HOW AND WHY RBI TRANSFERS TO GOVERNMENT
28, Aug 2019
Prelims level : Economics- Banking Mains level : GS-III- Indian Economy and issues relating to planning, Mobilization of Resources, Growth, Development and employment.
- The Reserve Bank of India (RBI) will transfer ₹1.76 trillion to the government this fiscal.
- RBI Board accepted the recommendations of a committee headed by former Governor Bimal Jalan on transfer of excess capital.
- Based on the panel’s report, the Central Board decided to transfer a surplus of Rs 1.23 lakh crore and Rs 52,637 crore of excess provisions made over the years.
- This marks the first time the RBI will be paying out such a huge amount, a one-off transfer.
- Earlier, the government had budgeted for Rs 90,000 crore from the RBI as dividend for this fiscal year.
- This practice was that started in 2016-17, only under exceptional circumstances.
Bimal Jalan Committee:
- The committee recommends that the framework may be periodically reviewed every five years. Nevertheless, if there is a significant change in the RBI’s risks and operating environment, an intermediate review may be considered.
- The Jalan panel recommended a surplus distribution policy, which targets the level of realized equity to be maintained by RBI within the overall level of its economic capital, a statement by RBI said on Monday.
- The committee defines economic capital as a combination of realized equity and revaluation reserves.
On what rationale was such a huge payout approved?
- The level of surplus or profits the RBI pays to the government has been an issue of conflict two for long.
- Over the last decade or more, the government had sought higher payouts saying the RBI was maintaining reserves or capital buffers that were much higher than many other global central banks’ buffers.
- The government has argued that such relatively lower transfers crimped public spending for infrastructure projects and social sector programmes, considering the pressure to meet deficit targets and to provide space for private firms to borrow.
- With the government amplifying its demand for a higher transfer, the Jalan committee reviewed the capital structure, statutory provisions and other issues relating to the RBI balance sheet.
- After making a distinction on the RBI’s capital structure especially on unrealised gains (which are essentially gains not booked) and taking into account the role of the central bank in ensuring financial stability, potential risks and global standards, the committee suggested a total transfer of Rs.1.76 lakh crore.
How does the RBI generate surplus?
- A significant part comes from
- RBI’s operations in financial markets, when it intervenes for instance to buy or sell foreign exchange;
- Open Market operations, when it attempts to prevent the rupee from appreciating;
- as income from government securities it holds;
- as returns from its foreign currency assets that are investments in the bonds of foreign central banks or top-rated securities;
- from deposits with other central banks or the Bank for International Settlement or BIS;
- besides lending to banks for very short tenures and management commission on handling the borrowings of state governments and the central government.
- RBI buys these financial assets against its fixed liabilities such as currency held by the public and deposits issued to commercial banks on which it does not pay interest.
- The RBI’s expenditure is mainly on printing of currency notes, on staff, besides commission to banks for undertaking transactions on behalf of the government and to primary dealers that include banks for underwriting some of these borrowings.
- The central bank’s total costs, which includes expenditure on printing and commissions forms, is only about 1/7th of its total net interest income.
Why are these called transfers to the Government, rather than dividends?
- That is because the RBI is not a commercial organisation like banks and other companies owned or controlled by the government to pay a dividend to the owner out of the profit generated.
- Though it was promoted as a private shareholders’ bank in 1935 with a paid-up capital of Rs 5 crore, the government nationalised it in January 1949, making the sovereign the “owner”.
- What the RBI does is transfer the surplus — excess of income over expenditure —to the government.
- Under Section 47 of the RBI Act, “after making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation funds and for all other matters for which provision is to be made by or under this Act or which are usually provided for by bankers, the balance of the profits shall be paid to the Central government”.
Globally, what are the rules relating to payment of dividends by central banks?
- In many top central banks — US Federal Reserve, Bank of England, German Bundesbank, Bank of Japan— the laws make it clear that profits have to be transferred to the government or the treasury.
- The quantum of profits or percentage to be distributed is also specified in the laws.
So, what is the difference in India now and compared to the past?
- The quantum is discussed and decided between the government and RBI.
- Periodically, this has been guided by policies set out internally, as last time when a committee headed by Y H Malegam recommended distributing 100% of the profits made during Raghuram Rajan’s time.
- The difference now is that the Jalan committee’s recommendation on a profit distribution policy has been endorsed by the Central Board.
- That will mean a more transparent and rule-based payout from next year, as in many other central banks, which could help narrow differences between the government and RBI.
What can the government do with this huge surplus?
- Normally, the money is transferred to the Consolidated Fund of India from which salaries and pensions to government employees are paid and interest payments done, besides spending on government programmes.
- The large payout can help the government cut back on planned borrowings and keep interest rates relatively low.
- Besides, it will provide space for private companies to raise money from markets.
- And if it manages to meet its revenue targets, the windfall gain can lead to a lower fiscal deficit.
- The other option is to earmark these funds for public spending or specific projects, which could lead to a revival in demand in certain sectors and boost economic activity.
What are the Potential Issues relating to a Higher Payout?
- That has been articulated by former Governor Rajan.
- According to him, much of the surplus the RBI generates comes from the interest on government assets (securities or bonds) or from capital gains made off other market participants.
- When this is paid to the government, the RBI is putting back into the system the money it made from it; there is no additional money-printing or reserve creation involved, he says.
- But when the RBI pays additional dividend, it has to create additional permanent reserves or, more colloquially, print money.
- So, to accommodate the special dividend, the RBI will have to withdraw an equivalent amount of money from the public by selling government bonds in its portfolio, he says.
Why do central banks hold back on Transferring Large Amounts?
- Especially after the global financial crisis when central banks had to resort to unconventional means to revive their economies, the approach has been to build adequate buffers in the form of higher capital, reserves and other funds as a potential insurance against future risks or losses.
- A higher buffer enhances the credibility of a central bank during a crisis and helps avoid approaching the government for fresh capital and thus maintain financial autonomy.
Given conflict in the past, how was the distribution of profits settled this time?
- In his memoir, former RBI Governor D Subbarao had written how arguments on this would go on year after year but a settlement would be reached with some flexibility shown by both sides.
- “Even though contentious, (it) has never turned acrimonious,” he wrote a couple of years ago.
- That wasn’t the case last year and in the first half of this year.
- As the government’s nominee on the Jalan committee, Garg had submitted a dissent note.
- His exit from the Finance Ministry and the entry of the new Governor, Shaktikanta Das, and Garg’s successor Atanu Chakraborty and backroom talks, may have led to the flexibility of approach that Subbarao indicated in his book, and the resultant decision on a record payout.