The Hindu Business Line : RBI Annual Report 2002-03

The RBI's latest Annual Report is a mine of information and analysis, and places in the public domain important data relating to its accounts. A tad too much emphasis on models and methodology puts it at risk of being consigned to the coffee-table instead of getting across to the non-technical reader and serving a more useful purpose, as it deserves to.

THE Reserve Bank of India (RBI) has released the Annual Report for its latest accounting year. As could be expected, it is a rich source of data and analysis. Old-timers recall how, till about three decades ago, it used to be a routine document, reading like a summary of the directives issued by the central bank during the year.

The high quality of the Report testifies to the competence of the staff of the Department of Economic Analysis and Policy, which has drafted the document, as well as of the management, which has approved it.

There are, however, a few areas where the Report could do with greater clarity. The various boxes are, no doubt, illuminating but they are somewhat overdone. Not many will be able to follow the discussion based on such methodology as vector error correction model (Box V.1, on pages 78-9).

The empirical conclusions on many issues are, in any case, indeterminate, so that even the knowledgeable reader is no wiser after reading them! If the boxes are meant to explain what could not be covered in the main report, they should be couched in terms understandable to most of the readers. Except for those trained in econometrics, others will not be able to follow these discussions.

The RBI Occasional Paper is the outlet for such technical work done by the staff. Too much technical material may reduce the Annual Report to the status of a coffee-table book, with the boxes replacing photos in the latter. The Bank used to prepare a short summary of the document. If it is not done now it is desirable to resume the practice. The summary should be addressed to the non-technical reader.

In keeping with its policy of transparency the Bank continues to come out with important data relating to its accounts. The net earnings from foreign currency assets, including/excluding capital gains/losses, as a percentage of average foreign currency assets, are given as 3.10 and 2.80, respectively, against 4.47 and 4.12, respectively, in the previous year (page 229).

The Bank's statement on this matter is somewhat ambiguous. On page 117 (para 6.55) it says: "Even after taking into account foreign-currency denominated non-resident deposit flows (where the interest rates are linked to LIBOR), the financial cost of additional reserve accretion in India in the recent period is quite low and is likely to be more than offset by the additional return on reserves" (italics added). Does this mean that the average interest rate on borrowed funds is less than the rate indicated above and arbitrage opportunities exist? The Bank could have provided the relative statistics instead of making a guess. No other institution in the country has the required data.

Further, the statement refers to flows during the year and not to stocks. What is equally important is the average cost of debt — say, at the end of June 30, 2003 — vis-à-vis the return earned on foreign currency assets held on that date.

The RBI should give out these figures. If there is a substantial difference to the disadvantage of the country, then the policy of repaying old high-cost debts should be pursued more vigorously than has been the case so far. There is no need to be apologetic about any loss on this account.

In paras 6.56 and 6.57, the Bank has clearly stated the objectives of building up the reserves. It can take the stand that any loss is worth bearing in view of the past experience, especially during Gulf War I.

The Bank refers in detail to the mechanism it has evolved to monitor reserve management practices. It also quotes an IMF study which has lauded the Bank's efforts. But from para 6.48 it appears that special external auditors look into only dealing-room transactions. This writer has in the past stressed the need for the audit of portfolio of investments, even if it is done with a time-lag, in order to avoid any impact on the markets. While there may no doubt as to the professional quality of the managers, the nation needs to be assured that the investments were the best in the circumstances.

One hopes that the inhibition about revealing the portfolio will be overcome, as was the case in publishing the level of forex reserves, which was a closely guarded secret till the early 1990s.

A related issue is the investment of the gold stocks. According to para 6.45, the Bank has a modest holding of 357 tonnes, of which 65 tonnes are with the Bank of England and Bank for International Settlements.

During the Gulf Crisis the Bank exported a part of its gold stocks to the Bank of England and Bank of Japan to pledge them as a security to raise funds for meeting certain immediate liabilities. Once the loans were repaid it was decided to keep the gold stocks abroad in order to avoid the hassles of re-exporting them again in case of another crisis.

Of course, the necessity for another such transaction did not arise. But the Bank has done well in keeping the stock abroad, earning some return. It should formulate a policy for earning returns on the remaining holdings kept in India.

The interesting point is that due to the requirements of lending agencies, the gold stocks had to be refined before they were pledged and, in that process, there was a value addition. There are reputed banks in Switzerland which do borrowing and lending operations in gold to help mines. During a visit to Switzerland a decade ago, this writer learnt that the return was as much as 2 per cent in those days for the lender of gold.

There is also the issue of the monetary policy of the Bank in sterilising the foreign inflows. It has clearly stated in para 3.2 that in recent years reserve money has become the operating target of policy. As a result of the heavy Open Market Operations (OMO), its stock of Central Government's dated securities has fallen. To deal with the problem, the Government has converted some special securities into marketable ones. But the problem may persist if heavy inflows of foreign currency continue.

The Bank could have given some indication of the possible solutions. There is a suggestion that the RBI may float its own paper, if it runs short of Government securities. But there are experts who have cautioned against this.

There are also examples from countries such as Indonesia, which used only its central bank certificates for OMO as its Government was prohibited by law from borrowing internally. The Bank should come out with a paper on the subject early for a wide discussion among experts.

(The author is a former officer-in-charge of the Department of Economic Analysis and Policy, RBI.)

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