Thread by @SahilKapoor

A Thread🧵 on RBI's Annual Report

The Reserve Bank of India released its annual report for 9 months ending March’21. The central bank, in its continued focus on growth, is focused on growing economic uncertainty and says there are “downside risks” to the economy.

RBI has been proactively focusing on growth with a series of steps ranging from maintaining liquidity surplus in the interbank market, cutting interest rates in FY21, moratorium on repayments, loan restricting for impacted sectors and LTRO/TLTROs for easing financial conditions.

In its assessment of the post pandemic economy - its “conduct of monetary policy in FY22 would be guided by evolving macroeconomic conditions, with a bias to remain supportive of growth till it gains traction on a durable basis while ensuring inflation remains within the target.”

RBI’s balance sheet grew ~7% in FY21 (9 months due to change of accounting year), or nearly Rs. 3.7 Lakh crores to 57 Lakh Crore. The central banks’ balance sheet as a percentage of GDP now stands at ~ 29% vs ~26% earlier.

Its income fell 11% and expenditure also fell by ~63%.

On account of lower provisioning the RBI had a surplus of Rs. 99,122 Crores vs Rs. 57,128 crores which it transferred to the Central Government. This is in comparison to a surplus transfer of Rs 53,510 estimated by the government during the budget.

The significant drop in expenditure is on account of reduced employee cost (-46%) and lower provisioning of about Rs. 20,710 crores vs Rs. 73,615 crores last year.

RBI’s income came in at Rs. 1.33 lakh crores fell 10% mainly due to a 37% fall in its income from interest.

This was because of lower interest rates, both globally and in India, and making payments for outsized reverse repos this year.

It’s other income rose 60% or Rs. 23,876 largely on account of foreign exchange transactions (Dollar sales), to the tune of ~ Rs. 20,636.

The jump in other income due to foreign exchange transactions is a reflection of a change in accounting policy. On the recommendation of Bimal Jalan committee, it was decided that any sales of foreign currency would be compared with the weighted average holding cost ...

...of the currency, and this difference would be taken to the RBI’s income statement as realized profit or loss. In the earlier policy, the central bank compared any sales to the weekly revaluation rate, which left very little by the way of profit or loss.

Takeaways -
The complexion of RBI’s balance sheet - A closer look at the RBI balance sheet indicates that RBI continues to hold its lions shares of Dollar assets through Foreign bonds to the tune of Rs. 39.5 Lakh crores, Rs. 13.3 Lakh crores of domestic and 1/2

Government of India bonds and rest in other assets including Gold. This indicates that RBI’s ability to support government of India borrowing programs through its own balance sheet remains underutilized. 2/2

Ability to Support Fiscal Policy - RBIs balance sheet remains robust to support monetization to the tune of 1.5% to 2% of GDP if the bank chooses to enact such a policy. This could provide a catalyst for the Central Government to enact a strong, stable and decisive stimulus

The Shades of Stimulus - In its finding on what drivers’ economic recovery after a crisis it suggests a role of investment led recovery for a sustainable post COVID rebound. However, it highlights that at the current low-capacity utilization rates and volatile HFIs, a durable 1/2

revival in private consumption and investment demand together would be critical for a stable recovery. This means, the next round of stimulus from GOI, could be a mix of policies to revive demand, (probably through cash transfers, tax cuts) and investment revival interventions.

The Rationality of Stock Prices- RBI uses an ARDL model to estimate, by regressing, stock prices (Sensex) on money supply M3, OECD composite lead indicator - CLI and foreign portfolio investments in the secondary equity market for the period Apr’05-Dec’20.

The results indicate that “stock price index is mainly driven by money supply and FPI investments.”
It goes on to say – “This assessment shows that liquidity injected to support economic recovery can lead to unintended consequences in the form of inflationary asset prices and

providing a reason that liquidity support cannot be expected to be unrestrained and indefinite and may require calibrated unwinding once the pandemic waves are flattened and real economy is firmly on recovery path.”

It also uses the standard PE model and analyses dividend yields to argue that equity markets are overpriced.

Interestingly many central banks in the past have indicated their comfort/discomfort with equity prices and valuations.

Most famous being the US Fed chair Alan Greenspan’s displeasure with equity valuation back in 1997 after which US stocks rallied for nearly three years. Recently the US Fed Chair, Jerome Powell, said that equity markets are priced reasonably if the impact of ultra-low and

Zero Interest Rate policy is taken into account. In any case, it shows that equity markets remain a mysterious place, even to the smartest and most well informed, and aren’t easy to value. It also highlights that discipline is the biggest edge and time the fastest friend.