because the balance sheet of the central bank needs to be strong to inspire confidence.

On the dividend issue, I wouldn’t call it an infringement on the autonomy of the RBI. Under the institutional arrangements, the RBI does make a surplus. Making profit is not one of the objectives of the RBI. Under the law, the RBI is allowed to put away part of surplus for building reserves for stability and then give the rest to the government as dividend.

The government because of its own fiscal needs asks for more dividends. The Centre’s grudge is that RBI is fortifying itself more than necessary. This has always been an issue -- during my time when I was the finance secretary, and when I was the RBI governor. But I think this is an issue that can be settled amicably.

You have discussed the issue of rift between the Centre and states for resource allocation. What is your view on the whole issue of fiscal federalism?

The Centre-state issues are there in every Federation, they’re not unique to India. They are in developed countries like the US, Canada, they’re in less developed countries like South Africa, Ethiopia, India, and China. So, these issues are common everywhere. I don’t think they will go away. The important thing is whether we have institutional arrangements for resolving these issues amicably, without too much politics coming in.

In India, we have institutional mechanisms to address this issue. We have the Finance Commission, which decides on the Centre-state issues. We have a mechanism for the central government deciding how much debt they should borrow, and when they can borrow, we have the FRBM Act. I am not suggesting that these are foolproof, but we should be able to resolve them, even if the existing institutions are inadequate to resolve them.

You have made an interesting point in your book that while Centre collects 60% of tax revenues, it has spending liability of only 40% and vice versa. Do you think there is a case for higher tax devolution to states?

If you take ballpark estimates, the Centre collects 60% and the states collect roughly 40% of the taxes. In the total pool of expenditure, the Centre’s share is 40% and state’s share is 60%. So, there’s an imbalance and that imbalance is corrected by the award of the Finance Commission, which has gone up over the years and is currently at 41%. States of course, want more, but the Centre has its own inability to give more as it is already fiscally stretched.

Are you happy with the current government’s performance on the fiscal front?

Back in 2021, I had criticised the finance minister’s decision to take a longer time for bringing down the fiscal deficit to 3% (as recommended by the FRBM Act). However, over the last four years, I believe the central government has been very responsible in fiscal management and finance minister has reiterated that she would be able to deliver on the target. We have to see after the election, which government comes into office and who becomes the finance minister. I hope whoever comes into office will adhere to the target.

Do you think current debt levels are sustainable?

No, I have my concern about the current debt levels. The debt-GDP ratio went as high as 90% during the Covid, which is understandable. And it has come down to 80% of the total government sector debt. The FRBM committee said that an appropriate or sustainable target for India is 60% -- 40% for the Centre and 20% for the states. We could probably review that target. But I don’t think we can afford to have a much higher debt-GDP ratio, the reason being interest payments are already very high for both Centre and states.

You said in book growth prospects and debt sustainability depend on private investment inflows. Do you think private investment is playing out well for India?

The numbers show that private investment has not yet picked up. The economy is clocking high growth rates, but the economy is running on one engine -- the engine of public investment. Public investment at these levels cannot be sustained, because we have fiscal constraints.

So, to maintain this growth momentum, the economy has to fire on all cylinders -- consumption, private investment, government investment, and net exports. Private investment is a very important component of our growth story and must pick up. It did not pick up over the last 10 years because we had had this twin balance sheet problem, which has since been resolved. Both corporates and banks are now in good enough health to take private investment forward. Capacity utilisation at 80% is coming to saturation levels. That’s the level at which corporates should think of adding to investment capacity. I think private investment is partly inhibited by export demand, which is not robust at the moment.

Do you think Indian rupee can be an international currency anytime soon?

It can be in theory, but in practice it is quite far away (from becoming international currency). By internationalisation of rupee, we mean the currency is used for settlement of global trades, and in this respect the Chinese experience would be very useful for us. Over the last 10-15 years, China has been successful to some extent in making its currency international. Today a significant amount of Chinese trade is settled in Yuan, but China also has a large footprint in global trade. It is the largest trading nation in the world. So China has been able to internationlise Yuan for trade settlement and not for store of value because China still has capital controls. So, if we want to internationalise our currency the way China did, we must first increase our global trade footprints. We must relax capital controls; our fiscal situation should be more robust, and our institutions of governance must command more credibility.

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