The annual report of the Reserve Bank of India for financial year 2011-12 was recently published and is available in the public domain for analysis. Central Bank balance sheets have been under enormous scrutiny since the commencement of the global slow-down in 2008, ever since massive accommodation by governments meant the transfer of systemic risk from the financial sector to the government sector. This is not surprising given that data available in the annual reports reflect in varying degrees, the extent of monetary expansion undertaken, the severity of domestic liquidity constraints and scale of central bank accommodation provided to the government sector.
Significant uptick in acquisition of domestic securities
As at June 30, 2012, cumulative assets on the RBI balance sheet aggregated INR 22 trillion – at current market prices this is nearly25% of India’s estimated GDP, while at factor cost it amounts to 42% for financial year 2011-12. Total balance sheet expansion during the financial year was of the order of INR 4 trillion- driven by two broad themes.
First, “demand-driven” factors have resulted in an increase in currency circulation of INR 1.4 trillion (14% increase YOY). In the seven years to June 2012, money in circulation has nearly trebled, pointing to the degree of monetary expansion undertaken. The offset to monetary expansion is visible on the RBI balance sheet where holdings of Government of India (GOI) securities have expanded over INR 1.9 trillion during 2011-12.
Obviously, part of this expansion reflects holding gains, given benchmark yield rates have edged lower during 2011-12. The RBI is estimated to have bought net securities to the tune of INR 1.3 trillion during 2011-12, nearly doubling its open market purchases over the previous year. Since June 2008, the RBI has been a net buyer of GOI securities every year.
The resultant increase in money supply in the economy has no doubt provided liquidity support in a market constrained by “crowding out” effects due to expanding government borrowing (central government public debt increased at a CAGR of 14% in the four years to June 2012). More recently, the scale of liquidity injection through open market operations have been necessitated by the need to restore liquidity in the system as a consequence of rupee liquidity absorbed out against exchange rate intervention efforts.
Clearly the RBI has had to walk a tight rope between the need to stabilise the foreign exchange markets and maintaining sufficient rupee liquidity in the system. Given overall trends in the last three to four years, from a quantity theory of money perspective, it is arguable, that the desired benefits expected from monetary policy tightening (read interest rates),have been at least partially offset by persistently expanding money supply.
The second factor contributing to balance sheet expansion is on account of significant valuation gains arising out of revaluation of gold and FCA (foreign currency assets). The RBI balance sheet increased by nearly INR 2.9 trillion on account of unrealised gains due to rise in gold prices and steep exchange rate depreciation. As always and broadly in line with accounting practices followed by responsible central banks worldwide, the central banker very prudently carries these unrealised gains directly to its Balance Sheet under the heading Currency and Gold Revaluation Account (CGRA).
Since these gains are not routed through the revenue account they are unavailable for distribution to the Government of India as a surplus for the year. In this manner, the surplus is well positioned on the RBI balance sheet and available for absorbing future valuation reversals rather than being taken to profit & loss account and its consequent diversion into immediate government spending. The need for such prudence is heightened by the fact that liberalizing economies such as India increasingly find their Central Banks more exposed to market fluctuations and need adequate cushioning through robust reserve balances from current revenue.
As a side note, the RBI is now sitting on 558 metric tonnes of total gold stock (bullion and coins).A comparison of year on year changes in gold stock indicates that the RBI did not add to its gold stock in the financial year 2011-12. A persistently high current account deficit appears to have impeded the Central Bank from augmenting its gold stock at a time when Central Banks worldwide are reported to have added nearly 450 tonnes.
Clearly, gold continues to be a ‘safe haven’ asset at central banks across the globe. In the long run, it will be interesting to observe whether the RBI systematically changes its international asset composition, further, in favour of gold.
Persistently high headline and core inflation, consequent tight money policy, a depreciating rupee, limited fiscal headroom and the continued threat of global slowdown have meant that the RBI has had to follow a fine balancing act during the last financial year. This is clearly visible in the distinct change in composition of assets on the balance sheet and the tilt towards government securities holdings.
For those interested in graduating beyond speculating on repo (interest) rate movements, future balance sheets should continue to make for interesting analysis as India navigates through the next phase of challenging economic growth.