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Economy

The RBI Buys Gold, Buys US Dollars But Refuses to Help the Indian Government: From The Annual Report

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The RBI has been hailed as an excellent regulator, but it’s indeed disappointing that it chooses to fatten itself up at the cost of the Indian public and government. I don’t say this in jest. The annual report of the RBI, released recently has details. I’ll go through this point by point.

Why is the RBI buying gold, and storing it abroad?

In the course of 2019-20, the RBI has bought 43,250 kgs of gold. Legally. After telling us for years that hello, you dirty scoundrels, you shouldn’t import gold. In 2013, they even banned all imports except by nominated agencies, and of what was imported, 20% had to be exported back in some form. (Except gold. India isn’t allowed to export gold as gold.)

The same RBI, which hated gold, and even has the government make sovereign gold bonds to avoid having to import gold, is doing the strangest thing:

  • It is buying gold itself. Like 43,250 kgs of gold. In the last year. They probably paid Rs. 20,000 cr. for it which is a whopping large sum of money – it’s greater than, for instance, nearly all IPOs in the country.
  • How did they buy it? They just gave some dollars they owned, and bought the gold.
  • Where is the gold? Not in India. They bought it abroad and chickened out of getting it back.
  • Why couldn’t they bring back the gold? We don’t know. If they had bought it with the idea that they might be able to reduce imports later by giving it up, understandable. But no. They bought it, and stored it abroad.

Gold

So what, you might think? Instead of holding dollars they are holding gold. What’s the problem?

  • Well, they bought a truckload of dollars, also.

The RBI Bought Over $48 billion in the last year

That’s Rs. 360,000 cr. worth dollars bought in the last year. About $9 billion worth since the pandemic started!

RBI Buys Dollars

Why is this bad? Of course some of it would have been needed, when so many dollars have been coming in. Jio raised over Rs. 110,000 cr. and then a bunch of banks have raised over Rs. 45,000 cr. in the last month alone.

But the point is that dollar buying says one thing: The RBI funds the US government with this massive purchase (since most of the buying is parked in US Govt bonds)

That is nice for the US, and we see that the RBI in turn did something else: Deny the Indian government money.

Before we come to that, we must note that the RBI has expanded it’s balance sheet by 30% by printing rupees to buy:

  • Dollars ($43 billion, or Rs. 360,000 cr. worth)
  • Gold (43.25 tonnes – about Rs. 20,000 cr. worth)
  • Indian Government bonds (Rs. 180,000 cr. worth)

So it’s not like they don’t like India – they actually bought a reasonable quantity (Rs. 180,000 cr.) of rupee bonds issued by the government. But there’s a problem:

RBI is Hoarding Money: They Stuff Funds But Will Not Pay Out Dividends

RBI’s balance sheet is absolutely huge and the equity generated is even bigger. In total, the RBI has 53 lakh crores on the balance sheet.

Of this, they have “equity” (initial equity plus retained profits) of Rs. 15 lakh crores.

This is roughly 29% of the balance sheet. That’s absolutely huge!

We have argued earlier that the RBI can free up a lot of this to pay the government a big dividend. Read: How the Government can get Rs. 400,000 cr. to fight the Covid Slowdown.

The point is:

  • RBI has too much equity. This is way higher than most other central banks.
  • RBI has always found excuses to keep that equity. Multiple committees have been formed and all of them have rapped RBI on the knuckles for doing this.
  • When you have too much equity, it’s like saying a subsidiary (RBI) refusing to pay it’s parent (Government) its fair share of profits.
  • RBI says it needs a “Contingency Buffer” (Now 260,000 cr.) but it never participates in contingencies – even the Yes bank rescue was done by SBI, effectively the government. The RBI never will participate directly – it is the government that needs the money.
  • But even that pales against the “Currency and Gold revaluation account” (CGRA). This is where “unbooked” profits go when the rupee falls (RBI holds dollars so the rupee falling is an unbooked profit) or when gold falls. This account has 9.7 lakh crores. (up 3.3 lakh crores in 2020)
  • The latest committe is the RBI Jalan Committee Report : Click here. You will find that the Jalan Committee clearly says that your TOTAL equity should not be more than 25.4% (lower bound: 20.8%).

Economic Capital

The Jalan committee has actually said: Look the worst case of the rupee rising is 20%. Your CGRA should cover that, max. And they said, okay do between 15% and 19%.

Right now we own about $465 bn of rupees. At a 20% appreciation, the rupee will go up Rs. 15 to a dollar, so the USDINR will fall from Rs. 75 to Rs. 60. This is the worst imaginable case (according to Jalan committee).

That would result in a requirement of a buffer of roughly Rs. 700,000 cr. We have Rs. 977,000 cr.

The excess buffer is over Rs. 277,000 cr. This can be transitioned to the government as dividend. How? Simple – just book the profit – work with public sector banks and offer to buy and sell the dollars from them immediately. This transaction books past profits (since the RBI keeps dollars in FIFO mode, and the earliest bought dollars will be sold first, and a profit will be booked. But at the same time, since the RBI buys back the dollars, there is no drop in forex reserves.

A simple accounting entry that will do two things:

  • Make equity come down to the Jalan Committee report recommendations (my case would bring it to 24%, within the range)
  • Give the government money to fight the Covid crisis

Why give the government a dividend? Isn’t it the same thing as printing to buy bonds?

No.

Because a bond is a debt. The higher debt the government takes, the more “vulnerable” it is.

The Indian government already has reasonably high debt (though it’s tiny compared to say the US, UK or even China). Even more debt could see a downgrade of the government.

But if RBI gave it a dividend, the government would see it as revenue and then borrow less, which reduces its need for debt. Remember, the highest expense of the government is interest payments: At Rs. 5 lakh crores a year, versus a defense expense of Rs. 3 lakh cr. a year. 

But the RBI has chosen not to do this. And retain itself a big fat amount in it’s balance sheet!

What happens now?

Right now, nothing.

The RBI isn’t giving the big dividend, and clearly wants to fund the US government and buy gold instead of helping the Indian government with a higher dividend. Therefore it’s obvious they will have to learn only by a massive crisis. (Either that, or the government can set up a cutoff limit on equity – which many countries do – and demand that any excess be immediately paid out. This is fair; everything needs the approach of checks and balances, and the Jalan committee report was clearly accepted by RBI and they have violated it in the second year, so a law can be pushed)

However, this is going to take time. So the RBI will only react when there is a serious crisis, which is anyhow coming up. And the government will be the one asked to rescue any banks or financial institutions in trouble. RBI on this front, has been miserable – they have still not resolved DHFL or IL&FS when they have been tasked with it – and there, they don’t even have to use their buffers; it’s all about selling the company’s assets.

What this means is: Don’t expect the RBI to help the government. They will only do so grudgingly. They will buy bonds, but only when yields rise so much that it’s unsustainable. There is no clarity of purpose, which is why, on Wednesday:

  • 91 day T-Bills were sold at 3.2%
  • The 10 year bond traded at 6.2%

This is the widest spread ever, and effectively means long term interest rates are going up. With no dividend, and no intention for the RBI to add more bonds, we should expect that rates will be allowed to increase until some other tsunami hits us.

What we should be doing:

  • Ensuring the RBI has a clear view on keeping short and long term rates low. Not just short term.
  • Ensuring the government make a rule that above 25%, RBI must pay all extra “buffers” as dividend.
  • Asking the RBI to get more aggressive if it really wants to keep rates down.

But we are more bothered, as a country, about people who have delivered food to some actress. Which is why I’m even happy you’re reading this far. We’re on our own, folks.