RBI balance sheet 1935-2019: A struggle to balance its FX reserve

Summary

We have created a long-term annual database for the Reserve Bank of India (RBI)'s consolidated balance sheet starting in 1935 and ending in the latest year, 2019. The RBI has been publishing its consolidated balance sheet on a weekly term starting in 2004. Prior to 2004, as far as we understand, RBI has not published a consolidated balance sheet, rather published its fiscal-year-end balance sheets for its Issue department, responsible for issuing bank notes, and for its Banking department, responsible for banking for the government and other banks. Please see the appendix of this report for the methodology we employed in creating this database and making adjustments for apparent errors in the RBI's official database.

In this report, we provide an overview of how RBI's balance sheet evolved since its initiation in 1935. In our view, the most noticeable evolution took place in its struggle to control the "right" balance of its foreign currency assets or its FX reserve. Through the 1960s to 1980s, the FX reserve was often scarce as India suffered a persistent current account deficit and insufficient capital inflow. Towards the end of the 1980s, India and its central bank nearly depleted its FX reserves, culminating into1991 balance of payment crisis followed by conditional bailout by IMF and the World Bank. Subsequent structural reform led to an improved current account balance and a robust net capital inflow. However, as Shakespeare put it in "As you like it", too much of a good thing could also cause problems. Towards 2004, the net capital inflow and the RBI's intervention to ease the appreciation pressure on Rupee left the balance sheet dominated by foreign currency assets and depleted the holding of domestic security, depriving RBI of the mean to control liquidity in its financial system. In 2004, foreign currency assets accounted for 83% of total assets in the balance sheet, while domestic securities fell below 1%. Subsequently, RBI became less active in its intervention and managed to hold a healthy level of domestic securities, as a provision of a flexible tool to maintain the level of liquidity in its financial system. As of 2019, foreign currency assets account for 69% of the total asset, while its domestic securities holding rose to 23%.

History of RBI

The Reserve bank commenced its services as a central bank of colonial India in 1935 as a private shareholders bank with a paid-up capital of Rs. 5 Crore. Along with British India which included Pakistan, the banking services of the RBI was extended to Burma now Myanmar, as an issuer of currency until 1947. In 1949, the government of India nationalized the reserve bank. At initiation, the two primary functions of the RBI were- the issuer of notes and the keeping of reserves.

Total asset of RBI rose from Rs.2 billion in 1935 to Rs. 40 trillion in 2019

The fall and the rise of RBI’s foreign currency assets holding

The total size of the RBI's balance sheet expanded from Rs. 2.4 billion in 1935 to Rs.18.9 billion in 1948 following India's independence in 1947. The expansion was led by an increase in foreign currency assets (Sterling assets), as it rose from Rs.0.9 billion in 1935 to Rs.15.9 billion in 1948.
However, the expansion of foreign currency assets in the balance sheet was short-lived due to capital outflows in the 1950s and payments of a share of foreign reserves to the newly formed Dominion of Pakistan. In fact, foreign currency assets accounted for a mere 2% of total assets in 1965.
The economic policy reforms in1970s and 1980s, led India to twin-deficit, namely persistent fiscal deficit, and current account deficit, culminating into the balance of payment crisis in 1991 when foreign-currency assets held by the RBI nearly depleted and the India had to resort to conditional bail out by IMF and the World Bank.

Through 1960s to 1991, foreign currency assets were in scarcity with RBI

The 1991 crisis proved to be a wake up call for India though. Post the balance of payment crisis in 1991, as the Indian economy liberalized, India markets were able to attract net capital inflows, and RBI was able to increase its foreign currency assets, partly to ease the appreciation pressure on Rupee. Between 1992 and 2004, the RBI increased its foreign currency assets from 10.4% to 83% of the total assets.

The sharp rise in foreign currency assets within the RBI's balance sheet was not without problems though. As the RBI purchases foreign currency assets in exchange for Rupee, India's monetary system gets effectively flooded with liquidity. To mop up the excess liquidity, RBI kept selling its domestic security holding, but this method came to a deadlock in 2004 when the RBI eventually ran out of domestic security to sell and was forced to resort to the introduction of Market Stabilization Scheme (MSS). With the MSS, the RBI mopped up the excess liquidity through selling the government bonds, it had borrowed from the government earlier. However, MSS was inconvenient for the government as it had to issue bonds and pay extra interests. Eventually, the RBI had to ease up on its foreign exchange intervention and let Rupee rise.

Rise in REER of INR represents rupee appreciation from 2004

The Real effective exchange rate (REER) of INR measures trade competitiveness of the Indian rupees against the major international currencies. The increase in the value of REER of INR indicates the appreciation of Indian rupee against a basket of foreign currencies.

Eventually, the deterioration in the current account deficit and the slower capital inflow into India enabled RBI to slowdown its foreign exchange intervention. The ratio of foreign currency assets to the total asset peaked in 2009 at 89.5%, and it has fallen since to 68.8% by 2019. As a consequence, the RBI was able to increase its domestic security holding to the total asset ratio from 4.8% in 2009 to 24.5% by 2019, thus enabling the RBI to use its domestic security holding to conduct its open market operation.  

Domestic securities as a share of total assets grew gradually after depleting in 2004

Conclusion:

The near depletion of FX reserve in 1991 was a wake-up call for India to start adapting and integrating its economy to the world. The subsequent accumulation of FX reserves in the RBI balance sheet can be viewed as a reflection of the progress India made in this regard. Another turning point arrived in mid-2000s, when the RBI had to ease up on its foreign exchange market intervention in order to maintain adequate amount of domestic securities in its balance sheet to conduct its monetary policy. It was a classic Impossible Trinity problem in the international economics where a country cannot have a fixed exchange rate, free capital movement and the independent monetary policy at the same time. We can see the subsequent decline in the share of foreign currency assets in the RBI balance sheet as the sign that India has been moving toward flexible exchange rate regime and allowing its currency to appreciate in real terms over the years. In our view, the next challenge for the RBI and for India is to see if the economy can remain competitive with a stronger currency. In this regard, the recent economic slowdown may be an ominous sign that the economy is in fact struggling of failing to meet the challenge and the next step is for RBI to engineer a moderate depreciation of rupee so that India can regain its international competitiveness.  

Appendix:

  • The annual time series data for the RBI balance sheet is not readily available. The data in our analysis is taken from the RBI occasional publication titled “ Handbook of monetary statistics of India” dated March 03, 2006.
  • The available data we gathered is segregated on the basis of functions of the RBI into- Issue department and the banking department. We have further consolidated the balance sheet by adding the components of the issue department and the banking department into their respective asset and liabilities class.
  • As the fiscal year for the RBIs balance sheet ends in June every year, the annual GDP in the balance sheet analysis is a summation of quarterly GDP between July-June. For example, GDP for 2018-19 is calculated by adding the quarterly GDP between July 2018-June 2019.
  • The RBI publishes its weekly balance sheet data on Friday every week. The balance sheet as on last Friday of the month is considered as a monthly data series.
  • In our monthly analysis, we notice that there were some inconsistent values in the RBI’s database, and we have made necessary changes to make it consistent in our data series. Values for some of the components for May 2011 were ten times as compared to other months, for example, the central government deposits was Rs.10 billion as compared to Rs.1 billion in all the other months, except when the government deposits increased due to RBI purchase of government bonds through market stabilization scheme. Therefore, we have reduced the values for those components by ten times. The foreign currency assets for September 2011 was Rs.208.5 billion, which is less when compared to Rs.1303.2 billion on September 16, 2011. So we have taken the balance sheet for September 2011 as of September 16, 2011. Gold coin and bullion values for October 2011 and November 2011 are 122.6 billion and Rs.131.7 billion respectively, this is about ten times less as compared to Rs.1119.4 billion in August 2011, and Rs.1418 billion in December 2011. Consequently, to make the values consistent, we increased the gold and bullion by ten times for October and November 2011.