The trouble with bolstering the RBA's reserves

Yesterday’s release of the Reserve Bank of Australia annual report shed some light on the controversial $8.8 billion cash injection to the Bank that Treasurer Joe Hockey announced earlier this week.

It was an odd decision to give the RBA such a large amount of money given the annual report expressed no concerns about the existing level of reserves nor have the financial markets viewed those reserves as anything other than a curious accounting issue. It was odd too because the $8.8 billion is being borrowed by the government and the interest paid on that debt will amount to an annual cost of around $350 million, based on the current 10 year government bond yield.

That cost aside, page 77 of the RBA Annual Report included a table that summarised the dividends paid by the Bank to the government since 1997-98. 

That table shows that under the Howard Coalition government, the RBA paid a total of $20.2 billion in dividends. This was $1.83 billion a year. In today’s dollar terms, the total amount paid by the RBA was in excess of $30 billion or almost $3 billion per annum.

Under Labor, the RBA paid a total of $7.9 billion in dividends or around $1.3 billion a year, on average. In today’s dollar terms, this total approximately $9 billion or an average of around $1.5 billion per annum. In the last three Labor budgets, the average dividend was a tiny $410 million a year.

In other words, Treasurer Peter Costello ‘raided’ the RBA, using Hockey’s language, to the tune of $3 billion a year in today’s dollar terms for every year in 11 years, while Treasurer Swan (and then briefly Chis Bowen) ‘raided’ $1.5 billion per year for six years.

Had Costello trimmed his demand for RBA cash by even $1 billion a year in today’s terms, the amount of reserves at the RBA would have been extremely high right now and would have remained elevated during the global financial crisis.

Either way, it matters little because the guise under which Hockey has given $8.8 billion back to the RBA is problematic. He said the payment is to deal with possible “headwinds” coming from risks in the global economy. Hockey is therefore giving the RBA some cash just in case it ever needs it. A better approach would be to come to an open arrangement, which would be uncontroversial and cheaper, where the Commonwealth would guarantee to give the RBA whatever it needs if an urgent injection of cash is ever required. The government implicitly already does this it must be noted.

The RBA clearly needs some reserves. The seemingly modest level of reserves it has held since the global crisis has interestingly been more than enough to completely satisfy all of its requirements. Having an extra $8.8 billion in the vault will not achieve anything specific.

Another critical issue to consider is that the $8.8 billion would be chicken feed if those economic headwinds turned into the cyclone of grief due to some global economic event. As we have seen around the world in recent years, amounts of 50 per cent of GDP and more ($800 billion in Australia’s case) are commonplace when a bailout is needed.

Should the government borrow even more than the $8.8 billion to give to the RBA, just in case?

And does anyone, including Hockey, seriously doubt that the government would not ‘bail out’ the RBA in such dire circumstances? The government would obviously provide any amount to the RBA if ever there were a circumstance that required such action. This is whether the RBA contingency reserves were $2.5 billion, $8.8 billion or $20 billion.

A cynic might say that Hockey’s actions are politically motivated.

By throwing money at the RBA now and adding hugely to the budget deficit in 2013-14, perhaps Hockey is hoping or expecting that in a couple of years, the RBA will divest some of this excess cash and will pay a divided to the government. An extra few billion dollars in 2015-16 or 2016-17 would do wonders to lock in a budget surplus, just before the next election.

I doubt that is the case.

Either way, it is an unnecessary policy change that has an ongoing interest cost to the budget and it appears to be more of a solution looking for a problem.