Analysis. Throwing caution to the winds

The RBI’s Contingency Fund, the kitty the central bank has painstakingly built over the years, is the topic of many debates in recent times. While additions to the fund have ceased since 2014, there are now suggestions being made by the powers-that-be that this money can be used to bail out the troubled banks.

It can be argued that the conservative stance of the central bank has helped it build an emergency fund that is far larger than similar funds with other central banks. But the volatile external conditions need to be kept in mind before deciding to carve a portion out of the fund; for whatever reason. It might even be prudent to keep adding to the Contingency Fund till the current crisis in the global monetary system blows over.

The RBI was contributing a chunk of its profit to the Contingency Fund (CF) up to 2012-13. The portion set aside was almost 50 per cent of its revenue in 2011-12 while in 2012-13 it was 38 per cent. The fund thus built by the RBI was aimed at helping the central bank meet unexpected and unforeseen exigencies that could include depreciation in value of securities and risks arising from exchange rate or monetary policy operations.

But these transfers have ceased from 2013-14. There is little clarity on why transfers to this fund have stopped, whether the balance in this fund is to be pegged to a parameter such as the assets held by the RBI or if the transfers will resume at any point in future.

With the halt in additions to the fund, the cover for RBI’s assets is eroding. In 2011, the amount outstanding in the CF account was ₹1,86,594 crore. This, together with the Asset Development Fund (ADF), amounted to 10.3 per cent of the RBI’s assets. In 2013, after which transfers ceased, the balance in the two accounts was ₹2,42,413 crore, amounting to 10 per cent of the assets. But since the central bank has been expanding its balance sheet every year, the balance towards the end of March 2016, at ₹2,42,870 crore, accounted for just 7.5 per cent of the total assets.

This reduction in funds set aside for emergencies is not very comforting, especially given the brittle state of the global environment. With many asset classes inflated due to the liquidity being pumped in by various central banks and the flourishing carry trades, most currencies are exposed to volatility once these central banks revert to policy normalisation.

Seventy one per cent of the RBI’s assets are held in foreign securities, which can see their value erode if currencies such as the dollar depreciate. The RBI’s foreign securities revaluation account currently holds only ₹13,266 crore; less than 1 per cent of the value of foreign securities held. The cover provided to the total assets, if all the revaluation reserves as well as the contingency fund are taken into account, is around 27 per cent. Since we have seen emerging market currencies such as the real depreciate over 30 per cent in one year in the recent past, it is not right to assume that the current cover is very comfortable. Again, if there is a repeat of 2013, when the rupee was under speculative attack following central bank policy moves, money will be needed to protect the currency. In such situations, having enough money in the contingency reserve is imperative.

It is not difficult to see why the Centre has been eyeing the RBI’s surpluses. Given the tight fiscal situation, consistent shortfall from divestment proceeds, the poor state of other PSU undertakings resulting in lower dividends from these entities, inability to cut back on food and other essential subsidies — the surplus that is transferred from the RBI has been a godsend in recent years to keep the deficit under check.

The surplus transferred from the central bank was ₹15,000 crore in 2010-11; this had increased to ₹65,876 crore by 2015-16. This was thanks to fact that the entire profits of the central bank are now getting transferred to the government, while less than half of the net income of the RBI was transferred to the Centre prior to 2013-14. The money transferred by the central bank accounts for around 3.3 per cent of the total receipts (revenue and non-revenue) of the Centre.

It is clear that the RBI’s transfers are helping the Centre dress up its budget. But compromising the safety of financial markets to do so is not right. SS Tarapore, in his article “What does the RBI’s MRI say?” in Business Line , wrote, “From June 2016 onwards, the RBI must restart building up the CF and the ADF (Asset Development Fund) by the same percentage growth as the total assets.” It will help if the RBI and the Centre heed this advice.

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