The Bimal Jalan committee submitted the much anticipated report on determining RBI’s surplus reserves late last month. While the report did help RBI transfer some surplus to the government, there is still lot of money left with RBI. So, what are the recommendations of the committee and how does RBI’s balance sheet look like. Here is a brief look at the same.
The Bimal Jalan committee, formed late last year, was tasked to review the existing economic capital framework (ECF) of RBI. While economic capital sounds fancy, in simple terms, it is nothing but the equity capital available with RBI. ECF refers to the policy determining how much equity capital it maintains and how much it transfers to the government. This could be loosely compared to the policy in case of any listed company, where management is expected to maintain equity capital required to run the company and transfer excess as dividend to the shareholders.
Before looking at the surplus, it is imperative to look at various component of RBI’s balance sheet. The major elements are ‘notes in circulation’ at Rs 21.7 lakh crore at the end of June’19, deposits of Rs 7.6 lakh crore and other liabilities & provisions of Rs 11.6 lakh crore. Provisions would be close to Rs 10.7 lakh crore within the third component. (These are FY19 figures although the report uses FY18 figures in its report). This, essentially, is the surplus and subject of deliberation on how much of this is required to manage risks faced by RBI.
Provision consists of Rs 2.3 lakh crore of contingency risk buffer (CRB) and Rs 6.6 lakh crore of revaluation reserves. CRB is profit retained by RBI over the years whereas revaluation reserve is ‘unrealized’ equity. It may be noted that RBI generates significant amount of income even though its expenses are quite low. For instance, during FY19, it earned a total income of Rs 1.9 lakh crore against expenditure of Rs 17,000 crore only. (However, FY19 was an exceptional year due to forex accounting changes and its income is generally half of this). This excess of income over expenditure, after transferring a part of it to the government as dividend, adds to its balance-sheet. CRB needs to be maintained to address any financial stability risk which refers to the risk of a bank failure. RBI needs to have sufficient reserves as it may have to pump-in the money as lender of last resort.
The second component, the revaluation reserve, refers to excess of current price over purchase price of foreign currency and gold held by RBI. For instance, assume RBI had bought 100 ton of gold when the prices was Rs 20,000 per 10 gram. At the current rate, this would be valued at close to Rs 40 crore against purchase price of Rs 20 crore. However, since it is not sold by RBI, it remains as ‘unrealized’ gain on the balance sheet. The same applies to its foreign currency reserves where it may have brought some part of the reserve even at Rs 40 per dollar and imply unrealized gain of as much as Rs 30 per dollar. Even though some part of its reserves may be held in the form of other currencies, rupee is largely depreciating because of higher inflation rate against all the major economies. (Considering the total size of revaluation reserves, average purchase price of dollar could be close to Rs 50).
This brings us to the report of the Committee. The two major recommendation of the committee is to main CRB in the range of 5.5-6.5% of its balance sheet and keep revaluation reserve as it is. Based on FY19 balance sheet, CRB would correspond to Rs 2.3-2.7 lakh crore. Since RBI was maintaining higher surplus than the lower end figure, it has transferred the excess to the government.
While the committee’s conservative approach to not touch the revaluation reserves may have its merit, a critical examination of the issue may be in order. The biggest risk that revaluation reserve is required to face is risk of flight of foreign capital. Assuming such a scenario does occur, RBI would have to sell huge amount of dollars to keep the market running. Since the rupee would depreciate in such a case, it would receive more from selling the dollar than what it would have paid for purchasing it. As a result, flight of capital would not dent the revaluation reserve. While this would reduce its total dollar reserve, that is a different risk not addressable by revaluation reserve. The revaluation reserve would decline only if the price of dollar falls which would happen if there is excess supply of dollars. This would signify strengthening economy which is not a risk. A figure buttressing this point is the fact that revaluation reserves accounted for only 38% of RBI’s economic capital in 1997-98 against as much as 73% in FY18. Releasing even 13% and bringing it down revaluation reserves down to 60% would free up over Rs 3 lakh crore from its surplus.
Even CRB should be bench-marked against the total balance sheet size of banking sector, which it intends to protect. While report does make indirect reference to that, the bench-marking should explicitly link CRB to the total balance sheet of the banking sector rather than to that of RBI.