Glenn Stevens today made a careful but inevitably considered contribution to the debate ignited by Joe Hockey’s decision to inject $8.8 billion into the Reserve Bank’s capital base last week. He provided fuel for both sides of the debate.
Critics of the decision to give the Reserve Bank the funds regard it as a purely political decision. It will add to the red ink of Labor’s legacy by inflating this financial year’s already substantial deficit, previously estimated at more than $30 billion.
It will also, as Stevens said today, allow the Reserve Bank to pay a regular flow of dividends to the government much earlier than would otherwise be the case, improving the bottom line of Hockey’s budgets. The injection, which was perhaps somewhat larger than most had expected, is clever politics.
It is, however, more than that.
The need for an injection, if one were needed, arose because the strength of the Australian dollar in the post-crisis period has had a significant impact on the Reserve Bank’s balance sheet and its reserve fund – its version of a capital base – in particular. The Reserve Bank holds very substantial interests in foreign securities and the fund had fallen from nearly $7 billion to less than $2 billion as a result of its currency losses.
There are those who argue that the size of the Reserve Bank's capital base is of no practical consequence given that its effective ability to print money means that it can’t suffer the kinds of liquidity or solvency issues of a commercial bank.
To a large extent that is true, although one suspects that a central bank with negative equity might have some credibility issues and the absence of reserves could affect its ability (or perhaps its willingness) to intervene in currency markets when, in normal circumstances, it would.
Certainly, the RBA believed the reserve issue mattered.
Stevens today said the diminution of the bank’s capital base had been to a level well below that "judged by the Reserve Bank board to be prudent". He said the Reserve Bank’s annual reports had made it quite clear for several years that the rundown in the capital base in the face of a very large valuation loss was exactly what the reserves were designed for and that it considered it prudent to rebuild that capital at the earliest opportunity.
‘’It has been clear that the bank saw a strong case not to pay a dividend to the Commonwealth during this period, preferring instead to retain earnings so far as possible, to increase the bank’s capital,’’ he said.
That’s a veiled shot at former Treasurer Wayne Swan.
Earlier this year, in an appearance before a parliamentary committee, Stevens revealed that the RBA had asked Swan not to take a dividend from the bank last year so that it could start rebuilding its reserves.
Indeed, correspondence between the RBA and the Treasurer that emerged subsequently made it plain that the bank was extremely concerned about its reserves level and had made it very clear that it didn’t want to pay any of its earnings out as a dividend.
Instead Swan, who was still trying desperately to maintain some level of fiscal credibility and the unrealistic aspiration for a budget surplus, insisted the bank pay nearly half its $1.1 billion profit over to the Commonwealth.
Hockey, in one action, has recapitalised the RBA, whereas it could well have taken years to get the reserve fund back to levels the RBA felt were prudent.
Central bankers, with good reason, tend to be very careful and cautious with their language. But when a Reserve Bank governor says the bank considered it ‘’prudent’’ to rebuild its capital base as quickly as possible, the only interpretation is that it felt it was absolutely necessary.
Whatever the technical arguments about whether or not the RBA needs to have positive equity the fact that it clearly believes it does, and has been prepared to say so repeatedly in private correspondence with Treasury and the Treasurer and in public comments, shouldn’t be over-looked and shouldn’t have been ignored by a federal treasurer, no matter how cash-strapped.
Joe Hockey may have over-egged his response to the RBA’s position by giving it more that it probably needed in one hit. There is inevitably a rather cynical political dimension to what he has done, but the RBA is again properly capitalised. Its credibility, independence and, perhaps, its ability to act have been protected.