RBI’s frozen assets

‘Rupee to trade at ₹50 to a dollar?’. Or consider another claim, ‘Gold breaching the $100 dollars a troy ounce mark?’ Such forecasts are bound to be greeted by even the not-so-well-informed reader with the response, ‘Not in my life time’. This writer would not be so churlish as to classify all his readers as just one step away from the grave merely to lend extra credence to the notion that such a denouement is simply round the corner.

In the event, the readers’ refrain should only be taken to mean as a comment dismissing the claim (Rupee at 50 to a Dollar or gold at $100 a troy ounce) as not within the realm of practical possibility, at least in the foreseeable future.

On the other hand, the RBI certainly does seem to think so. Or so it would seem, if you look at how it is responding to a possible diminution in the value of the current portfolio of its gold and foreign currency assets. It is loading up its books with a quantum of provision that seems vastly out of proportion to any reasonable notion of what is likely to happen to the value of foreign exchange reserves measured in rupee terms.

Consequently if we examine the size of the foreign exchange reserves (in rupee terms) and the amount credited as a provision for potential diminution in the value of these reserves (again in rupee terms) as of June 30, 2015, the inescapable conclusion is that the RBI would like to protect its balance sheet against a contingency of rupee appreciating by as much as 25 per cent if not more, from its current level of roughly ₹67 to a Dollar.

Let us look at some numbers. According to the Annual Report for the year July-June 2014-15, the RBI had valued its portfolio of foreign currency assets as on June 30, 2015, at ₹21,35,904 crore. Similarly gold holdings had risen up to ₹1,21,607 crore. These assets, from a level that was practically next to nothing in December 1990, had risen gradually over a period of 25 years, since then.

The RBI’s Weekly Statistical Supplement for the fourth week of June 2015 (June 26, 2015) put the foreign currency assets at $332 billion. Since this is very close to the balance sheet date, we might take this itself to be the dollar equivalent of what the balance sheet mentions as the rupee value of foreign currency assets.

In line with the accounting policy of the RBI, this rupee value was arrived at by applying the prevailing exchange rate (rate as on June 30) irrespective of the actual costs at which these were acquired over a 25 year period.

The difference between the actual cost of acquisition and the price at which these are required to be carried in the books is credited to Currency and Gold Revaluation Account as per the accounting policy of the RBI. As of June 30, 2015 the total value accumulated in this account amounted to ₹5,59,193 crore. Of course this amount includes the appreciation in the value of gold (relative to the cost of purchase) to the extent there has been an accretion to the quantum of gold hoard of the RBI.

But considering that gold accounts for roughly only a twentieth of the currency reserves, the bulk of the sum credited to the revaluation account should logically represent the impact of the value changes between the initial rupee cost of acquisition and the rupee value of currency reserves as on the balance sheet date of the RBI. Thus ₹5,59,193 crore works out to 25 per cent of the total portfolio value of gold and currency reserves at ₹21,35,904 crore mentioned earlier.

In theory the sum credited to the provision account is meant to cushion the potential appreciation of the rupee against the US dollar or other foreign currencies constituting the RBI’s basket of currency reserves. For the sake of simplicity let us represent it as US dollars alone.

So the question to be asked is this: what are the odds that rupee will appreciate by 25 per cent to settle at ₹50 to a dollar (67 minus one-fourth of 67) over a five to 10 year horizon? If the odds are so low as to approximate to zero, then does it not lead to the RBI having to write back some of the excess provision to its income statement and the resultant surplus distributed as dividend to the Government of India? It doesn’t have to be done on a judgemental basis alone although accounting standards permit of such an approach to the measurement of ‘fair value’ of assets and liabilities.

But if rigorous statistical models are to be employed then surely it should be possible to obtain empirical data on appreciation of a local currency against a benchmark reserve currency (US dollar) over an extended period to estimate the range within which the currency is likely to trade at, with a high level of confidence about the forecast of such a range.

Should the current provision be in excess of what is statistically deemed to be adequate then the write-back of such excess provision is in accord with the best principles of accounting.

The technical committee set up to examine the accounting policies of the RBI (Technical Committee II, headed by YH Malegam) had recommended that with effect from 2015-16 the valuation principle of ‘Lower of Book or Market value’ for RBI’s portfolio of rupee securities be done away with and in its place, adopt a principle of ‘fair value’ accounting while presenting the financial statements to the general public.

While the switchover to ‘fair value’ accounting in respect of investments in rupee securities is laudable, it is by no means clear why RBI should fight shy of adopting ‘fair value’ accounting to other items of assets and liabilities and more particularly ‘provisions’ created for various contingencies.

Adherence to the highest principles of ‘fair value’ accounting demands that provisions that are no longer required or in excess of actual requirements should be written back and the excess given back to the stakeholders and in this case, the Government of India.

Of course whether the Government uses the money to hike outlays in rural employment programmes or inject additional capital into the public sector banks is a matter for the Government and the elected representatives of the people to decide.

Unfortunately the recent debate about finding resources for meeting the incremental capital needs of public sector banks has been reduced to one of whether the Government ought to dip into the cash chest of RBI or not.

Actually, there is nothing really like a mountain of liquid cash that RBI is sitting on and which ought to be deployed in shoring up the capital base of public sector banks. So that is a non-issue.

But what is, is the one about whether the RBI’s financial statements truly reflect a true and fair view of the state of affairs of its monetary management and in particular, whether the RBI’s Balance Sheet gives a ‘fair value’ of its assets and liabilities.