Mumbai: Bond sales by the Indian central bank helped it earn a record profit—and transfer an eye-popping Rs25,009 crore to a deficit-ridden government in 2008-09.
Last week, the Reserve Bank of India (RBI) said in its annual report for 2008-09 that its “profits on sale of securities” shot up by Rs9,410.2 crore, or 132.73%—from Rs7,089.8 crore in 2007-08 to Rs16,500 crore in the last fiscal year. The central bank has a July-June accounting year.
Most of this increase came from sales of debt that RBI held under the market stabilization scheme (MSS), which was introduced in 2004 to insulate the domestic financial system from the after-effects of the central bank’s attempts to prevent rupee appreciation by buying dollars flooding into the Indian economy.
A central bank buys dollars to weaken the domestic currency and, hence, maintain export competitiveness. The dollar sales lead to a release of extra money into the local economy, fanning inflation and blowing asset bubbles. The central bank sucks out such excess liquidity before it can do much damage, by selling bonds to investors in exchange for money. This two-step intervention—buying dollars and then selling bonds—is known as sterilization.
Money matters: The RBI New Delhi office. The central bank’s profits on sale of securities shot up 132.73% to Rs16,500 crore in the last fiscal, helped by sales of debt that it held under the market stabilization scheme. Harikrishna Katragadda / Mint
“The increase in RBI’s income is largely on account of income from sale of securities under the MSS and interest earned on domestic securities,” said an analyst with a domestic brokerage who did not want to be identified.
Following the sudden reversal of global capital inflows, a severe liquidity shortage and a surge in short-term interest rates after the failure of investment bank Lehman Brothers in September, RBI stopped issuing of treasury bills under MSS. From November, to increase market liquidity, the central bank had also started buying back securities issued earlier under MSS.
Under MSS, the central bank held securities worth Rs1.74 trillion on 28 June 2008; this holding was pared down to Rs22,890 crore on 27 June 2009. The average yield on one-year securities during this period softened by 509 basis point, from 9.26% to 4.17%. One basis point is equal to one-hundredth of a percentage point.
The MSS portfolio is made up of treasury bills and government securities with a tenure of two years. The average tenure of the paper held in MSS is one year.
Rupa Rege Nitsure, chief economist, Bank of Baroda, said: “In the last two years, the economy had passed through a volatile phase. The country saw huge capital inflows and dollar flows; to suck out this excess liquidity from the system, RBI mopped up dollars from the system. In return, the central bank was pumping in rupee liquidity in the system. To check this rise in rupee liquidity, the central bank decided to sell bonds under the market stabilization scheme. This was the main reason for the rise in profit on sale of securities.”
“After the global crisis which was triggered by the Lehman collapse, RBI had to change its stance and injected funds into the system to ensure comfortable liquidity condition. Later, the government came out with the stimulus package which was financed through the issuance of more bonds,” added Nitsure. “Whenever the government debt rises, there is scope for RBI to churn its securities holding and make profits,” added Nitsure.
“The balance sheet of the Reserve Bank...reflected the impact of liquidity augmenting measures adopted by the Reserve Bank to deal with the contagion from the global economic crisis,” said the central bank in its annual report.
The huge dividend cheque given to the government was almost inevitable, said the analyst quoted earlier.
“The central bank’s income is largely put to two uses. First, transfers to the asset development reserve (ADR) and contingency reserve (CR). Second, transfer the surplus to the government. The ADR and CR now account for 11.89% of total assets which is close to the indicative target of 12% set by RBI, hence RBI has transferred so much of its surplus to the government,” he said.