Advantages of enlarging the balance-sheet of RBI

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September 7, 2020 5:15 AM

The advantage for the government when there is RBI intervention is two-fold. First, there is direct absorption of the debt by RBI, which won’t affect the market as the supply of paper remains unchanged. Therefore, there is no shock when such a transaction is undertaken. Second, there is a circular movement of money. Suppose RBI lends Rs 1 lakh crore to the government (the Centre or states) at, say, 6% per annum.

The RBI balance-sheet shows an increase of around Rs 12.3 lakh crore in the overall assets/liabilities in 2019-20.

RBI’s balance-sheet was at the centre of a debate last year as the Bimal Jalan Committee had opined on how much of the reserves could be transferred to the government. This luxury was not available in 2019-20, and the lower transfer of surpluses, of around Rs 57,000 crore, was not really a surprise. It would be a concern for the government as the non-tax revenue from the financial sector, including RBI, was to be around Rs 89,000 crore, and it is hard to see the balance being made up by the PSUs. One school of thought argues for expanding the balance-sheet of RBI, as was done in the West to support the economy in these times.

The RBI balance-sheet shows an increase of around Rs 12.3 lakh crore in the overall assets/liabilities in 2019-20. The asset-size of Rs 53.3 lakh crore has been interpreted as reflective of an expansionary central bank as growth in the balance-sheet size has been around 30% this year. But this may not be quite out of sync with other central banks. The central-bank-assets–GDP ratio is a measure of how much support is being provided by this institution to the economy as a larger balance-sheet means there is more money being put into the system—which is what the Fed, ECB and Bank of Japan have been doing under the various QE programmes.

This ratio of asset-size to GDP was around 25% for RBI. Compared with those of other central banks, it was quite modest (32% for the Federal Reserve, 37% for Bank of England and 40% for the ECB). For Bank of Japan, it was 123%. A higher ratio is indicative of the quantum of QE done by the central bank relative to the size of the GDP. The Japanese numbers, though, underline the limited effectiveness of the same as Japan’s economic growth has been low. Nonetheless, in our context, it can be argued by some that there is scope for further expansion of the balance-sheet, and RBI can go in for further monetary easing. Maybe, the idea of RBI monetising the fiscal deficit has its genesis here.

It is necessary to examine how this increase of ~Rs 12 lakh crore has come about. On the liability side, the increase in currency is around Rs 4.7 lakh crore; this happens exogenously, beyond RBI’s control. The lockdown made households hold currency, still the preferred choice for savings. In a way, this counters the demonetisation-logic, as currency is the safest asset in times of crisis.

Re-valuation of currency and gold accounts for an increase of Rs 3.5 lakh crore. Here, too, RBI is a passive player because as forex flows increase, adding to reserves, valuation can happen in either direction. The rupee had depreciated, and the price of gold shot up.

The third component is an increase in deposits by Rs 4.1 lakh crore, and the main element is reverse repo operations. The fact that there is surplus liquidity in the system on a continuous basis means that RBI has this window open which brings in deposits. Here, too, there would be exogenous flows, depending on how banks choose to use their surplus funds, especially when they are credit-averse.

The assets side shows how this increase is accounted for: investment in forex bonds/assets was as high as Rs 7.6 lakh crore, which, in effect, is the incremental reserves invested in foreign treasuries and bonds. As forex reserves increase, RBI must perforce invest them in safe assets, i.e., other central bank bonds. The accretion in reserves is more due to what happens on the balance-of-payments front.

Another Rs 1.8 lakh crore was investment in domestic securities, which RBI picks up through various liquidity management operations like OMOs; Rs 2.9 lakh crore came as advances to banks, the result of the repo operations. Here, the LTRO and TLTRO operations have injected substantial liquidity into the system. Given almost the entire amount is in longer tenures of 1-3 years, this component would remain on the balance sheet for a long period. The last component would reflect the additional support being provided by RBI to the system.

Therefore, the RBI balance-sheet expansion has been largely due to autonomous factors, with only a small part coming from monetary expansion measures. There is scope for further expansion here, where RBI can induce more liquidity, which is what is being spoken about. Ideally, any such expansion where the commercial sector benefits would be growth-positive; if used for lending to the government (something being spoken of in the light of the GST imbroglio), it won’t have the same intensity.

The advantage for the government when there is RBI intervention is two-fold. First, there is direct absorption of the debt by RBI, which won’t affect the market as the supply of paper remains unchanged. Therefore, there is no shock when such a transaction is undertaken. Second, there is a circular movement of money. Suppose RBI lends Rs 1 lakh crore to the government (the Centre or states) at, say, 6% per annum.

The interest paid will be Rs 6,000 crore, which, ceteris paribus, will add to the surplus of RBI which gets transferred back to the Centre. Hence, in a way, it would be free funds for the government in case the Centre is involved. If it is the states, the transfer will be from states to the Centre. In case, it is a market borrowing, the interest would be paid to banks and FIs. Hence, with the decision to transfer 100% of the central bank surpluses to the government taken already—for crises as prevalent today, where borrowing from the market can distort the market—enlarging the balance-sheet of RBI with direct involvement of the government has certain advantages that can be leveraged.

The author is a chief economist, CARE Ratings. Views are personal

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