RBI Buries the Ghost of Bimal Jalan Committee on Economic Capital Framework of RBI

 

RBI Buries the Ghost of Bimal Jalan Committee

Transfers More than 100% of the Surplus to Government

 

SUBHASH CHANDRA GARG

Economic, Financial and Fiscal Policy Strategist; Former Finance and Economic Affairs Secretary, Government of India

 

Introduction

Bimal Jalan’s Committee, constituted in 2019 to examine the capital framework of RBI, had made essentially two recommendations. One, maintain the valuation reserves/buffer (difference between market and book value of domestic and foreign assets) at about 16-18% of the total RBI assets (the actual number comes out of an unnecessarily complex formula relating to value at risk, confidence level etc.). Second, keep the realised reserves (actual surplus retained by RBI) between 5.5% to 6.5% of the total assets. RBI’s total assets or the size of balance-sheet are made up of two assets- domestic securities and foreign currency assets, including gold, which the RBI acquired and holds.

RBI, Jalan Committee mandated, must maintain total of two reserves/buffers between 22.5% to 23.5% of its assets. If the balance sheet or the size of RBI assets is Rs. 50 lakh crore, RBI was expected to maintain valuation buffers between Rs. 8 to 9 lakh crore and realised reserves between Rs. 2.75 lakh crore and Rs. 3.75 lakh crore. Jalan Committee recommendations received in 2018-19  and accepted by RBI have been applied to surplus transfers for three financial years of 2018-19, 2019-20 and 2020-21.

RBI’s normal business income is earned by way of interest and profit on sale of securities and foreign currency assets in the normal course. Gold has never been sold and it earns no interest. RBI spends on usual heads of expenditure like any other organisation on salary and allowances of the staff etc. In addition, RBI incurs expenditure on two special heads- printing of currency notes and payment of agency commission to banks for the government business carried on behalf of the RBI. RBI’s surplus is the difference between the interest and profits income and its expenditure.

RBI can also earn abnormal income- by converting its unrealised valuation gains into realised profits by simply selling the older foreign exchange reserves holding (earlier acquired at lower rate) and buying the same or similar security at the same time. The same profit can be created in accounts by simply valuing the securities/assets at current market price. Such abnormal profits amount to  converting unrealised valuation gains into realised surplus.

RBI profits in last three years

RBI reported massive increase in its total income for 2018-19, the first year of Jalan Committee, of Rs. 1,93,036 crore  (as against total income of Rs. 61,818 crore in 2016-17 and Rs. 78,281 crore in 2017-18). Total income for 2019-20 was reported at Rs. 1,49,672 crore. For the nine month financial year 2020-21, total income reported is Rs. 1,33,273 crore.

RBI reports its total income divided into two categories of interest income and ‘other income’ in its income statement. The interest income is further divided between domestic and foreign assets income. In the ‘other income’, there are two major heads. The head- exchange gain/loss from foreign exchange transactions- is used to book abnormal conversion kind of income by selling or buying the securities simultaneously. The head- profit or loss on sale and redemption of foreign securities- takes care of normal capital gains.

For 2018-19, the first year of implementation of Bimal Jalan Committee recommendations, RBI’s interest income was Rs. 1,06,837 crore and ‘other income’ Rs. 86,199 crore. The abnormal income under the head exchange gain/loss from foreign exchange transactions was Rs. 28,998 crore. In the year 2018-19, RBI transferred extra realised income of Rs. 52,618 crore as the ‘provision no longer required and miscellaneous income’ to the income account. As income of Rs. 81,616 crore was ‘abnormal income’ in 2018-19, the normal total income for the year was only Rs. 1,11,420 crore.

For 2019-20, RBI’s interest income was Rs. 1,09,333 crore and ‘other income’ Rs. 40,339 crore. The interest income from domestic sources was Rs. 60,957 crore and from foreign currency reserves Rs. 48,377 crore. The abnormal income under the head- exchange gain/loss from foreign exchange transactions- was Rs. 29,993 crore. Normal profit on sale and redemption of foreign securities was only Rs. 6,739 crore. Excluding the abnormal income of exchange gain/loss, RBI’s real total income for the year 2019-20 was Rs. 1,19,679 crore.

For the truncated 2020-21, RBI’s interest income is only Rs. 69,057 crore and ‘other income’ is Rs. 64,216 crore. The income under the head exchange gain/loss from foreign exchange transactions is as much as Rs. 50,629 crore. Excluding this, RBI’s normal income for the year 2020-21 is Rs. 82,644 crore.

In a nutshell, RBI’s normal income for years 2018-19, 2019-20 and 2020-21 are Rs. 1,11,420 crore, Rs. 1,19,679 crore and Rs. 82,644 crore. The annualised income for 2020-21 for 12 months would be Rs. 1,10,192 crore. RBI’s abnormal income during this period has been Rs. 81,616 crore, Rs. 20,993 crore and Rs.50,629 crore respectively.

RBI’s total assets were Rs. 41,02,905 crore as on 30^th June 2019, which rose to Rs. 53,34,793 crore on 30^th June 2020 and further to Rs. 57,07,669 crore on 31^st March 2021. The normal income on the assets base at the end of the financial year has been 2.72%, 2.24% and 1.93% for these three years. RBI’s normal income has thus declined consistently during this period. For 2020-21, it has declined in absolute terms as well. It is the large abnormal income which explain much of the surplus increase.

RBI’s expenditure

RBI’s income expenditure statement provides expenditure numbers for about 15 heads of expenditure, including the principal ones- printing of notes, agency charges, employee cost, depreciation and also “provisions” as expenditure.

The expenditure incurred under three major heads of printing of notes, agency charges, and employee cost in 2018-19 was Rs. 15,572 crore, Rs. 17,182 crore in 2019-20 and Rs. 12,080 crore in 2020-21. If annualised expenditure for 2020-21 of Rs. 16,107 crore is taken into account, there is not much volatility in these expenditures from year to year.

RBI, for reasons best known to it, treats the surplus it retains by transferring to the realised provision account- Contingency Fund- as expenditure and records it as such in the expenditure statement. This certainly treatment is certainly not in accordance with the accounting standards. Transfer to provisions is a below the line item and its treatment as expenditure misleads.

Total expenditure reported by RBI for 2018-19 was Rs. 17,045 crore. It rose sharply to Rs. 92,540 crore in 2019-20 and came back to Rs. 34,147 crore in 2020-21. In these three years, RBI transferred surplus of Rs. 64 crore, Rs. 73,615 crore and Rs. 20,710 crore respectively to the Contingency Fund. Excluding these transfers, RBI’s expenditures in these three years were Rs. 16,981 crore, 18,925 crore and Rs. 13,437 crore (annualised Rs. 17,916 crore). Minus the surplus transfers, the expenditures depict quite a normal order of things.

RBI’s real surplus and transfer to the Government

The normal income (excluding the abnormal income from booked valuation gains and one time excess reserves transferred in 2018-19) minus the normal expenditure (total expenditure minus transfer of surplus) is the real income or surplus earned by the RBI.

Taking into account the real normal income and real normal expenditure of RBI, the real surplus earned by RBI during these three years was Rs. 94,439 crore, Rs. 1,00,754 crore and Rs. 69,207 crore (annualised Rs. 92,276 crore) respectively. The real surplus, as a ratio of the RBI’s assets, at only 2.30%, 1.88% and 1.21% (annualised 1.61%) has consistently declined in last three years.  

RBI transferred Rs. 1,75,991 crore to the Government for 2018-19, Rs. 57,132 crore for 2019-20 an, Rs. 99,126 crore for 2020-21. RBI earned normal surplus of Rs. 94,439 crore but transferred Rs. 1,75,991 crore to the Government for 2018-19. For 2019-20, RBI earned normal surplus of Rs. 1,00,754 crore but transferred Rs. 57,132 crore and for 2020-21, while the normal surplus is Rs. 69,207 crore (annualised Rs. 92,276 crore), the amount transferred is Rs. 99,126 crore.

RBI effectively transferred 186% of the normal surplus for 2018-19, 57% of normal surplus for 2019-20 and 143% of normal surplus for 2020-21. For the three years of 2018-2021 together, RBI earned normal surplus of Rs. 2,64,400 crore, whereas it transferred Rs. 3,32,249 crores to the Government. RBI, in fact, has ended up transferring 125.66% of the normal surplus earned to the Government during the three year period.

Jalan Committee’s recommendations were fundamentally unimplementable

Both the key recommendations of the Bimal Jalan Committee were fundamentally flawed and unimplementable.

The first and principal pivot of the Economic Capital Framework (ECF) recommended by Jalan Committee related to how much of “realised equity” or the retained profits RBI must keep for meeting “monetary, financial and external stability risks” and also to cover “credit risk and operational risk”.

The Committee mandated that the RBI should maintain a Contingent Risk Buffer of 5.5% to 6.5% of the size of the RBI’s Balance Sheet as realised equity. RBI earned normal surplus in the range of 1.61% - 2.30% during this period. Depending upon the ratio of increase in balance sheet assets, RBI had to keep with itself a good part of the surplus to keep Contingency Fund equal to minimum 5.5% of the Balance Sheet. As RBI increases its asset size between 10%-25% every year, and the ratio of surplus earned to 5.5% ranged between 30% to 42%, the RBI had to, going by Committee recommendations, keep between 30% to 60% of the surplus earned.

There lies the impracticality of Jalan Committee. As RBI earned surplus much lower than 5.5% of assets, it could not meet the Government’s expectation of the transfer 100% of normal surplus earned. If RBI wanted to transfer more than 100% of surplus, as it was the case in 2018-19 and 2020-21, it could only do it by junking the Committee recommendations. The wise men of the Jalan Committee could not see this simple impossibility. They wanted to give RBI a tool to retain surplus but ended up providing a very blunt and defective tool.

Besides transferring hefty surplus to the Government, RBI had to find some surplus to keep the Contingent Fund reserves at 5.5% of the Balance Sheet. RBI faced this problem in a major way in 2020-21.

For 2020-21, the Contingency Fund RBI had opening balance of Rs. 2,64,034 crore (5.6%) of the closing balance sheet assets of 2018-19 and 2019-20 (Rs. 47,18,849 crore) for 2020-21. RBI’s assets grew from Rs. 53,34,793 crore to Rs. 57,07,669 crore in 2020-21 (average Rs. 55,21,231 crore). At 5.5%, RBI needed Rs. 3,03,668 crore in the Contingency Fund at the close of 2020-21.

RBI has chosen to maintain it at only Rs. 2,84,542 crore for some reasons which have not been explained. Even for maintaining the Contingency Fund at Rs. 2,84,542 crore, RBI required 20,508 crore to be transferred to it. RBI has clearly struggled to keep the façade of maintaining realised equity of 5.5% to 6.5% of the balance sheet assets size.  

The second major recommendation of Jalan Committee related to the valuation reserves.

The Committee recommended that no transfer be made from the valuation reserves even if the available valuation provisions are higher than the upper range of the valuation provision required as recommended by it. In the event of the available valuation provisions being lower than the lower limit of the provision required, the Committee recommended that the surplus be retained to the extent of the gap.

RBI counts four accounts- Currency and Gold Revaluation Account (CGRA), Investment Revaluation Account- Foreign Securities (IRA-FS),  Investment Revaluation Account- Rupee Securities (IRA-RS) and Foreign Exchange Forward Contracts Valuation Account (FVCA) as valuation reserves/provisions.

At end 2018-19, the accumulated balance in these four accounts was Rs. 7,30,995 crore. The valuation reserves rose to Rs. 11,24,391 crore at end 2019-20 . At end 2020-21, the reveluation accounts balance is Rs. 9,24,455 crore only. RBI’s valuation reserves were 17.8% at end 2018-19, 21.07% at end 2019-20 and only 16.20% at end 2020-21.

The revaluation reserves have slipped close to Jalan Committee’s lower limit of about 16% thanks to RBI’s decision to convert unrealised valuation gains into realised profits. While the revaluation balances are related to rupee appreciation/depreciation vis-à-vis US$ and rise/fall  in the interest rates on government bonds, RBI would probably not have the luxury of selling the foreign currency assets to jack up profits in years to come, constrained by the lower limit mandated by Jalan Committee.

How is RBI burying Jalan Committee?

RBI transferred more than 125% of the normal surplus it earned in last three years to the Government.

Only in 2019-20, the RBI adhered to the Jalan Committee recommendations. It violated the recommendations hugely in 2018-2019 and 2020-21.

The RBI was certainly faced with a major dilemma in 2020-21.

It required Rs. 39,634 crore to keep the Contingency Fund at the level of 5.5% of the average balance sheet assets. It earned only Rs. 69,207 crore during the truncated 9 months. If it retained Rs. 39,634, RBI could have transferred only Rs. 29,573 crore to the Government. Such a small transfer would have riled the Government. Non-maintenance of the realised reserves at 5.5% of the assets would have violated the Jalan Committee recommendation completely. How do you serve both these objectives?

This has led to the undermining of the basic premise of Jalan Committee’s recommendations. Jalan Committee wanted the RBI not to touch the revaluation reserves. The only way RBI could have got over this impossible situation was by fiddling with this recommendation. Operationally, this was not a very complex process. All it required was to convert the valuation gains into realised profits by selling and buying the foreign currency assets to book profits.

This is what RBI did.

RBI booked Rs. 50,629 crore of unrealised valuation gains into realised profits in 2020-21 by selling the foreign exchange securities it held and simultaneously bought the same or different securities at the current prices.

The booked valuation gains of Rs. 50,629 crore raised the transferable income from Rs. 29,573 crore to Rs. 80,202 crore. RBI actually transferred Rs. 99,126 crore. The balance of about Rs. 19,000 was made up by under-transferring an equal amount to the Contingency Fund.

By following these practices, RBI could manage to keep the façade of ECA as recommended by Jalan Committee, though in fact, it has become broken massively. RBI has also reached to the bottom of the revaluation corridor recommended by Jalan Committee. If the rupee appreciates on 31^st March 2022  a little bit more than what it was on 31^st March 21, the valuation buffer wall to  maintain even the lower limit of valuation corridors would get breached.

The lower limit of realised equity corridor has been saved in form this year by running down the valuation reserves. There is a very good likelihood that the RBI will not be able to defend the valuation corridor next year except if the rupee depreciate by good measure or Government settles for a very low transfer like 2019020. Jalan Committee has been de facto buried for 2020-21 transfers. It will most likely be formally buried while deciding 2021-22 surplus transfer.

 

SUBHASH CHANDRA GARG

JUNE 6, 2021