When Rajan trashed the Economic Survey
The Economic Survey argued for RBI's reserves to be cut. The RBI governor came back with a stinging reply
 
“….RBI is an outlier with an equity share of about 32%, second only to Norway and well above that of the US Federal Reserve Bank and the Bank of England, whose ratios are less than 2%. The conservative European Central Bank (ECB) and some EM central banks have much higher ratios, but even they do not approach the level of the RBI. If the RBI were to move even to the median of the sample (16%), this would free up a substantial amount of capital to be deployed for recapitalizing the PSBs. Of course, there are wider considerations that need to be taken into account…”
 
 
In his customary post-monetary policy press meet on 5 April 2016, Reserve Bank of India (RBI) Governor Dr Raghuram Rajan made the following observation on the content of Box 1.6 of Economic Survey 2016:
 
“Whoever wrote that piece does not understand monetary policy and monetary balance sheets as well as they should. There is an equity position that the RBI has. Think of this as government assets in RBI. The government's liabilities are its debt. What is being suggested is that we actually monetise this amount. If we have X number of crores by which we can monetise our assets, if we give half of that to the government, the residual value of it is always spent on buying government bonds. What we are saying is, given those constraints, any money given extra to the government will reduce our ability to buying government bonds directly and will have absolutely no effect on the public sector borrowing requirements. The government will have to find some other place to sell its assets. It is not a free asset to be given. We are saying 'treat it as a government asset'. It's not going to impact your borrowing requirement.”
 
 
Long back, the Reserve Bank of India (RBI) had taken a conscious decision to augment its reserves (Contingency Reserves + Assets Development Reserves) to a level of 12% of the Bank’s balance sheet total. The Bank almost managed to almost touch this level in 2009. The following table indicates the progressive deterioration in the reserves position, since then:
 
Balances in Contingency Fund (CF) and Asset Development Fund (ADF) (Rs Crore)
 
 
RBI’s capital since inception has remained at Rs5 crore. There is no clarity about the components reckoned for computing the RBI’s capital and capital-like reserves at 32% of balance sheet total. The Survey obviously has depended on the computation of figures by some external agency (the graph given in the Survey is attributed to BIS) instead of quoting from RBI’s Annual Reports.
 
To meet the internal capital expenditure and make investments in its subsidiaries and associate institutions, the Reserve Bank had created a separate asset development reserve (ADR) in 1997-98 with the aim of reaching 1% of its total assets within the overall indicative target of 12% of the total assets set for CF and ADF taken together, accepted by the Bank earlier. 
 
Obviously, the practice of transferring the entire ‘surplus income’ to government when the reserves position of the central bank shows a continuous declining trend (as a percentage of total assets) in the context of the present growth rate of Bank’s asset size, needs a review. Considering the size of RBI’s balance sheet, and remembering that the Bank’s share capital (Rs5 crore) has not been augmented since inception, the reserve position needs to be raised to healthier levels. 
 
It is in this context and in view of the internal and external pressures on its income generating capabilities in recent times, as also the nature of shocks RBI has to absorb from time to time, the government should support the central bank to augment its reserves at least to the level of 12% of total assets, which was accepted by the central bank decades ago.
 
The accounts presented in the RBI Annual Report 2014-15 (Chapter XI-Introductory), shows that the balance sheet size of the Reserve Bank increased by 10.09% for the year ended June 2015 primarily due to increase in foreign currency assets on the asset side, which rose by 21.50% and increase in notes in circulation and deposits that rose by 9.57% and 37.60%, respectively on the liability side. 
 
While gross income for the year 2014-15 increased sharply by 22.66%, RBI’s total expenditure increased by 11.92%. The year ended with an overall surplus of Rs65,896 crore as against Rs52,679 crore in the previous year, representing an increase of 25.09%. The entire surplus has been passed on to central government. This is based on a review of reserves position made by an internal panel headed by one of the Reserve Bank’s directors YH Malegam, which concluded in 2014 that the level of reserves then available was adequate to meet the needs for the subsequent three years. 
 
RBI’s reserves
 
Contingency Reserve (now renamed Contingency Fund-CF) 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 (now asset development fund-ADF). From its income in 2014-15, RBI has transferred Rs1,000 crore to ADF to provide for further investment as capital in the National Housing Bank (NHB). Such need-based transfer, though necessary in the present scenario of depleting reserves, can cause future embarrassments to the central bank, as there will be pressure on quantum and timing of use of such ‘ear-marked’ contributions. 
The Annual Report says that based on the recommendations of the Technical Committee [Chairman: YH Malegam (Technical Committee II)] constituted during 2013-14 to review the Level and Adequacy of Internal Reserves and Surplus Distribution Policy of the RBI, the forward contracts entered into by the Bank as part of its intervention operations are being marked to market on yearly basis as on the balance sheet date from the year 2013-14 and, as against the earlier policy of ignoring gain and accounting for loss only, now both gain or loss are accounted for. This change in policy seals another source of accretion to Bank’s reserves.
 
To ensure that temptations of government emanating from internal and external compulsions, like the one quoted at the beginning of this article, do not dilute the strength of RBI’s balance sheet, the government should take measures to augment the share capital of RBI after carrying out appropriate amendments to 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 Bank has to absorb from time to time, the central bank’s reserves need to be augmented on an ongoing basis. 
 
Needless to say, any effort to divert the central bank’s capital funds should be abandoned as such action under ‘direction’ will affect the functional freedom of RBI to use various tools in the central bank’s kit independently in times of need.
 
(MG Warrier  is former General Manager, RBI, Mumbai and author of the 2014 book "Banking, Reforms & Corruption: Development Issues in 21st Century India")
Comments
Ramesh Poapt
6 years ago
Sir,
Govt has certainly decided to cut the wings(liberty) of RBI since long. the proposed committee will restrict the powers of RBI Guv. Whether it will be accepted by any Guv particularly Mr Rajan is a big question.His term expires this year.
Let us wish for our economy and autonomy of RBI!
MG Warrier
Replied to Ramesh Poapt comment 6 years ago
Let us not view such issues as ‘fight’ between GOI and RBI or something affecting the present incumbents at North Block(GOI-Finance Ministry) or Mint Road (RBI). Here, there are much broader issues affecting long term interests of India. Every citizen has a stake. This century has the advantage of faster communication facilities and therefore better facilities for sharing of thoughts. No government or institution can function ignoring ‘public interest’ for long. It is true that many were aware of the position about the content of Box 1.6 of Economic Survey(as articulated by Dr Rajan in the press briefing on April 5) , the moment the document went public during the last week of February 2016. But, slowly ‘wiser counsel’ will prevail!
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