Gift from RBI
- The government should put the bonanza to use in a prudent manner
- After a long tug of war, the government has eventually had its way with the Reserve Bank of India, managing to get it to part with a portion of its accumulated reserves. The RBI board, on Monday, decided to transfer a massive ₹1,76,051 crore to the government, including a sum of ₹52,637 crore from its contingency reserve built over the last several years. The outflow from the RBI’s reserves was limited to this amount only because the Bimal Jalan Committee, appointed to recommend the economic capital framework for the RBI, decided to keep a major part of the reserves locked up and out of the reach of the government while opening up the remainder with strict stipulations. The Committee has recommended, and rightly so, that the Currency and Gold Revaluation Reserve Account (₹6.91 lakh crore as of June 30, 2018), at least half of which was eyed by the government, represents unrealized gains and hence is not distributable to the government.
- In the case of the Contingency Reserve (built out of retained earnings), which was ₹2.32 lakh crore as of the same date, the committee said that it should be maintained within a band of 6.5-5.5% of total assets. It left it to the RBI board to decide the precise percentage it was comfortable within this band and transfer the excess to the government. As it happened, the board, in its Monday meeting, decided to peg this ratio at 5.5% thus enabling it to transfer a sum of ₹52,637 crore to the government immediately. The committee should also be complimented for clearly specifying that the revaluation reserve cannot be used to bridge shortfalls in other reserves.
- In principle, it could be argued that the government as sovereign owns the RBI and hence there is nothing wrong if it decides to tap the central bank’s reserves. Yet, that it actually chose to do so is unfortunate because these reserves represent inter-generational equity built up over several years by the RBI by squirrelling away a part of its annual surplus. It is morally unacceptable that any one government can swallow even a part of such funds to help meet its expenditure in a particular year. The reserves, as the Jalan Committee has pointed out, represent the country’s savings for a ‘rainy day’, which is a monetary or financial crisis. Interestingly, the net surplus of ₹1,23,414 crore posted by the RBI in 2018-19 is more than double that of the previous year and is considerably higher than the ₹65,876 crore that it netted in 2015-16. Only the release of the RBI’s Annual Report in the next few days will help in the understanding of the reasons behind the sharp jump in the surplus. The big transfer from the RBI will free up the hands of the government at a time when tax revenues are undershooting the target by a long chalk. The money, it is hoped, will be put to use in a prudent manner.
- Finance Minister Nirmala Sitharaman’s press conference on August 23, announcing a slew of measures to boost the economy and financial market sentiments, had an interesting idea. It was about setting up a development bank.
- Ms. Sitharaman said: “In order to improve access to long-term finance, it is proposed to establish an organization to provide credit enhancement for infrastructure and housing projects, particularly in the context of India now not having a development bank and also for the need for us to have an institutional mechanism. So, this will enhance debt flow toward such projects.” The announcement could have far-reaching implications for India’s financial system. This article explains why.
What are development banks?
- Development banks are financial institutions that provide long-term credit for capitalintensive investments spread over a long period and yielding low rates of return, such as urban infrastructure, mining and heavy industry, and irrigation systems. Such banks often lend at low and stable rates of interest to promote long-term investments with considerable social benefits. Development banks are also known as term-lending institutions or development finance institutions.
- To lend for long term, development banks require correspondingly long-term sources of finance, usually obtained by issuing long-dated securities in capital market, subscribed by long-term savings institutions such as pension and life insurance funds and post office deposits.
- Considering the social benefits of such investments, and uncertainties associated with them, development banks are often supported by governments or international institutions. Such support can be in the form of tax incentives and administrative mandates for private sector banks and financial institutions to invest in securities issued by development banks.
- Development banks are different from commercial banks which mobilise short- to mediumterm deposits and lend for similar maturities to avoid a maturity mismatch — a potential cause for a bank’s liquidity and solvency. The capital market complements commercial banks in providing long-term finance. They are together termed as the Anglo-Saxon financial system. Historically, in the U.K. and the U.S., such a debt market took root to fund expansion of the market economy and colonial investments in the 19th century, such as financing of railways worldwide. This market was mostly sweetened by fiscal sops to promote Britain’s global political and commercial interests.
- Industrialisation of continental Europe and Asia was, however, financed under the aegis of German-type universal banks (providing long- and short-term credit) and state-sponsored (or guaranteed) development banks underwriting the risks of long-term credit.
- For instance, the earliest and ubiquitous saving institution, namely the post office bank (mostly government-owned and managed), mobilized national savings and channeled them into development banks for long-term investments whose social rates of return were higher than the assured interest rates for depositors.
- Alexander Gerschenkron, a Ukrainian economic historian at Harvard University, famously theorized that the greater the backwardness of a country, the greater the role of the state in economic development, particularly in providing long-term finance to catch up with the advanced economies in the shortest possible time.
- In the context of the Great Depression in the 1930s, John Maynard Keynes argued that when business confidence is low on account of an uncertain future with low-interest rates, the government can set up a National Investment Bank to mop up the society’s savings and make it available for long-term development by the private sector and local governments.
- Following foregoing precepts, IFCI, previously the Industrial Finance Corporation of India, was set up in 1949. This was probably India’s first development bank for financing industrial investments. In 1955, the World Bank prompted the Industrial Credit and Investment Corporation of India (ICICI) — the parent of the largest private commercial bank in India today, ICICI Bank — as a collaborative effort between the government with majority equity holding and India’s leading industrialists with nominal equity ownership to finance modern and relatively large private corporate enterprises. In 1964, IDBI was set up as an apex body of all development finance institutions. As the domestic saving rate was low, and capital market was absent, development finance institutions were financed by
(i) lines of credit from the Reserve Bank of India (that is, some of its profits were channelled as long-term credit); and
(ii) Statutory Liquidity Ratio bonds, into which commercial banks had to invest a proportion of their deposits. In other words, by sleight of government hand, short-term bank deposits got transformed into long-term resources for development banks. The missing capital market was made up by an administrative fiat.
- However, development banks got discredited for mounting non-performing assets, allegedly caused by politically motivated lending and inadequate professionalism in assessing investment projects for economic, technical and financial viability. After 1991, following the Narasimham Committee reports on financial sector reforms, development finance institutions were disbanded and got converted to commercial banks. The result was a steep fall in long-term credit from a tenure of 10-15 years to five years. The development of the debt market has been an article of faith for over a quarter-century, but it has failed to take off — as in most of Europe and industrializing Asia, where the bank-centric financial system continue to prevail.
- China’s development banks — the Agricultural Development Bank of China, China Development Bank, and the Export-Import Bank of China — have been at the forefront of financing its industrial prowess. After the global financial crisis, these institutions have underwritten China’s risky technological investments helping it gain global dominance in IT hardware and software companies. Germany’s development bank, KfW, has been spearheading long-term investment in green technologies and for sustainable development efforts requiring long-term capital.
- In this light, the Finance Minister’s agenda for setting up a development bank is welcome.
- However, a few hard questions need to be addressed in designing the proposed institution. How will it be financed? If foreign private capital is expected to contribute equity capital (hence part ownership), such an option needs to be carefully analysed, especially in the current political juncture. The design of the governance structure is fraught with dangers with many interest groups at work. One sincerely hopes that the political and administrative leadership carefully weigh in the past lessons to lay a firm foundation for the new institution.
Preference for the chulha
- Mr. Dubey had recently received an LPG cylinder and stove through the Pradhan Mantri Ujjwala Yojana. His family could afford to hire labourers to cut wood, and they used the gas stove only to make tea. Dal, sabzi, roti and rice were made by Mr. Dubey’s daughtersin-law on the chulha (earthern/ brick stove). Mr. Dubey believed that food cooked on a chulha was healthier and tastier. In contrast, rotis cooked on gas cause indigestion, he said. He thought that cooking with solid fuels was healthy for the person cooking too: fumes purified the eyes because they caused tears, and in blowing into a traditional stove, a woman did kasrat (exercise). Clearly, Mr. Dubey had never cooked on a chulha.
- In another part of the same village in Madhya Pradesh, Rajni Bai, a Dalit woman, had also received LPG through the same scheme. Ms. Rajni’s household did not own any land or animals. She did not have access to dung or agricultural produce to burn in a traditional stove. She appreciated the cylinder and the gas stove. The cylinder lasted her two and a half months. She had used it “carefully”, supplementing it with wood collected from the forest. But when we interviewed her, the cylinder had been sitting empty for 15 days. Ms. Rajni could not afford a refill. The rains had made the wood wet and harder to burn, but she made all the food on her traditional stove made from mud.
- Ms. Rajni and Mr. Dubey are at opposite ends of the wealth spectrum, but it would be hard to see this by looking at their cooking fuel. They are not unique. In our survey conducted in 127 villages across four States — Bihar, M.P., Rajasthan, and Uttar Pradesh — we found that the rich were less likely to use a chulha for cooking compared to the poor, but not by much: more than 60% of the richest households had used a chulha yesterday.
- Using cleaner fuels such as LPG is essential to reduce rural air pollution and improve health. What can policymakers do to achieve exclusive use of clean fuels in rural India? Three strategies could work: communicating the harms of solid fuels and the benefits of cleaner fuels; reducing the cost of LPG cylinder refills in rural areas; and promoting gender equality within households, particularly in cooking and related tasks.
Using clean fuel
- Like Mr. Dubey, 92% of the respondents in the survey said food cooked on a chulha tastes better than food cooked on gas, and more than 86% believed that food cooked on a chulha is healthier. Fortunately, only 22% agreed with Mr. Dubey that cooking food on a chulha is better for the health of the cook than cooking food on gas. Even among those who believed that cooking on a chulha harms health, the harms most often invoked were not respiratory, but to the eyes of the person cooking. A large anti-tobacco style campaign communicating that solid fuels harm respiratory health may change these beliefs. Similarly, advertisements that food cooked on gas can be as tasty and healthy as food cooked on a chulha would be helpful.
- Reducing LPG prices in rural areas, where residents are poorer and solid fuels are easier to access, would also help. One way is to build on the targeting experience of the National Food Security Act. Under this Act, 75% of rural households are classified as priority households and entitled to subsidized rations. Another 10% of extremely poor households are classified as Antyodaya households, eligible for higher grain amounts at even lower prices. If priority households could become eligible for even higher subsidies in a revamped LPG pricing regime, and Antyodaya households could become eligible for LPG cylinders free of cost, exclusive LPG use would likely be higher.
- Finally, public policy must recognize that in households such as Mr. Dubey’s, if he was doing his share of the cooking, a complete transition to LPG would have happened already. Our survey asked questions on who cooks food, who makes dung cakes, and who collects wood in rural households. Men rarely cook or make dung cakes in rural households. Current Ujjwala messaging, which focuses on the benefits of clean fuels for women, reinforces this inequality. Advertisements showing that gas is so good that even men can cook with it will challenge both misinformation on LPG and gender inequalities in household tasks.
- The RBI’s reserves consist of currency and gold revaluation account (CGRA), the investment revaluation account, the asset development fund (ADF) and the contingency fund (CF). The CGRA makes up the chunk of the reserves and has gone up substantially since 2010---at a compounded annual growth rate (CAGR) of 25 per cent to Rs 6.91 lakh crore in 2017-18. It essentially reflects the unrealized gains or losses on the revaluation of forex and gold