RBI’s excess reserve: What happens if it’s given to govt?

For any calculation of RBI’s excess reserve, the key items of interest on the liability side are the contingency fund (a specific provision meant for meeting unexpected and unforeseen contingencies including depreciation in value of securities, risks arising out of monetary and exchange NSE 0.00 % rate operations as well as systemic risks), asset development fund (provision specifically made to make investments in subsidiaries and associate institutions and meet internal capital expenditure), currency and gold revaluation, and investment revaluation accounts for foreign and rupee securities. RBI’s total reserve currently is at around Rs 9.5 lakh crore.

In 2018, revaluation and contingency accounts was around 26 per cent of total assets. The Economic Survey of 2015-16 had indicated that shareholder equity (capital plus reserves plus revaluation and contingency accounts) to assets was at a median of 16 per cent for major central banks. However, revaluation accounts are not reserves, but are an account of unrealised gains/losses.

RBI’s asset side is dominated by investments in rupee and foreign assets have a 90 per cent share along with gold investments. Foreign investments are a reflection of foreign exchange reserves, while domestic investments reflect RBI’s holding of government securities as a result of various liquidity operations and investments.

The issue of excess reserve is subjective with varying opinions on the optimum level and degree of conservatism of the central bank. The two sides of the argument are that RBI needs to be conservative with a strong enough balance sheet to withstand any adverse events while on the other hand the argument would be that a central bank can always print money to provide support in an adverse situation and, hence, does not need to hold excess reserves.

Within reserves, there are two points of debate; whether RBI should make any further provision to the contingency fund and pass on the entire surplus to the government and whether it should reduce its current reserves for the excess provision of the past.

The yearly transfer is easier to comprehend where RBI could transfer the entire year’s profit to the government without additional provisions made in the financial year. However, the existing reserve issue is more challenging.

Reducing reserves would imply a reduction on the asset side whether through reduction in RBI’s investment in sovereign debt or reduction in foreign currency assets or any commensurate increase in notes issued without reducing the balance sheet size or any commensurate increase in government deposit without reducing the balance sheet size.

Clarity will be required whether such a move is equivalent to direct monetisation of sovereign debt/fiscal deficit. It is quite uncertain how the existing reserves issue will pan out, but an impact on the markets seems to be a probable scenario in case if such a situation turns adverse.

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