Transfer of excess RBI capital to the fisc will not impact liquidity/RBI open market operations (OMO) if it is deployed to recapitalise banks
Media reports suggest that the expert committee, chaired by ex-RBI governor Bimal Jalan, to examine the RBI’s economic capital framework, will submit its report soon. How much will the Jalan committee identify as excess RBI capital? Contingency reserves would release Rs 1,282 bn if halved to 3.25% of RBI book from 6.5% now. This is still 50+% higher than BRICs’ (ex India) average. A 4.5% yield hike cover releases Rs 1,160 bn. It is estimated that the reserves would also release Rs 1,170 bn if restricted to cover a yield rise of, say, 4.5%, from about 9% now.
Revaluation Reserves: Rs 300-1,800 bn
Limiting the appreciation cover in RBI’s currency and gold revaluation account (CGRA) to 25% (i.e, Rs 52/USD) would release Rs 357 bn to the fisc. The current CGRA balance is about Rs 7,300 bn and covers Rs 18.2/USD to a level of Rs 51.15/USD, i.e, a 26.3% appreciation. A 20% appreciation cover releases Rs 1,744 bn. Limiting the appreciation cover to 20% (i.e, Rs 55.5/USD) would release about Rs 1,744 bn to the fisc from the CGRA.
Overall cap: Rs 2,000 bn
Capping reserves at 20% of RBI book (25.5% now) above the 2004 Thorat group’s 18% and Economic Survey’s 16%, releases Rs 1,959 bn. Can RBI really transfer reserves to the fisc beyond its annual surplus? The 1934 RBI Act places no bar as long as the ministry of finance maintains `5 crore/$0.7 mn of reserve funds under Section 46. While Section 47 enjoins RBI to credit its annual surplus to the fisc, after provisions, it does not place any restriction on further transfers.
Excess RBI capital OMO neutral if it recaps banks
RBI’s surplus capital held in, say, contingency reserves in net non-monetary liabilities (NNML) (net worth) is transferred to government deposits with it. The government draws this down to inject capital into PSU banks. PSU banks invest the monies received from recapitalisation in a government account that is parked with RBI. The entire transaction set is liquidity neutral. In the government balance sheet, the ministry of finance draws down its balances with RBI to infuse capital into banks. Banks, in turn, put these monies back in a government scheme that is held at RBI. The entire transaction set is fiscal deficit neutral. Finally, in the bank balance sheet, the bank invests the capital infused in a government scheme. This still relaxes its credit constraint by 10x at 9% CRAR. This should help to ease lending rates.
Edited excerpts from BofAML’s India Economic Watch (April 22)