Why the massive expansion in RBI's balance sheet isn't really extraordinary

As a share of nominal GDP, the balance sheet is well within the levels of the past few years; yet it could influence every sphere of economic activity in the country

The Reserve Bank of India presented its annual report for the accounting year 2019-20 in the last week of August. One of the key insight it holds is about the expansion of the central bank’s balance sheet by a massive 30 per cent, from 2018-19 to 2019-20. In absolute terms, the size of the balance sheet grew from Rs 41 trillion to Rs 53.3 trillion in a year. 

At the outset, this seems to be an unprecedented expansion, especially if we consider the fact that in 85 years of its existence, RBI's balance sheet grew to Rs 40 trillion, and that it took just a year for it to balloon to a staggering Rs 53.3 trillion. But the real trend is visible if we compare the size of RBI’s balance sheet to the nominal gross domestic product, which is the best proxy for the size of the economy. 

As a share of nominal GDP, RBI’s balance sheet is well within the levels of the past few years. Its size was 23.8 per cent of nominal GDP in 2011-12, when the new national accounts series began. From 2016-17 till 2018-19, it remained low, at 20-22 per cent, and in 2019-20, it has sprung back to 24.3 per cent. 

TABLE: RBI’s balance sheet back to its original size vis-a-vis GDP

Year	Financial assets of RBI as % of nominal GDP	Year	Financial assets of RBI as % of nominal GDP
2011-12	23.8	2012-13	23.4
2013-14	23.3	2014-15	22.6
2015-16	23.7	2016-17	20.7
2017-18	21.7	2018-19	21.1
2019-20	24.3	.	.

Source: Reserve Bank of India, Monthly Bulletin for July 2020

In terms to the economy, RBI’s balance sheet has thus expanded this year, but is close to the levels it has attained before. 

But why has the balance sheet grown this big this year? More fundamentally, what is its relevance for the citizen, and the economy? What signals does it send? 

A reflection of the economy

Economists say that RBI’s balance sheet is the mirror image of the country’s economy, in that, it reflects the needs of the economy, its apprehensions, touches upon savings behaviour, and broadly underlines the health of the financial sector. 

Unlike the balance sheet of banks and other corporates, where the direction is usually from the liabilities side to assets side, the direction of Indian central banks’ balance sheet is from assets towards the liabilities. For example, banks will lend (assets) as much their deposits (liabilities) will allow. An automaker will invest into a plant (an asset) by borrowing money first (liability). 

The central bank usually does the opposite. It builds assets in the form of gold or foreign currency (by value), or buys government securities (assets), and lets deposits rise, issues notes to the public in equivalent amounts, or provides for risks and contingencies. 

For instance, the RBI is routinely doing open market operations to sell and buy government securities in the secondary market. While this does instil confidence in the financial markets about the health of the economy, it essentially adds assets to the RBI’s balance sheet. To “balance” it, RBI prints more money to increase its liabilities in the form of “notes issued”. 

This does not mean that the balance sheet does not work in the opposite direction. And the way banks are parking money with the central bank is a good example. 

The RBI sets the policy repo rate, and the reverse repo rate, in its bi-monthly policy meetings, to control money supply in the economy, and also target inflation and support growth. The reverse repo rate is the interest rate at which the RBI can borrow money from banks, and in another way, banks who park money in the central bank get an interest equal to the reverse repo rate. 

The reverse repo rate is usually very low in comparison to the interest banks can get on commercial loans to corporates, or retail loans (such as vehicle and education) to individuals or households. It is currently at 3.35 per cent (moved south from 4.9 per cent in January 2020), in comparison to the weighted average lending rate of 8.5 per cent (down from 9.4 per cent in January 2020). 

But still, the money parked by banks with RBI under reverse repo operations massively increased from Rs 2.15 trillion at the end of June 2019, to Rs 7.1 trillion at the end of June 2020.

The RBI reduced the reverse repo rate faster than the repo rate in 2020, to dis-incentivise banks from parking money into RBI, and subsequently to nudge them to lend to borrowers instead. But still, banks are raising their bets in reverse repo operations.  

This, as economists have noted, represents a high level of risk aversion among commercial banks in India.

Scheduled commercial banks are also supposed to mandatorily park a certain amount of liquidity they have with the RBI, to ensure that all the money in the form of deposits is not lent to borrowers: so that it does not run out of cash if depositors demand cash. This is determined by the cash reserve ratio (CRR). 

These liabilities of the RBI have shrunk a bit in the accounting year 2019-20. From a level of Rs 5.5 trillion at the end of June 2019, they have fallen to Rs 4.7 trillion as of June 2020, though well within the CRR limit. 

The money parked under reverse repo operations, thus, is a big reason why the liabilities of the central bank have risen this year.

The liabilities in the form of notes issued have risen Rs 21.7 trillion to Rs 26.4 trillion in a year, a jump of 21.5 per cent. “The increase is on account of the continued efforts of Reserve Bank to supply adequate quantity of banknotes to meet the transactional needs of the public,” the annual report said. 

This money issued to the public in the form of notes is generally backed by two types of assets: foreign currency assets and gold, both of which have shown a big increase this year. 

Its foreign currency assets, or FCA, generally include deposits with other national central banks, those with Bank of International Settlements, with overseas commercial banks and Special Drawing Rights acquired from the government of India. They form nearly half of the central bank’s overall assets. 

FCA with the Issue department of RBI grew from Rs 20.9 trillion to Rs 25.2 trillion (a growth of 21 per cent), to back the need to issue more notes to the public. At the same time, FCA with the Banking department of the RBI rose from nearly Rs 7 trillion to Rs 10.2 trillion over a year to June 2020. 

RBI added 43.25 metric tonnes of gold to its chest this year, taking the central bank’s gold reserves to 661.41 metric tonnes. Coupled with the phenomenal rise in international gold price, the assets of RBI in the form of gold grew 62 per cent, from Rs 0.88 trillion to Rs 1.4 trillion. 

RBI is also a holder of long term government papers, essentially bonds sold by government to RBI, in which the former gets immediate liquidity to spend. This falls under the assets of the RBI, as the government becomes liable to pay the principal and interest to the RBI. 

“The Reserve Bank’s holding of domestic securities increased by 18.4 per cent, from Rs 9.9 trillion as on June 30, 2019 to Rs 11.7 trillion as on June 30, 2020. The increase was on account of liquidity management operations conducted by way of net purchase of government securities ,” the RBI annual report noted. 

Apart from deposits and notes issues, the other major parts of liabilities of the central bank are the contingency fund, asset development fund, and revaluation accounts. 

The contingency fund came into limelight in 2018-19, when the then extant economic capital framework of the RBI was replaced by a new framework according to the recommendations made by a panel under former RBI governor Bimal Jalan, and the RBI made an unprecedented transfer of surplus towards the government, which is the equity holder of the central bank. 

The Jalan panel recommended major changes in the risk provisions of the central bank, to tackle market risks, financial stability risks and its preparation for a rainy day. They prompted the RBI to maintain the contingency risk buffer between 5.5 and 6.5 per cent of its balance sheet.

In the medium term, the Jalan panel report recommended that the size of the contingent-risk buffer should not be lower than four per cent of RBI’s balance sheet in the medium term. As the balance in contingency fund was more than seven per cent of its balance sheet in June 2018, the RBI wrote back “excess provision” in the contingency fund equal to Rs 52,637 crore (showing it in its income statement), which had resulted in higher surplus to the government, and cutting the contingency fund to size, at 5.34 per cent of the balance sheet. 

In 2019-20, as the central banks’ balance sheet expanded, the RBI had to allocate Rs 73,615 crore--more than what it wrote back last year—to its contingency fund (showing it in its expenditure statement) to keep the balance in risk provisions at nearly the same level of last year. 

The revaluation gains were high time on account of a strong depreciation in the rupee--resulting in rise in valuation of dollar assets--and appreciation in gold price.

“During 2019-20, the balance in the Currency and Gold Revaluation Account increased from Rs 6.6 trillion to Rs 9.8 trillon as on June 30, 2020, mainly due to depreciation of rupee and the rise in the international price of gold,” said the report. 

The RBI will do accounting in a truncated year this time, from July 2020 to March 2021, after which India’s central bank will begin accounting along the lines of government finances, April to March.