The Reserve Bank (RBI) resisted a “raid” planned by some in the government to extract ₹2-3 lakh crore from its balance sheet in 2018 to meet populist spending in run-up to general elections, Viral Acharya, who was deputy governor at RBI at that time, has written.

This apparently had led to differences between RBI and the government, which even contemplated invoking never-used Section 7 of the Reserve Bank of India Act to issue directions to the central bank.

Mr. Acharya who had first flagged the issue while delivering AD Shroff Memorial Lecture on October 26, 2018, in a fresh prelude to his book ‘Quest for Restoring Financial Stability in India’, called the exercise a “backdoor monetisation of the fiscal deficit by the central bank”.

“Creative minds in the bureaucracy and the government” devised a plan to transfer substantial sums accumulated by RBI during the tenure of previous governments to the current government’s account, he said in the prelude in the updated edition of his book first published in 2020.

RBI every year sets aside a part of its profit instead of giving it all to the government. In three years leading up to the 2016 demonetisation, the central bank made record profit transfers to the government, Mr. Acharya said.

During the demonetisation year, the expense for currency printing reduced the transfers made to the Centre, resulting in “intensifying” the government’s demand ahead of the 2019 elections, he said.

Extracting more dividends from the RBI was in a way “back-door monetisation” of fiscal deficit – the difference between the revenue government generates and its expenditure. The deficit widened after disinvestment missed targets.

“Why cut populist expenditures in an election year… when the central bank balance sheet can be raided and surging fiscal deficits essentially monetised?” he wrote.

Mr. Acharya quit in June 2019, six months before his three-year term as the deputy governor in-charge of the monetary policy, financial markets, financial stability and research.

Prior to that, Urjit Patel had resigned as the governor of the central bank in December 2018. Though he cited “personal reasons”, the resignation came amid reports of the rift between the RBI and the government. His was a rare case of a serving governor leaving his job midway through his three-year term.

Delivering the AD Shroff Memorial Lecture, Mr. Acharya had in October that year stated that: “Governments that do not respect central bank independence will sooner or later incur the wrath of the financial markets, ignite economic fire, and come to rue the day they undermined an important regulatory institution.” Mr. Acharya, who was deputy governor of RBI from January 23, 2017 to July 23, 2019, in the prelude wrote that the conditions in 2018 were “undoubtedly challenging” but not extreme, like the global financial crisis of 2008-09 or the U.S.’s ‘taper tantrum’ of May-September 2013.

The real catch was that a national election was due from April to May 2019, he wrote, adding, “some creative minds in the bureaucracy and the government conjured up an idea for generating ₹2-3 lakh crore, or equivalently $30-40 billion at the then exchange rate, for populist spending”.

Demonetisation of November 2016 was of course another such idea, the former deputy governor wrote.

In this case, however, the magic wand would be waived on the RBI balance sheet rather than on currency notes, he said.

Explaining the events that led to the standoff where the never-used Section 7 of the RBI Act to issue directions to the central bank was discussed, Mr. Acharya said “No democratic emerging market government with reasonable institutions is likely to get its way without meeting formidable resistance when it repeatedly proposes plans to raid its central bank’s balance sheet for short-term populist expenditures.” His going public about the tensions, led to some sort of wise counsel prevailing and a committee under former governor Bimal Jalan was set up to draw a reasonable framework for future transfers from RBI balance sheets to the government.

“To its credit, the government sidelines most of the original architects of the ‘idea’ [to raid RBI balance sheet],” he wrote. “And indeed, a rather large transfer, which unlike in 2018 could be well justified during the pandemic in 2020, was delivered by the then Reserve Bank Board.” The RBI, he pointed out, generates revenues primarily via seigniorage.

Each year, the central bank’s board sets aside some provisions out of the profits so generated rather than distributing them all to the central government.

In short, the Reserve Bank saves from its profits, maintains provisions and holds safe assets for financial stability purposes, he said and added the ‘idea’ conjured up was to transfer a significant portion of these provisions from the central bank balance sheet to the account of the present-day government – provisions accumulated over several terms of prior governments and needed to smoothen financial fragility during several terms of future governments.

“As is now publicly known, the Reserve Bank did not play along with the idea,” Mr. Acharya wrote.