To ensure that temptations of the government emanating from external compulsions do not to dilute the strength of RBI’s balance sheet, the government should take measures to augment the share capital of the RBI after amending the RBI Act

The building up of the contingency reserve is particularly important as the government is in no position to pick up the losses once the contingency reserve is wiped out. One of the saddest events that can occur is the death of a central bank. This has happened in some countries and the RBI can never be too careful.—S S Tarapore, former deputy governor, RBI and economist.

The Reserve Bank of India (RBI) has published its Annual Report 2011-12 on 23 August 2012. The accounts presented in the report shows that RBI’s income increased during 2011-12 by about 43% as compared to the previous year (from Rs37,070 crore to Rs53,176 crore). Transfer of surplus profit to the Government of India (GOI) was Rs16,010 crore which as percentage to gross income is lower by around 10.4% as compared to 2010-11. Obviously, the transfer of “surplus income” to the government in a routine manner when the reserves position of the central bank shows a declining trend needs a review. Considering the size of RBI’s balance sheet, recouping the reserves position to healthier levels will be a Herculean task.

Considering the size of its balance sheet and the internal and external pressures on its income generating capabilities, as also the nature of shocks RBI has to absorb from time to time, GOI should support the central bank’s efforts to augment its reserves at least on par with the 12% norm of capital adequacy RBI expects from banks it supervises.

RBI, on its part, should think in terms of generating reasonable income from deployment of captive funds it is mandated to manage, without any compromise on safety of investments. In this context, the addition of about 200 tonnes to holdings in gold three years back was a welcome move. The central bank should further augment the gold component in reserves by tapping domestic gold stock with policy and legislative support from GOI.

Earnings from Foreign Sources

 The RBI’s rate of earnings on Foreign Currency Assets and gold was lower at 1.47% in 2011- 12 compared with 1.74% in 2010-11. The report attributes this to the low interest rates prevalent in international markets. The following table gives the details.

It is a fact that our Forex Reserves Management has not been getting the attention it deserved, as RBI’s own priorities hovered more around internal debt management and monetary policy concerns. It is comforting to see that RBI governor Dr D Subbarao is focusing on the components of forex reserves and their vulnerabilities. The return on forex investments has not been encouraging and one gets an impression that there has been some complacency in augmenting the reserves position, resulting in the reserves stagnating around $300 billion for quite some time now. On the part of GOI/RBI, it was a late decision in the last quarter of 2009 to increase the gold component in the country’s forex reserves by about 200 tonnes, by a purchase from the International Monetary Fund. In the context of improving the country's image as one with a decent net-worth, it is important to manage the domestic gold holdings outside the forex portfolio also and make them visible and available as part of the nation’s resources. Let us not forget the 1991 episode when solid gold had to be carried abroad for pledging and borrowing. Such shameful experiences can be avoided in future, if a part of domestic stock of the estimated 18,000 tonnes of gold is made tradable and a decent domestic stock of standard gold acceptable in international market is built up.

RBI’s internal reserves

Contingency Reserve (CR) represents the amount set aside on a year-to-year basis for meeting unexpected and unforeseen contingencies, including depreciation in the value of securities, exchange guarantees and risks arising out of monetary/exchange rate policy operations. In order to meet the needs of internal capital expenditure and make investments in subsidiaries and associate institutions, a further sum is provided and credited to the Asset Development Reserve (ADR). The amount of transfer to the CR and the ADR and the surplus transferred to the government as a percentage of the total income in the last five years is set out in the table below:

The report recalls that “to meet the internal capital expenditure and make investments in its subsidiaries and associate institutions, the RBI had created a separate ADR in 1997-98 with the aim of reaching 1% of the central bank’s total assets within the overall indicative target of 12% of the total assets set for CR and ADR taken together”. But despite a transfer of Rs2,348 crore in 2011-12, from income to ADR raising its level to Rs18,214 crore as on 30 June 2012, the CR and the ADR together constituted only 9.7% of the total assets of the RBI as on 30 June 2012 showing a fall of 0.6% from the level of 10.3% during the previous year, taking the original target of 12% further away. It may be recalled that in 2009 the target was almost in sight when the level reached 11.9%. The ADR now accounts for 0.8% of the total assets of the RBI as against the target of 1%.
 

The position of CR and ADR during the last five years was asunder:
To ensure that temptations of the government emanating from external compulsions do not to dilute the strength of RBI’s balance sheet, the GOI should take measures to augment the share capital of RBI after carrying out appropriate amendments to the RBI Act. Till such time RBI should be allowed to retain surplus income by transfer to reserves. Considering the size of its balance sheet and the internal and external pressures on its income-generating capabilities, as also the nature of shocks the apex bank has to absorb from time to time, the central bank’s reserves need to be augmented on an ongoing basis.

 (The writer is a former general manager, Reserve Bank of India.)