RBI incurs ₹94,000 crore loss as foreign treasury yields spike

The Reserve Bank of India (RBI) incurred a loss of over ₹94,000 crore in FY22 on its foreign investment accounts as treasury yields on foreign securities, primarily US T-bills, rose amid growing signs of a tightening of the easy monetary policy by the US Federal Reserve and other global central banks. Since prices and yields move inversely, when bond yields rise, prices fall. As a result, the RBI had to incur mark-to-market loss on its portfolio.

The RBI annual report for FY22 states that the foreign dated securities are marked-to-market on the last business day of each week ending Friday and the last business day of each month and the unrealised gains/losses arising therefrom, are transferred to the investment revaluation account-foreign securities (IRA-FS). The IRA is a cushion against changes in the security prices over the holding period.

Following the yield spike, the balance in IRA-FS decreased from ₹8,853.67 crore as on March 31, 2021, to negative ₹94,249.54 crore as on March 31, 2022, following an increase in yields across the maturities in all the major markets.

The yield on benchmark 10-year US treasury note began 2021 at 0.91%, hitting a high of 1.77% in March 2021 and, finally, ended the year at 1.51%. But, by March 2022, the yield had further risen to 2.33% as inflation hit a four-decade high in the US even as Russia sparked off a geo-political crisis.

Consequently, the central bank's expenditure surged from ₹34,146 crore in FY21 to ₹1,29,800 crore in FY22 as it had to transfer ₹1.1 lakh crore to the contingency fund during the fiscal to erase a debit balance of ₹94,249.54 crore in the IRA-FS. As a result, the balance in the fund rose to ₹3,10,986.94 crore compared with ₹2,84,542.12 crore as on March 31, 2021. The charge to the fund is reversed on the first working day of the following year.

Contingency fund is a specific provision created for meeting unexpected and unforeseen contingencies, including depreciation in the value of securities, risks arising out of monetary/exchange rate policy operations, systemic risks and any risk arising on account of the special responsibilities enjoined upon the RBI.

As of March 2022, India was the 13th largest holder of US treasuries with net exposure of $199.8 billion, substantially lower from $220 billion seen as of June 2021. It's not clear if the fall is on account of the decline in US T-bill prices or whether the RBI has pro-actively sold off treasuries in the open market.

Following the losses there is nil balance in the IRA-FS account. "There is now precisely zero buffer," points out Josh Felman, principal at JH Consulting, the Washington DC-based macroeconomic consulting firm, and also the former India representative of the IMF from 2006 to 2008. The buffer in the rupee account (IRA-RS) too has fallen -- from ₹93,415 crore in March 2020 to ₹18,578 crore. Felman believes as interest rates continue to rise, provisions will soar. "Then RBI profits will really crash. Consider yourself warned," tweeted Felman.

However, with the 10-year yield falling to 2.745% on May 27, from a high of 3.106% seen a couple of days before - its highest level since 2018 - the expectations are that the RBI may not incur significant losses as it did in FY22. "With the yields cooling off, I don't see the RBI incurring significant losses in FY23," says Madhavi Arora, economist at Emkay Global Financial Services.

Though the Fed on May 5 hiked interest rates, marking the largest single hike since 2000, chairman Jerome Powell said a 75-basis-point hike was not something the Federal Open Market Committee was "actively considering".

A deadly concoction of the US yield spike and the Russia-Ukraine conflict has pulled down India's foreign exchange (forex) reserves from it's all-time high of $642.45 billion in September 2021 to $597.5 billion in the week ended May 20, 2022. In fact, since the Russia-Ukraine conflict began in the last week of February, the reserves have kept declining even as the rupee fell to 77.57 against the greenback.