India: A large dividend transfer to the government confirms the central bank’s declining independence

Event

The well-capitalised Reserve Bank of India (RBI) decided to transfer USD 24.4 bn to the fiscal accounts of Modi’s government, a sum consisting of dividends (70% of the total) and excess reserves. 

Impact

The transfer of RBI dividends is not exceptional. However, the timing and the magnitude of the payment are more so. Considering the closer relation between the RBI and the government, such a payment is not surprising. Indeed, PM Modi has increasingly been putting pressure on the Central Bank governor. During Modi’s first mandate, that culminated last December with the decision of the previous governor, Mr Patel, to step down due to a profound disagreement with Modi on the allocation of the RBI’s reserves. The new RBI governor looks more pliant to PM Modi and, with this latest remittance, he gives the signal that he could support the economy and the federal budget whenever deemed necessary. The economic and fiscal situation is indeed currently all but rosy, with steadily declining GDP growth data over the past three quarters, record high unemployment and a widening fiscal deficit due to lower revenues. Therefore, such a significant transfer of about 1% of GDP is certainly a welcome boost to the recently re-elected Modi and to the public finances. Though in theory he could use this money productively, with a long-term perspective, for example to invest or to recapitalise fragile state banks, in practice, Modi is expected to allocate a large share of it to plug current budget holes.

This is probably a new episode highlighting the growing politicisation of the economy that has been observed in India over the past years, notably with the questionable revision of past GDP growth figures, political pressures to relax lending to state banks, four cuts in interest rates this year or the RBI’s interim dividend payment of USD 4 bn last February during Mr Modi’s election campaign. Governmental pressures to reduce the independence of the central bank are witnessed in other large countries (e.g. US, Turkey…) and are not welcome – the RBI governor is appointed by the government, though. They could favour populist measures, undermine the RBI’s credibility, create uncertainty and ultimately harm the monetary policy effectiveness.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com