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India Strategy - RBI reserve bonanza to fund stimulus

Dr Bimal Jalan Committee report on ‘Economic Capital Framework’ is of paramount importance and is expected to be presented after of the upcoming budget (5 July 2019). Importantly, extracting RBI’s surplus reserve to pay dividends to GoI is pertinent amid exhausting fiscal space and tardy transmission of earlier monetary easing. RBI’s excess reserve is estimated at Rs3.8trn, and if restricted to contingency reserve, at Rs1.5trn at the lower end. As PSBs are mostly capitalised, GoI is looking to use the buffer to frontload fiscal stimulus to counterbalance the pervading slackness in economic growth. GoI’s focus on rural & farm sectors and unemployment implies gains in household disposable incomes, which could likely resurrect the sagging consumption demand.

Questions addressed in this note: a) Why is RBI’s reserve transfer important? b) How will GoI use it? c) Potential excess reserve? d) Which reserves of RBI’s are relevant? Is it fine to strip out revaluation reserve? e) Will GoI gain cash flow? f) How do we position IDFC India Portfolio?

Antidote to ongoing slowdown: India’s economy urgently needs stimulus, given its multipronged slowdown. As influence of traditional counter-cyclical tools has diminished due to the exhausted fiscal latitude and slow transmission of monetary easing, RBI’s excess reserve would be used to fund the fiscal stimulus. (Pages 1-9)

Reserve transfer will boost consumption: PSB recap mostly done: With the PSB recap mostly done (Rs400bn required over next 12 months), GoI may use bulk of the reserve transfer for fiscal spending and focus on the agri sector, rural economy, job creation and in providing consumption impetus. Higher government revenue spending demonstrates high responsiveness for discretionary consumption items like: a) furniture, home furnishing, home appliances, b) food, beverages & tobacco, c) clothing & footwear, d) Personal care and e) Automobiles. (Pages 10-12)

An estimated Rs 3.8tn of RBI’s Rs10trn capital can go out as dividend: RBI’s total assets is estimated at Rs40.6trn (FY19E, Jun 2019 ending). Of this, Other liabilities & Provisions at Rs11.5trn, represents RBI’s capital, which comprises 28% of total assets (32% in FY18). The same is very high on global comparison and also against the expected portfolio risk RBI can face. Of this, the key components, Contingency Reserve (CR, accumulated undistributed profit) and Revaluation Reserve (RR, revaluation portion of forex reserve) are estimated at Rs10.1trn, which is subject to extraction for paying off special dividend. Using estimates of Value at Risk (VAR), we estimate excess reserve at Rs3.8tn. However, if we restrict to CR, excess reserve would have a lower bound of Rs1.5trn. In our opinion, utilizing valuation gains on Forex assets to pay dividend does not conform to existing accounting rules, with monetary policy ramifications. (Pages 13-19)

Possible scenarios of reserve transfer: We illustrate flow of transactions between RBI and GoI. Effectively, the transfer of reserve to GoI and its usage for bank recap is cashless. If used for fiscal spending, there will crowding out of bank lending to private sector. In all cases, supply of Gsecs in the market would rise, enabling monetisation through RBI’s repo and OMOs. (Pages 20-23)

Introducing IDFC India Portfolio: We introduce our IDFC India portfolio, aligning it to the theme, thus taking take a positive view on the consumption oriented sectors, which have seen a soft patch over the past two quarters; Consumer goods and autos in particular; top Over weights (OW) are Hero Motors, HUL, Dabur and Marico. Sustenance of demand visibility and potential weakening in INR/USD will likely overweigh margin concerns in ITES space; OW HCL Tech & TCS. Banking is equal weigh largely due to steep run up some stocks; ICICI Bank & Axis banks are OW. We like MMFS in the NBFC space (UW). Slight OW on Metals (Tata Steel & NMDC). Other Under Weigh (UW) sectors: Telecom, Media, Power Utilities and O&G. (Pages 24-25).​