Context
- On August 26, the central board of the Reserve Bank of India (RBI) had decided to transfer a surplus of Rs 1.76 lakh crore to the government-its highest transfer ever-sparking a fierce debate.
- The government was acting on the recommendations of a committee chaired by former RBI governor Bimal Jalan, on capital transfer.
RBI’s earnings
- The RBI is a “full service” central bank— not only is it mandated to keep inflation or prices in check, it is also supposed to manage the borrowings of the GOI and of state governments; supervise or regulate banks and NBFCs; and manage the currency and payment systems.
- While carrying out these functions or operations, it makes profits.
- Typically, its income comes from the returns it earns on its foreign currency assets, which could be in the form of bonds and treasury bills of other central banks or top-rated securities, and deposits with other central banks.
- It also earns interest on its holdings of local rupee-denominated government bonds or securities, and while lending to banks for very short tenures, such as overnight.
- It claims a management commission on handling the borrowings of state governments and the central government.
RBI’s reserves
Besides above earning, the RBI maintains four different Reserves which comprise of assets and earnings. These reserves are:
I. Asset Development Fund
- It aims to meet internal capital expenditure and investments in its subsidiaries to build contingency reserves of 12% of its balance sheet.
- It provides support to the RBI associates like National House of Banking.
II. Currency and Gold Revaluation Account
- The Currency & Gold Revaluation Account (CGRA) makes up the biggest share — it was Rs 6.9 lakh crore in 2017-18.
- This represents the value of the gold and foreign currency that the RBI holds on behalf of India.
III. Contingency Fund
- The Contingency Fund (CF) is a specific provision meant for meeting unexpected contingencies that arise from RBI’s monetary policy and exchange rate operations.
- In both cases, the RBI intervenes in the relevant markets to adjust liquidity or prevent large fluctuations in currency value.
- The CGRA and CF put together constituted 26% of assets
IV. Investment Revaluation Account
- It is the fund available with the RBI to compensate losses and accommodate gains in foreign and domestic securities.
It’s Expenditure
- Its expenditure is mainly on the printing of currency notes and on staff.
- Besides the commission it gives to banks for undertaking transactions on behalf of the government across the country, and to primary dealers, including banks, for underwriting some of these borrowings.
RBI’s surplus
- This represents the amount RBI transfers to the government.
- The RBI isn’t a commercial organisation like the banks or other companies that are owned or controlled by the government – it does not, as such, pay a “dividend” to the owner out of the profits it generates.
- Although RBI was promoted as a private shareholders’ bank in 1935 with a paid up capital of Rs 5 crore, the government nationalized it in January 1949, making the sovereign its “owner”.
- There are two unique features about RBI’s financial statements. It is not required to pay income tax and has to transfer to the government the surplus left over after meeting its needs.
- What the central bank does, therefore, is transfer the “surplus” – that is, the excess of income over expenditure – to the government, in accordance with Section 47 (Allocation of Surplus Profits) of the RBI Act, 1934.
Total Transfer
- The surplus from the central bank comprised two components-Rs 1.23 lakh crore of surpluses for the year 2018-19.
- An additional Rs 52,637 crore of excess provisions that was made available as per the revised economic capital framework recommended by the Bimal Jalan committee.
- Of the Rs 1.23 lakh crore, the RBI has already transferred Rs 28,000 crore to the government in the previous fiscal, which will reflect in RBI’s upcoming annual report.
- The transfer is also almost double the Rs 90,000 crore that was targeted in the Union budget presented by finance minister Nirmala Sitharaman.
The revised Economic Capital Framework
- The RBI had formed a committee chaired by former Governor Bimal Jalan to review its economic capital framework and suggest the quantum of excess provision to be transferred to the government.
- The panel recommended a clear distinction between the two components of the economic capital of RBI i.e. Realized equity and Revaluation balances.
- Revaluation reserves comprise of periodic marked-to-market unrealized/notional gains/losses in values of foreign currencies and gold, foreign securities and rupee securities, and a contingency fund.
- Realized equity, which is a form of a contingency fund for meeting all risks/losses primarily built up from retained earnings. It is also called the Contingent Risk Buffer (CBR).
The revised Surplus Distribution Policy
- It was finalized is in line with the recommendations of the Bimal Jalan committee. It states-
- Any surplus due to the government can be paid only from retained earnings and not by using the notional revaluation reserves.
- The contingent capital buffer has to remain at all times in a band of 5.5 per cent – 6.5 per cent of the RBI’s total balance sheet
- The total economic capital of the RBI needs to be in the range of 20 per cent – 24.5 per cent of the RBI’s total balance sheet
- Adhering to the recommendations, the RBI has decided to set the CBR level at 5.5% of the balance sheet, while transferring the remaining excess reserves worth ₹52,637 crore to the government.
- If CBR is below the lower bound of requirement, risk provisioning will be made to the extent necessary and only the residual net income (if any) transferred to the Government.
- However keeping CBR at a lower range of 5.5%, will reduce RBI’s space to manoeuvre monetary policy.
Issues with the surplus transfer
- The government has long held the view that going by global benchmarks, the RBI’s reserves are far in excess of prudential requirements.
- Former RBI governors Y.V. Reddy and D. Subbarao had publicly opposed such transfers, as did former deputy governor Viral Acharya, who argued such a move could be “catastrophic”.
- Former Chief Economic Advisor Arvind Subramanian had suggested that these funds be utilized to provide capital to government-owned banks.
- The central bank, on its part, has traditionally preferred to be more cautious and build its reserves – keeping in mind potential threats from financial shocks, and the need to ensure financial stability and provide confidence to the markets.
- From the central bank’s perspective, bigger reserves on its balance sheet is crucial to maintaining its autonomy.
- The Opposition criticised the government for “stealing from the RBI”, saying that the government was “clueless about how to solve their self-created economic disaster”.
Govt stance
- The transfer of money from RBI to Government has been going on for years. It is not the first time that the apex bank has transferred its surplus money to the GoI.
- The RBI reserves the right over the surplus money made by it; however, the Government thinks the other way round.
- As per the Government, RBI reserves are filled with way more money than it requires.
- This dilemma has always been an issue of conflict between the Central Government and the RBI.
- This friction was lately seen in December 2018, which forced the then RBI Governor Urjit Patel to resign.
Arguments in favor
- The supporters of the government have been stout in the defence of this move.
- They say that after all a committee headed by a well-regarded former RBI governor has recommended it.
- They also argue that there is no point in RBI accumulating excess surplus and then doing nothing with it when the government can use it to boost the economy.
How will govt use this surplus?
- A major question has to do with what the money will be used for.
- The amount could either be used to provide a fiscal stimulus to the economy-which is in the grip of a slowdown-or to reduce off-balance sheet borrowings, or meet an expected shortfall in revenue collections.
- In the Union budget, the government had presented an optimistic scenario of raising Rs 4.76 lakh crore in additional resources to meet budget expenses.
- However, since there is a clear slowdown ahead, this revenue target may not be met, in which case the surplus from the RBI would be used to bridge the shortfall.
- However, if the budgetary targets are met in the normal course of activity, the government will use the amount as a stimulus.
Way Forward
- The government cannot stop or slow down spending – the economy is already losing steam with exports, private consumption and private sector investment slowing down.
- If the government spending also goes down, it will hit an already beleaguered economy.
- With the economy slowing down and the Goods and Services Tax (GST) not kicking in the expected buoyancy, the shortfall may even be higher.
- The infusion of additional funds, thus, will help the government to substantially overcome this shortfall and achieve the fiscal deficit target without having to axe allocations to social sector and poverty alleviation.
- It needs the money and the RBI is living up to its role as the lender of last resort – except that this is not a loan, and the government is not a bank, which needs a lender of last resort.
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