The government is well within its rights to demand that `73,625 crore be transferred to general revenue as dividend instead of being transferred to the contingency reserves of the bank
By TV Mohandas Pai & Nisha Holla
The Reserve Bank of India just released its annual report for 2019-20, and its annual accounts. It makes for interesting reading. As usual, RBI has transferred its surplus of Rs 57,132 crore to the government as dividend. Last year, RBI transferred Rs 1.76 lakh crore, inclusive of the surplus written back, of Rs 52,618 crore.
This year’s transfer is post a transfer of Rs 73,615 crore to the contingency reserves. On a comparable basis, the surplus without the write-back from reserves in 2018-19 was Rs 1.23 lakh crore, against Rs 1.31 lakh crore in 2019-20 before transfer to reserves. This means the transfer to the government, in the midst of an unprecedented economic fallout, has actually come down this year due to a large transfer to the contingency reserves despite increasing surpluses.
The matter of whether RBI must carry such significant reserves has been previously discussed by the Bimal Jalan Committee (BJC), which made recommendations about the treatment of RBI surpluses. It suggested a contingency reserve of 5.5-6.5% of the balance sheet and economic reserves of 20.8-25.4% which includes the revaluation reserve on RBI’s holding of gold, foreign currency, foreign securities and Indian government securities. As of June 30, 2020, RBI carried a total revaluation reserve of Rs 11.25 lakh crore, of which Rs 9.77 lakh crore stemmed from its gold and foreign currency holdings, Rs 53,800 crore from foreign securities and Rs 93,400 crore from rupee securities. Besides, the contingency reserves are a whopping Rs 2.64 lakh crore. The total reserves consisting of all four holdings was Rs 13.89 lakh crore, on an entire asset base of Rs 53.34 lakh crore—a whopping 26% of the balance sheet!
The question now is should RBI carry such high reserves—26% of the balance sheet—including cash reserves of Rs 2.64 lakh crore, which amounts to nearly 5% of total assets, marked to market?
The surprising issue to note is that RBI calculates its contingency reserves on the market value of its foreign currency, gold, foreign securities and Indian securities assets. It maintains that these assets have a price- and market-risk, and consequently, there is a need for vast reserves. The critical issue is whether the contingency reserves should be based on the market value of assets, where the revaluation surplus is not distributed but held as a reserve in the balance sheet?
The total carried value of the foreign currency, gold, foreign and Indian securities on RBI’s balance sheet is Rs 49.73 lakh crore, with the residue-assets being Rs 3.61 lakh crore, amounting to total assets of Rs 53.34 lakh crore! Netting off the total revaluation reserves of Rs 11.25 lakh crore assets means the cost of these assets is Rs 38.48 lakh crore. Market- or price-risks due to price fluctuations are always calculated on asset costs, net of the revaluation reserve. If the gold price were to fall or the rupee to appreciate, or GoI bonds were to decline in value, the reduction in value will be first set off against the revaluation reserves, and only after that will the need for a contingency reserve apply. The revaluation reserve is at 22.6% of these assets, an extremely high figure. It is inconceivable that the Indian rupee will appreciate by 20%+ (RBI had $465 billion worth of foreign currency carried at Rs 76.23 as against a cost of around Rs 60) or that gold will decline by 25% or that government bond yields will appreciate by 20%+ to wipe out the revaluation reserves first and impact the cost of these assets.
Taking these factors into consideration, the appropriate thing to do is calculate the contingency reserve on the cost of these assets, which are prone to market- or price-risks, rather than on the market value. If calculated on the cost of Rs 38.48 lakh crore, the contingency reserve of Rs 2.64 lakh crore, including the current year’s transfer of Rs 73,615 crore, will be at 6.87% of the cost of these assets. Along with the contingency reserve, RBI has a total economic reserve of 26% of total assets, an incredibly high amount, due to which it ranks amongst the largest of such reserves of all central banks globally.
It is evident that RBI is exceptionally conservative, and transferring more profits than necessary to cash reserves. If the surplus of Rs 73,615 crore were to be transferred to the government, the sovereign and lawful owner of RBI, it will help India at a time of extreme financial stress due to the economic fallout of Covid 19. The cash-reserves without the current transfer will then be nearly 5% of the cost of these assets—more than adequate to meet any risks. BJC too did not consider this aspect of having a contingency reserve on the cost of assets, net of revaluation reserves, and took the market value of assets for this purpose.
This methodology leads to an unusual situation where if gold, foreign currency and foreign security prices were to appreciate or the rupee depreciate further, then RBI will be forced to transfer more from its profits to contingency reserves because of this conceptual issue of basing the contingency reserves on market value rather than on cost, while the revaluation reserves are increasing commensurately.
India is today facing a financial crisis of unprecedented magnitude, a ‘once in a 100 years’ crisis. It speaks very poorly of RBI that it feels the need to transfer such high amounts to an already well-padded contingency reserve, instead of transferring it to the government. This massive transfer to reserves is unnecessary at this time, and insensitive to the needs of Indian citizens. The government is well within its rights to demand that the Rs 73,625 crore be instead transferred to general revenue as dividend. The BJC also said that RBI carries an extraordinarily high amount of reserves to meet the rarest-of-rare cases of crisis. Today’s unprecedented global pandemic certainly qualifies.
RBI is wholly-owned by the sovereign Government of India, a creation of Parliament and thus an agent of the government. Its status can never be higher than India in the global financial markets even though some mistakenly believe it should. It is autonomous under the law for purposes of monetary policy, it earns its revenues from its operations as an agent of GoI, and must, therefore, hand over its surpluses after adequate—but not excessive—provisions. The citizens of this democratic country are owed this support from their central banker.
Pai is chairman, Aarin Capital Partners, & Holla is Technology Fellow, C-CAMP