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Using reserves: When, if not now?

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Though we have had some improvement in the last one or two weeks in parts of urban India, very many other parts of the country are going through a somewhat disastrous medical situation. What can we do? One part of the solution can make use of the very large reserves that the Reserve Bank of India (RBI) has. These are not just for dealing with a macro-financial crisis but any crisis including a medical crisis. But how?

India continues to be in urgent need of various supplies to deal with Covid-19. The items include oxygen, oxygen cylinders, oxygen concentrators, make-shift hospitals, and nursing homes in general and intensive care units in particular, various medicines, medical equipment of different kinds, and, last, but not the least, vaccines to gradually arrest the spread and severity of the disease in India.

Our problem is domestic availability of various items needed urgently. Our problem as a nation is not the inability to pay for the much-needed imports — more so when the RBI is sitting on large reserves. And since the RBI is associated with the Government of India (GOI), the latter cannot leave the matter entirely to the state governments.

The term “reserves” can be used in two different senses in the context of the balance sheet of the central bank. First are the foreign exchange reserves on the asset side of the balance sheet. Second are what I call capital reserves, which are effectively an addition to the equity capital on the liabilities side of the balance sheet. These reserves are a result of the accumulation of the retained profits; these have been reinvested by the RBI (typically in forex reserves and domestic government bonds). There is a need to use both kinds of reserves in the current situation. How? What follows is a much simplified picture of the modalities.

Let the RBI pay out an extraordinary dividend to the GOI this year. This will reduce the capital reserves of the RBI and increase the government’s cash balances with the RBI. The GOI can spend these funds to acquire foreign exchange from the RBI and spend this on imports to take care of shortages that need to be addressed urgently at home. At the end of the day, there will be two changes in the balance sheet of the RBI. First, on the asset side, the foreign exchange reserves will get reduced. Second, on the liabilities side, the capital reserves will get reduced.

Note that eventually as a result of the policy suggestion here there will be no change in the cash balances of the GOI with the RBI; these rise initially but fall subsequently. Also, there will be hardly any effect on variables like bankers’ deposits with the RBI, currency, fiscal deficit, or government bonds held by the RBI. Accordingly, there is hardly any effect on interest rates in the economy. There is also hardly any effect on the exchange rate, given that both the supply of and the demand for foreign exchange rise.

Forex reserves of the RBI stand at a very large figure of $589.465 billion as on May 7, 2021. To put this in context, the ratio of short-term external debt to forex reserves had already declined to 17.7 per cent at end December 2020. Given the huge size of forex reserves, India can easily reduce these. In any case, the amount of foreign exchange needed to deal with the current situation is likely to be a very small, if not an insignificant, proportion of the forex reserves held by the RBI.

Let us turn now to what I have called the capital reserves though the main term used by the RBI in this context is Other Liabilities and Provisions. This term suggests that these reserves are all kept for reasons of prudence, given that prices of assets of the RBI can fluctuate. However, such accounting treatment is not entirely appropriate, given that the revaluation of foreign exchange and gold held by the RBI is a reflection of not just the short-term rise in prices but also the more or less permanent appreciation in rupee terms of the foreign exchange and gold held over a very long period of time.

The so-called Other liabilities and Provisions made by the RBI stood at Rs 15,61,621 crore as on June 30, 2020. This amount is 28.43 per cent of the total assets of the RBI. It is also 78 times the amount budgeted for the Central Vista project and 86 times the amount recently approved for the PLI scheme for manufacturing ACC battery storage. There is scope for and an urgent need now for reducing the huge “provisions” in the RBI balance sheet, if we cannot cut public expenditure elsewhere.

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