In a press release issued on February 18,2009, the World Bank (WB) has indicated, inter alia, that it might help finance the recapitalisation of banks in the public sector, as proposed by the Indian government. The forex and debt markets may not be disturbed if the transaction is between the government and the RBI, on the one hand, and the former and banks on the other (through the issue of bonds). The forex will go into reserves and get invested in very low-yielding securities of developed countries or deposits of international institutions. External debt will go up. One does not know whether the proposed WB loan will be an interest-free International Development Agency (IDA) assistance or a regular commercial one from the International Bank for Reconstruction and Development (IBRD).
An innovative way to deploy the country’s reserves is to utilise them for strengthening the capital base of banks following the Chinese example. In January 2004, the central bank of China injected $45 billion from its forex reserves into the Bank of China and the Construction Bank of China to raise their capital bases. Again it made a similar contribution of $15 billion to the Industrial and Commercial Bank of China.
A study by the European Central Bank staff makes two important points. First, capitalisation of the public sector banks was done not by increasing the liabilities of the government but by transferring assets. Secondly, the forex assets remained in the same currency in the books of the banks and were not converted into yen thus avoiding any upheaval in the market, although still subject to currency risks. Further, the government retained control over the management of the transferred assets through a newly-created investment company run jointly by the central bank, ministry of finance and the State Administration for Foreign Exchange.
Since, under the current policy, RBI cannot invest in the share capital of banks, the government has to buy the forex for its investment. It is not beyond the ingenuity of experts to get over the problem of payment to RBI by a cash-starved government. RBI shares in State Bank of India were sold to government against cash on June 29, 2007. It was timed to coincide with the transfer of the year’s surplus income by the RBI to government. There may be other procedures — normal or innovative — to deal with the problem of payment. But the objective should be to avoid unnecessary external debt.
A Seshan, via email
