Firstpost.com
The Indian market may be dreading the US Fed's plan to taper down its quantitative easing programme, but the Reserve Bank of India (RBI) may not be that unhappy about it. Reason: with the gradual withdrawal of QE, interest rates will rise, and with that its own earnings.
The RBI is sitting on large foreign exchange reserves-USD 277 billion at last count - most of which is denominated in dollars. But it earns a pittance on these reserves. Let's call it UPA-under performing assets.
According to the RBI annual report released yesterday, its foreign currency assets (FCA) earned an average of 1.5 percent in interest in 2012-13, almost the same as in the previous year. This is because of the Fed's announced policy of keeping domestic interest rates low due to the economic slowdown.
However, ever since the markets sniffed the possibility of a QE tapering, yields on US government bonds have begun rising. From well under two percent, 10-year US treasury bonds are now inching up to yield closer to 3 percent returns-almost twice what the RBI earned last year on its dollar currency assets (the RBI's accounting year runs from July to June). The current yields are around 2.89 percent on 10-year US treasuries and 3.87 percent of 30-year bonds.
Simple forecast: as QE goes, the RBI's UPA will start performing, delivering better returns.
However, there is another area where rising US growth is bad for the RBI's financial health. In 2012-13, the RBI's gold reserves fell 11.3 percent in value due to the global fall in gold prices. Gold prices are falling largely because investors sense that the US economy may be reviving, and they can't short bonds anymore. Money is being moved from gold to other assets.
Perversely, the falling Indian rupee and the government's response to a rising current account deficit is moving gold in a different direction back home. Thanks to increasing customs duties and the government's efforts to prevent further gold purchases for investment, domestic gold prices are now rising to their old peaks-with current prices ranging well above Rs 31,000 per 10 gm.
In fact, if the RBI had valued its gold based on domestic prices, it would not have reported this kind of loss.
The RBI should thank the government for making gold a worthwhile investment, even while thanking the US Fed for tapering off its QE.
To be sure, foreign currency assets are not the main sources of income for the RBI, and, once again, it has the government's profligacy to thank for this.
The RBI's annual report shows that earnings from domestic sources increased 60.7 percent from Rs 33,366 crore in 2011-12 to Rs 53,611 crore last year largely because of an increase in government borrowings. Put another way, as the fiscal deficit bloats, the RBI prints more money on behalf of the government and earns interest income on it. According to the RBI, "the rate of earnings on average domestic assets increased from 5.4 percent in the previous year to 7.2 percent in 2012-13."
Put another way, the more irresponsible the government gets, the money the RBI's profits. Given that P Chidambaram has no love lost for the current RBI Governor D Subbarao, he should have denied him this pleasure by being less profligate.
But he got his own back when he swiped Rs 33,010 crore in terms of profits transferred back to the exchequer. As the RBI report notes: "After appropriation to reserve funds, the surplus payable to the Central Government amounted to Rs 330.10 billion (Rs 33,010 crore), the largest ever surplus transfer in absolute terms."
In sum, both the RBI and the finance ministry profit from imprudent spending and borrowings.
The writer is editor-in-chief, digital and publishing, Network18 Group
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