Revenue from foreign and domestic investments apart, there was a spike in RBI’s holdings of GSecs for which it earns interest
The transfer of RBI surplus of nearly ₹1 lakh crore to the government sounds good as it helps a lot to balance the Budget. As the announcement comes in May, it would be used in the Budget for FY22 as the government follows the cash accounting system where income is reckoned when received. In the previous year, the surplus was ₹57,132 crore.
The RBI accounts are quite singular in terms of what drives activity during the year. Being the central bank there are no limits on what the RBI can do in terms of creating money and hence the balance-sheet size can be increased based on the conditions in the economy. Interestingly, the balance-sheet size increased from ₹28.9 lakh crore in 2014-15 to ₹41.03 lakh crore in 2018-19 (July-June). This is an increase of ₹12.13 lakh crore. But in 2019-20, the size increased to ₹53.34 lakh crore which is an increase of ₹12.31 lakh crore and further by ₹3.72 lakh crore in the next nine months ending March 2021.
In 2020-21, for example, around ₹39.51 lakh crore was in foreign investments and another ₹13.33 lakh crore in domestic investments. Intuitively it can be seen that as the investments increase, the revenue of the RBI goes up which translates into higher surpluses. This happens in the normal course of activity.
During the year, the RBI undertakes OMOs (open market operations) where government paper is bought in exchange for liquidity to banks, which increases holdings. In FY21, for instance, the RBI bought securities worth ₹5.07 lakh crore and sold ₹1.94 lakh crore with a large part being in the nature of Operation Twist, where there was shuffling of securities. A net purchase of around ₹3 lakh crore resulted.
Simply put, by just undertaking OMOs, the RBI could have earned an additional income of ₹18,000 crore, assuming an average return of 6 per cent on these bonds. Here there is no cost for the RBI.
Similarly, the LTRO/TLTRO operations earn the repo rate for as long as they are in operation which adds to the income of the central bank. And, finally, as dollars flow into the economy and the RBI mops them up and the forex reserves increase, there is income to be made again by the RBI. For all these operations there is a virtual zero cost increase in money supply.
Last year, around $100 billion of forex came into the country, which is around ₹7-7.2 lakh crore. With a return of even 2 per cent, the income would be around ₹14,400 crore. Therefore, normal central banking activity which includes monetary policy operations leads to an increase in the income of the RBI.
The use of reserves of RBI as transfers to the government is now passé. With the RBI expanding its operations on the liquidity front to maintain stability in the system, there are two things happening. First, interest rates have been stabilised by yields being kept low.
Second, through OMOs which take place even in the face of surplus liquidity, there is a tendency for GSec (government security) holdings of the RBI to increase which then yields an income to the central bank.
In fact, OMOs ensure that even though at the primary stage banks bid for GSecs, the pre-defined quantum of OMO ensures that by monetary policy action the funds flow back to the banks.
Interestingly, there was a time when there was the concept of private placement of GSecs of the government with the RBI, which led to monetisation of the debt. This was disallowed post 1997 when it was decided that the government has to borrow from the market with the caveat that the un-subscribed part of the debt could devolve on primary dealers.
But with OMOs being a legitimate tool, the same was being done when the RBI purchases bonds in the market. The anomaly in the market since last year is that OMO purchases have been reckoned at a time when there was surplus liquidity in the system.
The aim ostensibly was to temper yields, which was achieved. But the resultant holdings of GSecs of the RBI increased sharply which helped the government finally as the interest paid on debt finally comes back as the transfer of surplus from the RBI, which would not have been the case if the securities were held by the banks.
Assets of US Fed
This is an inherent advantage in central banking. The Fed, for example, had assets of around $870 million in 2008 at the time of the Lehman crisis.
With the QE programme it rose to $4.5 trillion in early 2015. There was some normalisation between 2017 and 2019 when the size was $3.8 trillion. In May 2021 it is around $7.9 trillion.
Hence, all monetary intervention which involves provision of liquidity enlarges the balance sheet of the central bank.
As the balance sheet of the Fed increased from $4.1 trillion in 2019 to $7.3 trillion in 2020 the surplus that was transferred to the Treasury increased from nearly $54 billion to $87 billion. The gain was to the government.
Therefore, central banking is an art when the dynamics are looked at closely. It is a win-win situation when the central bank plays an active role in debt management of the government.
The government gets to run high deficits knowing very well that the central bank will manage the programme.
The use of open market operations balances liquidity in the system and has the government pay interest to the central bank rather than the banks on the holdings of the latter, which then comes back as surpluses to the former.
The writer is Chief Economist,
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