The Reserve Bank of India (RBI) Board meeting to be held on the 19 November is going to be a landmark one based on all the speculation that has been generated in the market. Such board meetings have always been considered to be internal affairs and never evinced any public interest.
The strong difference of opinion between the central bank and the government has toned down in decibel in the last few days. The reason could be that a possible resolution will take place through the official channel which is the Board of Directors. With new members on the honourable board, these issues would probably be taken up for discussion and a decision reached. This will provide guidance on the shape of things to come.
Let us look at some of the pressing issues. First is the one on transfer of government reserves. There has been no official demand made though innuendos have been sent thorough proxy means. The issue is interesting in terms of how it will play out. Let us assume that for argument sake the reserves of the RBI have to be brought down to keep it on par with what happens in other central banks.
This can mean one of the two things. The first is that the balance sheet has to be shrunk by lowering the liabilities. This will imply also that the assets have to come down by a similar amount to tally the balance sheet. If this has to be done then the corresponding assets, which is either FOREX or government securities or both, held have to be sold.
The reserves which are created are notional because when FOREX reserves are at say $400 billion and exchange rate Rs 65, the rupee value would be Rs 26 lakh crore. Now if the dollar becomes Rs 70 then the value goes up by Rs 2 lakh crore which goes into reserves. It is notional in the sense that the reserves have come in from outside and is not real.
If the reserves have to come down, then the dollars have to be sold which is not practical. If securities are sold instead then it will create an upheaval in the market and go against the OMO principle where the RBI is providing liquidity as it will be taking our money form the system.