Blogs from Our Experts | January 27, 2017
A question that always comes to mind is that who decides How much additional money need to be printed. The answer is RBI. Can it print as much money as it wants to? The simple answer is yes.
In consultation with ministry of finance it decides on the quantum of money to be printed. This is based basically on three things – A. Size of mutilated torned off notes needs to be destroyed, B. Size of the economic growth/budgetary deficit that will require additional currency and C. As and when additional liquidity is required to be infused in the system.
One simple question comes to mind then, if it has the mandate and machines too, then why not it prints a huge amount of currencies.
But mind it, A hundred rupee note is an asset in every ones hand but it is a pure liability in the hand of RBI, because the RBI governor under its seal and sign, promise to pay the value to the bearer of this currency.
If a currency is liability in the balance sheet of RBI, then there must be an equal amount of asset against it. Whenever RBI prints additional notes it infuse this money in the system through `Open Market operation` that is, it buys equivalent amount of bond with this money from individual and institutions and give rupees in purchase consideration. It also buys gold and dollar with this newly printed rupee. It creates liabilities by printing notes and buy asset with this not.
If it has purchased bonds it must be earning interest on it, if gold price has increased it is a capital gain for it. If it had purchased dollar at Rs.60 and now it has gone up Rs.67 it is making extra ordinary gain of rs.7 per dollar. Except some extra ordinary wind fall gain, all other gains after adjusting its own expenses (which is very less barely 3-5% of its total gain), rest is paid out to government as dividend. In August 2016 RBI paid Rs.65,876 crore as surplus dividend to Government.
Through OMO, RBI not always buy bonds and distribute money in the system to infuse liquidity but at times it sells its stock of bond also and suck out additional liquidity from the market. Here it again may make gains if the price of bond has increased. Money collected from market through this system is not given to government, other wise government will re infuse this money in the system through various expenditure, but RBI keeps this money with it and cancel this much of liability from its book. So balance sheet is equal again. Asset gone (sell of Bond), Liabilties gone (cancellation of rupee). In fact this the main difference between OMO and bond auction, where RBI auction the bond on behalf of Government and all the money collected is passed on to the Government.
Now, we are listening in news quite frequently these days that if 5 lakh crore, 4 lakh crore or 3 lakh crore whatever be the amount, if this much of black money is destroyed by the hoarders, it simply means that this much amount of liabilities will automatically be reduced in the balance sheet of RBI but this will happen without any sale of asset from RBI, reduction in asset side will not happen, this will create mismatch in balance sheet. So, in order to match the balance sheet RBI will extinguish that much asset from balance sheet and will show it as one time profit and pay-out dividend to government. Alternatively it may not treatit as revaluation liabilities and will not pay any dividend.