Using Reserves: When, If Not Now?

Context: A case for utilisation of reserves held by the RBI amidst the pandemic.

Reserves with the RBI:

• Forex reserves of the RBI stand at a very large figure of $589.465 billion as of May 7, 2021.
• The Other liabilities and Provisions (or capital reserves) made by the RBI stood at Rs 15,61,621 crore as of June 30, 2020 – amounts to 28.43 per cent of the total assets of the RBI.

Types of “reserves”: The term “reserves” can be used in two different senses in the context of the balance sheet of the central bank.

• The foreign exchange reserves on the asset side of the balance sheet.
• The Capital reserves, which are effectively an addition to the equity capital on the liabilities side of the balance sheet.
  • These reserves are a result of the accumulation of the retained profits; these have been reinvested by the RBI (typically in forex reserves and domestic government bonds).

How can RBI utilise these reserves?

• RBI can give payout as dividends to the GoI, which will reduce the capital reserves of the RBI and increase the government’s cash balances with the RBI.
• The GOI can spend these funds to acquire foreign exchange from the RBI and spend this on imports to take care of shortages that need to be addressed urgently at home.
• This will entail two changes:
  • First, on the asset side, the foreign exchange reserves will get reduced.
  • Second, on the liabilities side, the capital reserves will get reduced.
• Advantages:
  • Eventually, as a result, there will be no change in the cash balances of the GOI with the RBI.
  • There will be hardly any effect on variables like bankers’ deposits with the RBI, currency, fiscal deficit, or government bonds held by the RBI.
  • Accordingly, there is hardly any effect on interest rates and the effect on the exchange rate.

Conclusion: There is scope for and an urgent need now for reducing the huge “provisions” in the RBI balance sheet.