Biggest growth in RBI's balance sheet in 13 years; and why thats not great news

KEY HIGHLIGHTS

• At Rs 200 lakh crore GDP size, the balance sheet is now around 26 per cent of the GDP

• Over the years, RBI's balance sheet has grown at around 10-12 per cent annually.

• Globally, central banks' balance sheets started rising after 2008-09 when they started pumping in money to save their economies.

• Post COVID-19, most central banks have no option but to chase expansionary liquidity policies.

For the first time in more than a decade, the Reserve Bank of India (RBI)'s balance sheet witnessed a massive growth of over 30.02 per cent in a single year.  The RBI's balance sheet size, which comprises of currency in circulation (liabilities) and foreign exchange reserves (assets) among other items has grown from Rs 41.02 lakh crore in 2018-19 to Rs 53.34 lakh crore. The RBI follows a July-June accounting year.

At Rs 200 lakh crore GDP size, the balance sheet is now around 26 per cent of the GDP. Globally, there has been a rise in the countries' balance sheet because of expansionary liquidity policies. European central bank's balance sheet has grown to over 50 per cent of the GDP of euro zone countries. Similarly, the US Federal Reserve's balance sheet has risen to over 32 per cent of the GDP of US.

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There are two big dangers of a rising balance sheet to a central bank.

Any rise in the foreign assets increases the size of the balance sheet. This brings risks of its own. The RBI in a note has said that the issue (rising forex reserves) assumes special relevance because foreign capital is generally seen to be beneficial to an economy. However, if it is not absorbed into the real economy to finance investment, it can lead to upward pressure on the exchange rate, overheating the economy  and create asset price bubbles. That's the first big danger of a rising balance sheet because of accumulation of foreign assets. These assets are also low yielding since interest rates are near zero.

Secondly, the rise in the reserve money and currency circulation increases the balance sheet size if there is no commensurate rise in the output. This has implications  on inflation and other economic variables. Experts are already hinting at debt monetisation by the RBI. The central bank is already active in open market operations  to buy long-term  government paper and sell short-term paper to reduce the yield in the G-sec market.

The high growth in central banks' balance sheet started post 2008-09 when the global central banks started pumping in money to save their economies. But there was no big unwinding of balance sheet in later years. Post COVID-19, most central banks have no option but to chase expansionary liquidity policies.

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The balance sheet of the Reserve Bank plays critical role in the economy since the bank carries out the function of issuing currency, managing liquidity and reducing volatility in foreign exchange market. Over the years, RBI's balance sheet has grown at around 10-12 per cent annually. In fact, the big rise was in 2011-12 when it grew by 22 per cent plus. The last big jump was in 2007-08 when it rose by 46 per cent at Rs 14.62 lakh crore.

According to RBI, the increase on asset side in 2019-20 was due to increase in domestic and foreign investments by 18.40 per cent and 27.28 per cent, respectively. There was an increase in loans and advances by 245.76 per cent and increase in gold by 52.85 per cent. On the liability side, the increase was due to increase in Notes Issued, Other Liabilities and Provisions, and Deposits by 21.52 per cent, 30.47 per cent and 53.72 per cent, respectively. Domestic assets constituted 28.75 per cent while the foreign currency assets and gold (including gold deposit and gold held in India) constituted 71.25 per cent of total assets as on June 30, 2020 as against 28.03 per cent and 71.97 per cent, respectively as on June 30, 2019.

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