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Financing budget expenditure through RBI surplus is novel financial engineering

Madan Sabnavis
RBI has a balance sheet size of Rs 36.3 lakh crore.

The focus of attention is once again on the Jalan Committee as it is to be seen how much money can possibly be transferred to the government and the modalities of the same. This addresses the issue of utilisation of RBI’s excess reserves, which have not been touched so far on the balance sheet side though surpluses generated on account of income and expenditure are transferred almost fully to the government. The other issue is how balance sheet entries will be drawn up to accommodate such drawls.

RBI has a balance sheet size of Rs 36.3 lakh crore. The liabilities include a large part of issued currency, which, as of June 2018, was Rs 19.2 lakh crore. Another part, of around Rs 6.5 lakh crore, is deposits kept with RBI, of which Rs 5 lakh crore is under CRR stipulation. These two components are tangible. The 'other liabilities' constitute the second largest part of the balance sheet at Rs 10.4 lakh crore, and is the Committee’s target.

Within this category, there are four significant components: contingency fund (Rs 2.3 lakh crore), asset development fund (Rs 0.22 lakh crore), investment revaluation (Rs 0.13 lakh crore), and currency and gold revaluation reserve (Rs 6.91 lakh crore). It looks likely that the contingency fund and currency revaluation funds will be the ones targeted for transfer to the government.

The contingency fund has remained virtually unchanged in the last five years at Rs 2.2-2.3 lakh crore and is supposed to be used in case of revaluation of securities held by RBI. With yields coming down, the value of securities would go up and so would these funds, becoming one potential source of funds. The other is currency revaluation-quite high at Rs 6.91 lakh crore. If the rupee declines, the fixed set of dollars would be valued higher in rupee terms on the assets side, increasing the reserves on the liabilities side. However, if the rupee appreciates, as is the case today, the reverse would occur and the rupee value of reserves will come down.

Hence, one is really looking at these Rs 10 lakh crore of reserves, a part of which can be potentially monetised by RBI and passed on to the government. Since this is legally permitted, there can be no questions in this regard. Some of the questions that the Committee will address are the following.

First, what is the quantum of reserves that can be monetised and drawn out of the balance sheet? Is the contingency fund adequate or too high. However, if we go back another five years, a level of Rs 1.5 lakh crore was also witnessed in 2009. Therefore, depending on how far back the Committee looks, there is still potential to draw down this reserve on the grounds that one could manage with a lower amount, as there has not been an instance when the level dipped sharply. Prima facie, keeping a limit of Rs 2 lakh crore could be a safe level that releases RS 0.3 lakh crore.

The currency revaluation reserve has been more volatile-Rs 5.3-6.9 lakh crore in the last five years, with the lower end being reached in 2017 and a low of Rs 1.2 lakh crore in 2010. Here, the Committee can think of lowering the reserves by a considerable amount-by, say, around Rs 1.5-2 lakh crore-and keeping 15 lakh crore as the floor. Overall, around Rs 2-2.2 lakh crore can be drawn from these two reserves.

The second question which follows is that if reserves were to be lowered, how would adjustment be made to the assets side of the balance sheet? If the liabilities get reduced by, say, Rs 2 lakh crore, the assets, too, should be lowered. This will be interesting, because if the currency revaluation reserve is reduced, it means that some part of the forex should drop out of the system. RBI has been buying forex from banks to supply liquidity and, hence, any drawdown of forex will mean selling the same to banks, which will create a liquidity problem. Therefore, it is more likely that the dollars have to be kept in a separate suspense account to balance the accounts. Even if the contingency reserve is reduced, it could mean lowering the stock of GSecs (through OMOs), which will impact liquidity in the system as well as GSec yields. This, too, may have to be held in a different account, much like the MSS bonds. The Committee's call on this aspect is something that will be awaited.

The third question is whether the transfer will be done in one stroke or over a period of time. The indication is that it will be done over a period of three to five years, which, being more manageable, has the advantage of reducing market volatility. A one-shot transfer can mean a major shock for the financial market because if RS 2 lakh crore is taken out from, say, the currency revaluation account, the shock for the forex market can be a matter of conjecture. Alternatively, if the contingency fund is being lowered, a call has to be taken on RBI’s GSec holdings, which can create disturbances in bond yields. This is something RBI has to consider finally.

Fourth, would the transfer of funds would be conditional or not? Economists would argue that if the RBI reserves are used for financing the budget and are treated as a revenue/capital receipt, depending on how the Committee sees it, it would resemble the disinvestment receipts that are used for general expenses. On the other hand, if they are earmarked for, say, bank capitalisation or specific infra projects, it would be targeted and easier to accept. Unlike disinvestment, which can spread over decades as the government can potentially sell stake in various entities, in this case, it would be almost limited by the target amount decided by the Committee. This is so because the recent experience has been that all RBI annual surpluses are transferred to the government as non-tax revenue. Hence, scope of these reserves increasing may be limited. This will subsume the concept of a macro norm being applied on the desirability of reserves and surpluses in relation to the balance sheet size, which can be 15% or 20%.

Using RBI surplus reserves for financing the budget expenditure is definitely novel-more akin to recap bonds that finances expenses through a different financial engineering. With fiscal pressures mounting, it is natural that new sources of finance are explored as traction in tax revenue is always uncertain. Sale of assets, like land or property, can be the next frontier, and the Railways could open up space for discussion.

The author is Chief Economist, CARE Ratings. Views are personal