The other noticeable weakness in the reserve system of the RBI is the low level of its contingency reserves. The RBI maintains a contingency reserve (CR) to enable it to absorb unexpected and unforeseen contingencies. It is pursuing an aggressive mechanism to strengthen this account as it had fixed a target of 12 per cent of its total assets to be achieved by 2005.

It may be added that as a consequence of globalisation and integration of domestic financial markets with the foreign markets, it is of great importance to have a strong contingency reserve position to meet several market risks emerging from domestic and international financial exposures.

According to the RBI Annual Report, despite the increase in the absolute level of contingency reserves, there has been a shrinking trend, falling from 11.7 per cent of total assets at end of 2000-01 to about 10.3 per cent at end-June 2007.

In an environment of volatility in the financial markets, world over, it is imperative on the part of the RBI to increase the contingency reserves up to a level of 15 per cent or so. Similarly, the exchange fluctuation reserve funds formed only 0.11 per cent of RBI’s total assets.

The size of external transactions between India and other countries, financial convergence between the Indian financial system and the major financial systems of the world are posing challenges in the form of uncertainty and volatility in the outcomes of financial transactions.

The RBI itself has cautioned: “Given the flux associated with both financial market and monetary policy settings, India cannot be immune to these developments. Accordingly banks, financial institutions and corporates need to be vigilant and well prepared with appropriate risk mitigation strategies to deal with significantly higher volatility than before.” (Annual report of RBI 2006-07, P.117).

As such it is a very transparent fact that the same warning implies to the central bank of the country. In view of these emerging circumstances, the RBI and the Government should collectively agree to transfer a larger portion of the RBI’s profits to contingency reserves.

In order to complete the discussion we may mention about the paid-up capital (PUC) of the RBI which looks a weak indicator in its balance sheet. Since the time of its inception, the PUC has remained at Rs 5 crore.

With the increase in operations of the RBI, particularly the assets, the capital has to be increased. The paid-up capital should have some relationship either with assets of the banking department. Thus, the paid-up capital of RBI needs to be augmented taking into account the increase in its operations and risk associated with them.

The RBI, of course, has 100 per cent backing of the Government but it should have strong net worth, of which the paid-up capital should be contributed by the Union Government or jointly by the Union and State governments because the RBI functions as a central bank not only for Union Government but for State governments also.

In an economy such as India going in for large-scale privatisation, the public sector role as an investor in the economy will decline.

Consequently, the borrowings of the Union and State Governments will fall significantly. At present, the gross fiscal deficit of Government is as low 3.3 per cent (2007-2008) while the combined fiscal deficit of the Union and State Governments has also decreased from 9.1 per cent in 1990-91 to 6.4 per cent in 2007–08.

On top of this, the devolvement of government borrowings on the RBI has been restricted following the adoption of the Fiscal Responsibility Act. Hence, the RBI will have fewer opportunities for investing in government securities and, consequently, its income would decline unless other sources of income are available. In such a situation, the RBI may have to start funding the private sector on a larger scale to augment its income.

The net income from foreign currency assets would remain always uncertain. In such a situation, the RBI may not be in a position to strengthen its various reserve funds and there would be always be the need for a strong capital base. It is possible that in the long run, the RBI may have to face the same risks and exposures as the other financial institutions.

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