The Hindu Business Line : RBI’s Annual Report for 2006-07

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RBI’s Annual Report for 2006-07 — Telling a credible story

S. VENKITARAMANAN

The RBI Governor, Dr Y. V. Reddy…Pointing to the progress in fiscal consolidation of both the Centre and the States.

Although the RBI’s latest annual report covers both the performance of the Bank and that of the economy in 2006-07, public attention is focussed on the latter. Since the annual report has come closely after the annual monetary policy statement issued recently, there is obviously nothing very different in the stance on monetary policy and other aspects. The central bank continues to be focussed on sustaining growth with stability. It draws pointed attention to the ris ks inherent in the global economy, with particular reference to the home loan crisis in the US and the crude oil and commodity prices.

Supply shocks

On inflation, the report represents a slight shift in stance. While the RBI is steadfast in sticking to price stability in the overall sense, it seems to have given due emphasis to supply factors as well as monetary aspects. It is important that this line of thinking is pursued. While inflation is in the main a monetary phenomenon, most economists now agree that supply shocks have a great deal to do with the inflationary behaviour of the economy.

For instance, a supply shock arising from global rise in wheat price has a more damaging effect than monetary factors citing money supply alone. So too, with oil price increases. Therefore, it is right that the RBI has emphasised the need for action on increasing supply responses.

This can cover a wide variety of actions, such as those on the farm front, infrastructure, as well as on the fiscal side, including measures such as duty adjustment. Too much emphasis on reducing money supply and, therefore, credit can be injurious to the health of the economy, its growth prospects and inflation control itself.

Performance review

Contrary to what most analysts have written about the annual report, I would like to focus on the fact that it produces a review of the accounts and performance of the RBI itself — which should be the main purpose of any annual report of an institution. I shall deal, in particular, with the income and expenditure account. The RBI derives its income from the deployment of its foreign currency as well as domestic resources.

The foreign currency revenues are invested in highly-rated debt securities of the Governments of the developed world. They are mostly denominated in dollars. Although the report does not give a break-up of investments, we are given to understand that this is the position as disclosed in the documents of the US Federal Reserve, which show the holdings of individual central banks in US Treasury securities.

The income from investment of foreign currency assets in 2006-07 came to 4.7 per cent as against 4.1 per cent in 2005-06. The increase in 2006-07 was because of the generally higher level of interest prevalent in the developed world in 2006-07, compared to 2005-06. The rate of income earned is considerably below what Temasek, the investment vehicle of Singapore, appears to have got over the last 25 years since it began investing foreign currency resources in stock markets of the developed world — nearly 9 per cent in recent times. This is, of course, a riskier way of deployment than that adopted by the RBI, particularly in the context of recent gyrations of the markets in the US.

There is obviously a risk-reward trade-off in the matter of investment of forex reserves. The debate on establishing a vehicle for investment of sovereign foreign assets has been settled already elsewhere in the world. Japan, China, Korea, besides Singapore, have voted in favour of the Singapore model.

Whether India will take that route is not known. A higher return on reserves can mean a significant boost to the central revenues as it will increase the RBI’s income by nearly 5 per cent on its foreign currency assets, which runs to about Rs 9 lakh crore. An additional income of Rs 4,500 crore is not to be sneezed at.

Sale of SBI shares

The accounts of the RBI for 2006-07 contain an extraordinary item, arising from the sale to Government of India, of shares in SBI held by the RBI as majority owner of SBI. Following the Securities and Exchange Board of India (SEBI) rules, the value on sale of these shares was determined on the basis of six-month average market price. This brought a hefty gain on sale to the extent of Rs 34,308 crore.

Including this, the excess of receipts over expenditure came to Rs 78,348 crore. The distributable surplus, that is, the amount to be transferred to Government of India, is arrived at after making due provision for contingency reserve and asset development reserve, which are allocated as a matter of prudential accounting.

The net available surplus for transfer to Government after making these provisions and the essential expenditure of the RBI and excluding profits from sale of SBI shares came to Rs 11,400 crore, as against Rs 8,400 crore in the previous year on a like-for-like basis. In addition come the RBI’s profits on sale of SBI shares.

It is interesting that the entire transaction of sale of SBI shares to Government of India is, in effect, a case of the RBI itself financing purchase by Government, transferring the profits on sale of shares to Government of India, thus making the transaction ‘neutral’ from the budgetary point of view. Given the size of the profits, one reflects on what Government would have gained from the transaction if there had been a public offering of shares, as has been done by China in respect of its large State-owned banks.

That would have really meant additional income to Government in real terms. What we have done is a make-believe — the RBI getting additional income and passing it on to Government of India for financing the purchase. All for the sake of ideology that the RBI, as regulator, should not own shares in the institution that it regulates. That argument would apply at a second move to Government, in the sense that ultimately Government owns RBI, which regulates and supervises the working of the SBI.

The latest annual report is, by and large, a professionally competent document. It has got a credible and creditable story to tell, not only in terms of GDP growth but also in terms of the external front. The report does not refer too much in detail to the possible problems arising from potential appreciation of the rupee. That is, of course, being tackled by Government of India on its own initiative. The stance on exchange rate policy continues to be the same as adumbrated in the monetary policy statement.

Fiscal consolidation

In particular, the annual report has a good story to tell on the progress in fiscal consolidation of both the Centre and the States. The States seem to have made perceptible progress in achieving the targets set for them with regard to revenue and fiscal deficits.

The report for 2006-07 does not face the same problem as it did in 2005-06 when it addressed the issue of seeing reluctance on the part of the planners to observe fiscal prudence as mandated by the FRBM Act.

The States and the Centre have turned out to be willing disciples of the doctrine of fiscal austerity. How long this will last is anybody’s guess. The coming elections and the Pay Commission may make this a premature celebratory sentiment. But, hopefully, fiscal hawks will ensure that the States and the Centre continue to remain on the straight and narrow path, provided the monsoons and the global economy cooperate in adequate measure.

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