Central Bank preparing for a rainy day

Contrary to expectations of a massive surplus transfer to the government, the central bank raised its Contingent Risk Buffer (CRB) by 50 basis points to 6%, when the Economic Capital Framework adopted in 2019 prescribed the 5.5% to 6.5% range.

It was a bumper year for the RBI with its income rising 47% to ₹2.35 lakh crore, driven by its interventions in the currency market and narrowing of losses from domestic market interest payments, as excess liquidity tapered off.

“With a record $200 billion gross US dollar sales, profits were healthy,” said Anubhuti Sahay, economist at Standard Chartered.

With the highest income gains, it transferred ₹1.30 lakh crore to the Contingency Fund, taking the CRB to 6%, and transferred ₹87,416 crore surplus to the government.

The RBI is probably preparing for more volatile financial markets amid bank blow-ups in the US, the fallout of the US debt ceiling debate, and a markedly slowing global economy.

“This signals a preference to maintain sufficient headroom via the risk provisioning mechanism to cover against upcoming operational, monetary, and credit risks in light of spillover risks from unexpected financial market volatility and uncertainties,” said Radhika Rao, economist at DBS.Foreign exchange reserves that fell more than $100 billion from their peak are back near the $600-billion mark. The Indian rupee is expected to even appreciate this year as foreign portfolio flows resume, with the China trade fizzling out.

When things brighten for the economy in general, that may not necessarily be good for the central bank’s income.

“The RBI probably may not get many opportunities (to sell forex in the currency markets) to book that kind of gains,” said A Prasanna, head of research at ICICI Securities Primary Dealership. “The CAD (Current Account Deficit) is likely to narrow and the Balance of Payments may record a surplus this year.”

This strengthening comes amid a general weakening of central bank balance sheets with many private calculations showing that central banks are in paper losses and their equity probably eroded. The Reserve Bank of Australia’s equity is wiped out due to mark-to-market losses from bond holdings.

A higher transfer also provides room for the RBI to pay to the government when the fiscal chips go down, as the current year poses challenges to the economy.

“Fiscal dynamics have a lot of moving parts – with a potential undershoot of nominal GDP growth, lower tax buoyancy, an overly tight budget for revenue expenditure, and ambitious capex targets,” said Aurodeep Nandi, economist at Nomura Securities.

RBI may not have recourse to funding from the government in case its position gets like that of some advanced economy central banks because of years of Quantitative Easing. But it is probably better positioned than some of its peers.

“The RBI’s economic capital is higher than many of its peers, which reflects the underlying preference for strengthening the institution’s financial resilience,” said Rao of DBS. “A resilient institutional backbone is a key structural strength for the economy.”