Reserving all judgement

Indian Express, 20 December 2004

The Reserve Bank Of India needs to become much more transparent about what exactly it does with its reserves of public money.

What part of Indiaís foreign exchange reserves does the RBI hold in US dollars, a declining currency? How does it make this decision? Who is held accountable if it loses Rs 50,000 crore in its portfolio management?

Think of any other government agency with a portfolio worth Rs 5,00,000 crore. A 10 per cent profit on this portfolio would be a profit of Rs 50,000 crore and a 10 per cent loss would be a loss of Rs 50,000 crore. These are big sums of money ó e.g. when compared with the Rs 40,000 crore required for the Employment Guarantee Act.

How would we deal with such a situation? Good governance requires many steps. We would start with expert committees which would argue, from first principles, what this agency should be doing and why. There would be a governance structure where wise men are put in charge. There would be a clear policy document, which removes all discretion from the hands of staff, and clearly lays out every step of what should be done. There would be copious transparency, where every move of the government agency would be in the public domain. There would be no arbitrary exercise of power. When any decision does not flow from the written down manual, there would be clear accountability for profits or losses. The CAG and Parliament would ask to know why public money is being wasted, and heads would roll when losses are incurred.

Remarkably enough, the RBI, which is sitting on a portfolio of roughly Rs 5,00,000 crore, doing speculative portfolio management, has none of the above strictures.

The reserves portfolio is invested in a basket of currencies across the world. Currencies fluctuate dramatically. The dollar-euro exchange rate, or the dollar-pound exchange rate, has a volatility which is roughly half of the volatility of an equity index.

In the private sector, traders manage portfolios, but the main difference is their accountability. If they earn a profit, they get a bonus. If they make a loss, they get sacked. The staff of RBI has no such incentives: their secretive trading constitutes power without accountability. There is also a major gap between RBI staff and the private sector in terms of skills, IT systems etc in these trading functions.

With the benefit of hindsight, the Indian reserves portfolio management has been pretty bad. We have clung to the dollar for years, while it was very clear that the dollar was a sinking ship. As the value of the dollar has gone down, our reserves portfolio has effectively depreciated. We only have the illusion of stability because we insist on doing measurement in rupees or in dollars. But in reality, India has taken quite a beating on this front.

This is not to suggest that there was malfeasance in these losses. All speculation is risky, and with a 50 per cent chance, it will always be the case that losses are made. The point of this article is not to focus on the loss. It is to focus on good governance. When a government agency trades on markets, and does speculative portfolio management, good governance requires many things, in terms of due process, accountability and transparency. None of those precepts of good governance is being followed today.

As an example, consider transparency. While FII trading on the Indian equity market is reported daily, RBIís trading on the currency market is only reported monthly. Further, there is a huge time lag. As of mid-December, data for RBI trading is only shown for September. What RBI was doing in October, November and half of December is completely non-transparent. In non-transparency lies the exercise of arbitrary power.

How should this situation be remedied? The following five-point action programme should to be put into place:

An expert committee consisting of economists from outside the RBI should be set up, which will write a policy document on how and when RBI should buy or sell in the currency market.

This expert committee should turn into a standing committee that does regular oversight over RBIís trading, and writes quarterly reports about what was done with the public money.

There should be a complete process manual defining what the employees of RBI would do, so as to remove all discretion. This manual should be publicly released, so that everyone knows what the government agency is doing when it is speculating with public money.

There should be daily disclosure of the complete portfolio and of every single trade that is undertaken (on a same-day basis).

Every situation where the staff chooses to diverge from the process manual should generate an exception report, which is reported to the standing committee with explanations.

It is bad for Indian democracy if a pot of Rs 5,00,000 crore is being traded on speculative markets without adequate oversight by Parliament, accountability to the public, and total transparency. This is a glaring oversight in Indian governance which needs to be immediately remedied.

Ila Patnaik