A matter of reserves! How RBI can help India come out of Covid crisis

RBI should transfer 618 tons of gold at cost to the govt and repurchase it at 90% of market value, amounting to Rs 2.33 lakh crore transferred to the govt account.

Taxpaying capacity of India's narrow taxpaying base is decimated.
Taxpaying capacity of India's narrow taxpaying base is decimated.

By TV MOhandas Pai & Nisha Holla

India is facing a once-in-a-lifetime crisis due to the COVID-pandemic and the resultant economic fallout. A more substantial quantum of government aid is required to provide both health and financial relief to many groups and restart India’s $3 trillion economy. The combined fiscal deficit of the central and state governments could rise to 11-13%, while revenues may fall by 30-35% of FY20. Taxpaying capacity of India’s narrow taxpaying base is decimated. It is imperative to look to other sources for relief funding.

RBI is the central bank, and banker to the sovereign government of India. Under law, the RBI has multiple functions—managing monetary policy and government debt, regulating banks, issuing and managing currency, and holding India’s foreign-currency reserves. These functions provide a significant source of revenue, of which the surplus is passed on to its lawful owner annually. For the last few years, there has been much debate about the considerable reserves RBI holds via three primary sources—annual surplus, the gain in value from holding foreign currency reserves and appreciation of gold reserves.

RBI has managed India’s finances exceptionally well, which is evident in the significant amount of reserves it has amassed. While we wait for RBI’s latest balance sheet as of June 30, 2020, last year’s balance sheet of June 30, 2019, gives us a firm idea of the reserves:

  • Foreign currency reserves: $400 billion, valued at Rs 27.6 lakh crore, marked to market
  • Unrealised gains from foreign currency reserves: Rs 5.17 lakh crore, marked to market at Rs 69 per dollar as against a book value of Rs 56 per dollar
  • Gold reserves: $24.3 billion, 618 tons at Rs 1.67 lakh crore at 90% of market value, with an estimated cost of Rs 20,000 crore
  • Unrealised gains from gold reserves: Rs 1.47 lakh crore
  • Total unrealised gain: Rs 6.64 lakh crore
    Contingency fund: Rs 1.96 lakh crore, allocated from undistributed profits
  • Total reserves: Rs 8.6 lakh crore

RBI’s balance sheet size is Rs 41 lakh crore (as of 30/6/2019); total reserves of Rs 8.6 lakh crore amounts to 21% of assets. This is an extraordinarily large share of total assets, and a portion can be now mobilised to provide relief to India and accelerate the economy.

RBI needs some quantum of reserves for managing currency risks and price risk of gold, and to react to external and internal shocks to the currency and country. What then is the optimum level of reserves required to manage these risks? The Rupee won’t appreciate by Rs 10-15 against the dollar permanently (history shows large fluctuations are temporary) or the gold price won’t collapse by 50%, and so the massive Rs 8.6 lakh crore reserves need to be examined. The Bimal Jalan Committee (BJC) had studied the same last year.

BJC was set up by RBI as an independent committee when the government raised concerns about excess reserves and ultra-conservative risk-management practices. The BJC researched the practices of 53 other central banks (CB), apart from RBI’s, and concluded the following:

  • Some CBs pass on such currency and asset reserves to the sovereign while others treat unrealised valuation gains as reserves.
  • Among the CBs, RBI stands fifth with economic reserves of 26% of its 2018 balance sheet, which include realised and unrealised gains
  • RBI had seen currency appreciation of 17% to 19.5% over periods of 9-16 months between 2006-2014. BJC suggested 20% appreciation of the Rupee as the worst-case scenario.
  • BJC recommended that RBI follow the Expected Shortfall Method to manage reserves, based on risk modelling of expected extreme scenarios.
  • The Contingency Risk buffer (the country’s savings for a rainy day) can be maintained at 5.5%- 6.5% of the balance sheet.
  • It suggested that RBI keep an economic reserve between 20.8-25.4% of the balance sheet. It also said there should be no transfer of unrealised revaluation reserves. It observed that unrealised revaluation reserves were now at 73% of RBI economic reserves in FY18 as against 37.9% in 1997, obviously because of the significantly larger foreign currency reserves.
  • It modelled the growth of the balance sheet for the next few years to look at future economic reserves. The study demonstrated that RBI was extremely conservative in its risk and accounting policies.

The study found excess capital over the reserve requirements to manage risk. Per the recommendations of the BJC, RBI transferred Rs 52,637 crore of excess provisions as part of the Rs 1.76 lakh crore surpluses for the year. This sets a precedent for transferring surplus reserves, even in normal economic conditions. Today’s conditions are not.

The balance sheet of June 30, 2020, will show RBI’s economic reserves have grown more robust, as the weekly statements indicate:

  • RBI’s assets size increased to Rs 53.2 lakh crore as of June 26, 2020, an increase of nearly 30% from June 30, 2019. This is more than the BJC had projected and amounts to 26% of India’s GDP
  • Foreign currency holding has increased by $75 billion to a total of $475 billion or Rs 35.7 lakh crore due to the rupee depreciation from Rs 69 to Rs 75 per dollar in one year since June 30, 2019. This alone has added Rs 2.4 lakh crore to foreign currency reserves held on June 30, 2019, not taking into account revaluation gains on the additions during the year
  • Gold prices have appreciated massively, leading to an increase of Rs 86,000 crore in unrealised gains without any known physical additions

Just in foreign-currency unrealised gains of Rs 7.57 lakh crore, gold unrealised gains of Rs 2.34 lakh crore, added to the contingency fund of Rs 1.96 lakh crore, RBI’s economic reserves will be a minimum of Rs 11.87 lakh crore. This is without current year additions—and that too will add further.

Extraordinary circumstances call for commensurate measures
RBI can mobilise part of its reserves to provide relief to India and the sovereign. It is suggested RBI transfer the 618 tons of gold at cost to the government and repurchase it at 90% of market value, amounting to Rs 2.33 lakh crore transferred to the government account. This is in addition to its regular dividend this year. There is a precedent here, as RBI had previously transferred its holding in SBI, NHB and NABARD at book value to the government when the market value was higher. Transferring unrealised gains will be against the BJC recommendations. However, the BJC also concluded that RBI needs large reserves for the rarest of rare situations, which the COVID-pandemic has undoubtedly proven to be.

RBI has just completed its financial year, and has to plan its annual government transfers. The suggested Rs 2.33 lakh crore transfer will be a cashless credit to the government account, to be monetised. The benefit to the government is that its fiscal deficit will decrease to the same extent, negating the need to borrow this amount. RBI is no worse off, as the intention was never to sell the gold, only maintain the necessary reserves. Even after the transfer, RBI will have more than adequate reserves to manage risks. This `2.33 lakh crore transfer will benefit the economy and its citizens, who need their government and central bank to take care of their lives and livelihood in these trying times. With this, RBI can execute its duty to its owner and country and fully stand behind the government’s valiant efforts to keep the country afloat in these extraordinary times we live in today.

Pai is chairman, Aarin Capital Partners, and Holla is technology fellow, C-CAMP

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