The Hindu Business Line : Add-on sterlisation tool — Will RBI issue its own securities?

The real dilemma facing the RBI is that its G-Sec holdings have fallen to such low levels, raising questions over the sustainability of its sterilisation operations.

New Delhi , Oct. 12

FISCAL purists and diehard monetarists may abhor the idea of governments running huge deficits and central banks monetising the same.

But it is precisely the legacy of past profligacy that the Reserve Bank India (RBI) has found handy to tackle the present problem of `exogenous' monetary expansion stemming from unbridled capital inflows.

Consider the facts. During the last five years, between October 2, 1998 and October 3, 2003, the value of RBI's foreign currency assets has swelled from Rs 1,11,377 crore to Rs 3,81,023 crore. The same period has seen its holdings of government securities (G-Secs) dwindle from Rs 1,40,622 crore to Rs 72,269 crore.

Simply put, the massive scale of capital flows in recent years has forced the central bank to mop up all the surplus dollars in order to prevent undue rupee appreciation to the detriment of the country's export competitiveness.

While this has led to an unprecedented build-up of RBI's forex reserves, it has simultaneously entailed the release of potentially inflationary rupee resources into the system.

The RBI has, then, had to suck in this primary liquidity, which it has by offloading its stock of government paper.

However, such `sterilisation' would not have been possible, but for the fiscal profligacy of the past.

Till the mid-1990s, a significant part of the fiscal deficit used to be `monetised' through issue of ad hoc treasury bills by the Government to the RBI or through the latter's primary subscriptions in gilt auctions. All this resulted in a substantial accumulation of gilts with the central bank.

The practice of issuing fresh ad hoc bills and automatic monetisation of deficits was discontinued with effect from April 1, 1997, alongside the decision to convert all outstanding ad hocs to non-transferable `special securities' bearing a fixed 4.6 per cent interest in perpetuity.

The Fiscal Responsibility and Budget Management Bill, 2000 has originally proposed to also ban primary subscriptions to gilts by RBI from April 1, 2004, but this provision was dropped in the final Act that was passed by Parliament.

Ironically today, the real dilemma facing RBI is that its G-Sec holdings have fallen to such low levels, raising questions over the sustainability of its sterilisation operations.

Significantly, the Rs 72,269-crore stock of government paper with RBI as on October 3 includes Rs 41,818 crore worth of `special securities', which are non-marketable.

That leaves the central bank with dated marketable stock of only Rs 30,451 crore.

To this, if one adds the outstanding securities of Rs 21,020-crore sold through repo auctions under the Liquidity Adjustment Facility (LAF), the total holding of marketable securities in the RBI's portfolio for undertaking open market operations (OMO) would amount to Rs 51,471 crore. And of this, Rs 11,000-crore of gilts were offloaded in the OMO auction on October 10.

True, the central bank's sterilisation armoury can still be bolstered by converting a part of the Rs 41,818 crore of special securities into regular dated paper.

But then, this option has been repeatedly exercised over the last couple of years, so much so that the stock of special securities have declined from the original April 1, 1997 level of Rs 1,21,818 crore.

According to Mr Saumitra Chaudhuri, Economic Advisor, ICRA Ltd, "a realistic solution could be to allow the RBI to issue its own securities that can be deployed in OMO auctions. This would, however, require an amendment to the RBI Act, 1934, which currently does not permit the RBI to float securities that would form its own, rather than the government's, liability."

"There are some central banks (in Japan, Germany and Thailand) who issue securities on their own account to supplement their conventional gilt holdings. The RBI could perhaps deploy such securities as long-term repo instruments, which are bought back after longer periods beyond the existing 1-14 days," he noted.

`No plan to amend RBI Act'

THE Finance Ministry officials say that there is no proposal as of now to amend the RBI Act to enable the central bank to issue its own securities as an additional sterilisation weapon.

"We have not received any such proposal, though it is quite possible that Mint Street (RBI) is pursuing an exercise on these lines," a top North Block official told Business Line.

A true picture could perhaps emerge when the new RBI Governor, Dr Y.V. Reddy, unveils his maiden credit policy on November 3.

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