RBI: Why a ‘joint family’ story from the past is creating a buzz todayhttps://indianexpress.com/article/business/business-others/rbi-central-board-budget-government-5452696/

RBI: Why a ‘joint family’ story from the past is creating a buzz today

This story of a “joint family approach”, being shared in a small circle of past directors of the RBI Central Board, holds much relevance in the context of the current debate on the optimal level of reserves the Reserve Bank must hold. 

At present, the RBI Central Board has 18 members
In June 1994, while finalising its balance sheet, the RBI realised it was unable to provide for the exchange loss liability on account of a foreign currency deposit scheme offered by banks since 1975. (Express Photo by Pradip Das)

THE GOVERNMENT is today seen as raiding the central bank’s reserves but 25 years ago, it had agreed to provide from its own Budget when the Reserve Bank of India was staring at the prospect of a loss for probably the first time in its history. This story of a “joint family approach”, being shared in a small circle of past directors of the RBI Central Board, holds much relevance in the context of the current debate on the optimal level of reserves the Reserve Bank must hold.

In June 1994, while finalising its balance sheet, the RBI realised it was unable to provide for the exchange loss liability on account of a foreign currency deposit scheme offered by banks since 1975. “RBI’s balance sheet was going to be in the red. It could have been an embarrassing position,” said a source, who did not wish to be named. The scheme was called the Foreign Currency Non-Repatriable Deposit Scheme, or FCNR-A, and was introduced to attract capital inflows and help finance deficit in the current account. Prodded by the government, banks offered interest rates higher than what they offered on local deposits. These deposits ballooned in the 1980s.

The RBI had agreed to provide exchange guarantee on these deposits. It didn’t think too much into the future then, and had a simple rationale: the dollars were added to foreign currency assets, these were revalued when the rupee depreciated, and so the revaluation gains would be available for meeting losses during repayment of principal. The interest to be paid on the FCNR-A deposits would be met through earnings on the dollars invested abroad.

Read | Decoding RBI’s Central Board

Essentially, it was a no loss, no gain scheme, as long as the dollars remained with the RBI.

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But then, India was hit by a Balance of Payments crisis in the late 1980s. According to sources familiar with the developments then, the forex assets depleted fast and even the $1.1 billion of assets in 1991 represented dollars sold forward under a separate swap arrangement with State Bank of India. The losses from 1991 till 1994 were met by drawing from the Exchange Equalisation Account and the Contingency Reserve of the RBI. By 1994, both these reserves were fully depleted, and there was no source for providing for exchange losses on $10-billion worth dollar liabilities under the FCNR-A scheme.

The FCNR-A liabilities comprised $5 billion in principal and $5 billion in accrued interest. The average rate at which these dollars were bought was about Rs 16 a dollar. In 1994, the exchange rate was almost double at Rs 31.37, meaning the RBI had to bear a loss of Rs 15 more on every dollar. The total loss added up to Rs 1,500 crore.
When contacted by The Indian Express, Montek Singh Ahluwalia, who was the finance secretary then, said that he did recall the situation but didn’t remember the exact details of this “joint family approach”. At the time, Manmohan Singh, who later became the prime minister, was the finance minister, C Rangarajan the RBI Governor and Shankar Acharya the Chief Economic Advisor.

A former RBI board member said: “I think there was a board meeting in Bangalore where the top brass had huddled for a solution. And an ingenious solution was worked out between Janaki Kathpalia in the ministry of finance’s budget division and R Janakiraman, deputy governor in RBI. The RBI’s books were kept on actual basis, the government’s on a cash basis.”

The board member said: “It was decided that from 1994, all losses on FCNR-A scheme would be met by the government on a cash basis, viz, on the actual dollar sold during the year under the scheme to enable the banks to meet their dollar outflows. Thus, provision for the exchange loss on accrual basis as required by RBI’s accounting policy would not be necessary. The RBI agreed to transfer additional profits to the government to meet such liability every year.”

In Budget 1994-95, the government provided Rs 365 crore for taking on its books the RBI liability due to exchange losses on the FCNR-A deposits.

Ahluwalia said that since then, the government decided that the exchange risk should be borne by the banks themselves instead of the RBI. In the FCNR-B scheme launched subsequently in 1994, banks bore the exchange risk.
“Certain relaxations were provided to the banks in terms of their statutory liquidity ratio (SLR) requirements,” Ahluwalia said. SLR refers to the portion of bank liabilities that need to be kept in the form of cash, gold and government securities.