The Hindu Business Line : Change of guard at Mint Street

The new RBI Governor needs to look at two issues raised earlier; the RBI accommodating a substantial part of its total revenue for transfer to a contingency reserve, and whether the central bank should “shoot” for a target of CPI or WPI.

S. Venkitaramanan

Dr Y.V. Reddy has just handed over charge to an accomplished Economic Administrator, Dr D. Subbarao. Dr Subbarao combines in himself academic excellence in economics and rich experience in both State and Central finances. I have had the privilege of working with him briefly in the late 80s during my tenure in the North Block.

Some critical voices have been heard protesting against the practice of a Finance Secretary moving in as Governor of the RBI, as it may interfere with the central bank’s autonomy. I differ from these critics.

I make bold to say that Dr Subbarao comes in the great tradition of Dr Manmohan Singh, Dr I.G. Patel, Dr L.K. Jha, Mr M. Narasimham, to mention only a few, who moved from Finance Secretaryship to Mint Street. In fact, in the French and German traditions, it has been the practice to appoint the head of the Treasury, a Civil servant, to be the Governor of the Central Bank.

The last Chief of the Bundesbank before the ECB took over it was the head of the Finance Ministry of Germany. Similarly, De La Roissere, who was Governor of the Central Bank of France, moved from the French Treasury. So is the present head of the European Central Bank, Mr Trichet, who was Chief of the French Treasury, before it merged into the ECB on its formation.

The British and the American traditions have, however, been different from the French, German and Indian practices. They have chosen the Governors of their Central Banks from among the former bankers or Wall Street specialists or economists per se. One has to note that the tradition of having Treasury officials become the Central Bank Governors has a credible precedent in Europe and India.

Of course, Dr Subbarao is both an engineer and an economist by training. Educated in IIT and subsequently after passing out as a topper in the IAS in the hard school of experience in State and Central administration, he is familiar with the Indian practice of members of the public offering felicitations to officials on their assuming high office and simultaneously presenting requests of favour.

On contingency reserve

While I felicitate Dr Subbarao, I request him for two favours. One of these concerns the points raised in my review of the Annual Report of the RBI for 2007-08. This is about the practice of the RBI accommodating a substantial part of its total revenue for transfer to a contingency reserve.

The figures in the Table illustrate my point. The total revenue derived by the RBI from its investment of $300-plus billion reserves even at the current low rate of returns amounted to Rs 51,883 crore for 2007-08. Added to this was interest revenue from domestic sources of the order of Rs 4958 crore.

Of the total revenue of Rs 57,000 crore, the Central Bank transferred Rs 33,430 crore to contingency reserve and Rs 3200 crore to asset development reserve, leaving only Rs 15,011 crore for transfer to Government. Figures for 2003-04, 2004-05, 2005-06, 2006-07 and 2007-08 are given in the Table.

There does not seem to be any clearly defined principle behind the allocation for contingency fund reserve, which is a large part of the total revenue, except to lower the residual for transfer to Government of India. As a result of these transfers, the total contingency fund reserve at the end of June 2007 came to roughly Rs 93,000 crore and at the end of June 2008 to Rs 1,27,000 crore. This is the order of magnitude of revenues appropriated to its own reserves by the RBI. They are almost as large as double the annual revenue from the return on investments.

Viewed another way, the shareholding of the RBI is entirely owned by the Government of India. The Government of India has the first right to the revenues earned by the RBI. No portfolio manager worth his name will normally allow appropriating such large percentages out of the revenues earned from its investments in the form of a contingency reserve.

In my view, the whole revenue derived by the RBI should normally be part of the contribution to the fisc of the Government of India. I am stressing this point because a sum of about Rs 50,000 crore derived from out of the investment of foreign currency reserves can be a substantial relief to the fiscally embattled Government of India, which point as former Finance Secretary, Dr Subbarao will appreciate.

CPI, rather than WPI

I turn to another point I had referred to in my recent review of the RBI’s operations. While I do not have any difference with the RBI’s management, the importance of focusing on controlling inflation, the point at issue is whether the RBI should “shoot” for a target of consumer price index (CPI) or wholesale price index (WPI). It is true that there are a number of problems in collating information on the CPI. But most other countries in the world, such as China, use the CPI and not the WPI for inflation management.

It may be argued that for some years in the past CPI may be ahead of WPI. But, by and large, experience in recent years has been that increase of CPI per annum has been about 4 to 5 per cent below the WPI inflation. If this is true, it stands to reason that the RBI should examine the possibility of switching over to inflation target on CPI rather than on WPI.

The transition has to be preceded by a campaign of education of the public. The arguments in favour are substantive. Countries around the world follow the practice of aiming at CPI rather than WPI. There is a related issue, which had been touched on in the latest annual report that concerns with what is known as “core inflation”, which excludes fuel and food prices. It had been argued in the report that exclusion of food prices in India is not advisable because food accounts for a substantial part of the consumer expenditure.

The same argument will apply against exclusion of fuel prices in the US. But, nonetheless, the US Federal Reserve concentrates on core inflation excluding fuel and food. I suggest that Dr Subbarao revisit this problem. (From the technical point of view as well as the practical advantages, focusing on CPI, excluding food and fuel prices, is more susceptible to monetary action.)

At a critical juncture

Dr Subbarao has come into office at a critical time. One complicating factor is that the current account deficit of India is on the increase. The rupee is depreciating to Rs 45 per dollar. While exporters will celebrate this development, the fisc may stand to feel the pressure of higher petroleum price subsidies. The depreciating rupee is a consequence of global forces, partly the appreciation of the dollar.

The Governor will, no doubt, weigh all the implications before deciding on the stance. Perhaps, Dr Reddy’s nuanced attitude will continue under Dr Subbarao’s regime also. These are but a couple of my random thoughts. I offer them to Dr Subbarao with the best of wishes for a reign of good luck, which he deserves.

As Napolean once famously said, he wanted not only brilliance in his generals but generals with luck. Similarly, may good fortune favour Dr Subbarao in his discharge of the onerous responsibilities at Mint Street!

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