The math behind RBI’s Rs 1.76 lakh crore surplus transfer to the Central Government

BL Research Bureau

The Bimal Jalan Committee-recommended surplus transfer by the Reserve Bank of India (RBI) has offered a much-needed respite to the Centre, in the current fiscal. Excluding the Rs 28,000 crore interim dividend already paid by the RBI to the Centre last fiscal, the Rs 1,48,051 crore of transfer in the current financial year, could make up for the shortfall in tax collections to a great extent.

True, the market had already pencilled in some windfall gains by way of RBI’s higher than the usual dividend, but what has come as a surprise is the one-time bonanza, rather than a staggered pay out as was broadly expected.

While the Centre dipping into the RBI’s coffers, to meet its fiscal deficit, has not gone down well with many economists and market players, what offers some comfort is the fact that the committee has decided to keep the RBI’s revaluation reserves out of the funds that can be distributed. Also, given that much of the excess provisions under the RBI’s contingency fund has been transferred in the current fiscal year, a similar pay out may not happen in the next financial year. This mitigates the concern over the Centre dipping into the central bank’s coffers time and again for its needs.

On the flip side though, with the contingency fund now at the lower band of the desired 5.5-6.5 per cent of the balance sheet, the RBI is left with little wiggle room in future.

Read: Surplus bonanza: RBI to transfer ₹1.76-lakh crore to government

What the committee recommends

Before we delve into what the Jalan panel report recommended, let us break down the reserves of the RBI.

The RBI’s reserves consist of currency and gold revaluation account (CGRA), the investment revaluation account, the asset development fund (ADF) and the contingency fund (CF). The CGRA makes up the chunk of the reserves and has gone up substantially since 2010---at a compounded annual growth rate (CAGR) of 25 per cent to Rs 6.91 lakh crore in 2017-18. It essentially reflects the unrealized gains or losses on the revaluation of forex and gold.

Next, the CF constitutes over a fourth of the RBI’s reserves. The CF is a specific provision made for meeting unexpected contingencies from exchange rate operations and monetary policy decisions. The RBI contributes a notable portion of its profit to the CF.

The IRA is sub-divided into IRA-foreign securities (IRA-FS) and IRA-rupee securities (IRA-RS). The former reflects the unrealised gain or loss on the mark-to-market of foreign securities while the latter is on account of marking rupee securities. The ADF has been created to meet internal capital expenditure and make investments in subsidiaries and associated institutions.

The IRA and ADF constitute a small portion of the RBI’s reserves.

A peek into RBI's key reserves

CGRA: currency and gold revaluation account, CF: Contingency Fund

Arriving at the surplus transfer

The amount of surplus that the RBI must transfer to the Centre is determined based on two things---realized equity and economic capital.

The ‘realized equity’ is the risk provisioning made primarily from retained earnings referred to as the Contingent Risk Buffer (CRB). This is essentially the existing amount in the RBI’s CF. The Jalan panel has recommended that the CF be maintained within a range of 6.5 per cent to 5.5 per cent of the RBI’s balance sheet.

The current CF outstanding stood at 6.8 per cent of the RBI’s balance sheet and hence, the excess from the pre-decided range of 5.5-6.5 per cent is written back. Here, the panel decided to go with the lower threshold of 5.5 per cent and hence the excess Rs 52,637 crore has been written back (to be transferred to the Centre).

Two, at the aggregate level, the panel suggests maintaining economic capital--- realized equity and revaluation balances (essentially CGRA)—at a range of 24.5 per cent to 20 per cent of balance sheet. Since it stood at 23.3 per cent as of June 2019---within the desired range, the entire net income of the RBI of Rs 1,23,414 crore for the fiscal (without transferring to the CF) has been transferred to the Centre as surplus.

Hence a total of Rs 1,76,051 crore has been paid out to the Centre.

What’s of concern?

The RBI had been contributing a chunk of its profit to the contingency fund up to 2012-13. Between 2010-11 and 2012-13, the RBI had set aside 32-45 per cent of its gross income to this fund. Hence CF was a high 9-10 per cent of total assets.

Additions to this fund though had ceased since 2013-14. The entire surplus in the RBI’s coffers was being transferred to the Centre. But from 2016-17, the RBI once again started transferring funds to the CF. The CF has been 6-7 per cent of assets over the past three to four years.

The Jalan panel has chosen to opt for a lower 5.5 per cent level for the CF (as against the upper end of 6.5 per cent). This is the lowest level that the RBI has maintained thus far under the fund. This lowers the RBI’s flexibility to manoeuvre in future.

May not repeat

The current year’s transfer from the CF has also lowered the buffer for excess transfer of provisions next year. A strong growth in balance sheet may in turn, require the RBI to transfer some portion of its earnings to the CF next year to maintain the 5.5 per cent threshold, eating into the surplus funds accruing to the Centre. Over the last eight years, the RBI’s balance sheet has grown by 10-11 per cent annually.

Secondly, the net income of Rs 1,23,414 crore earned by the RBI 2018-19 (July - June), is quite large. In 2017-18, the RBI had earned a net income of Rs 50,000 crore. Such a robust growth may also not recur next year.

The strong net income in 2018-19 may have come about due to the net interest on LAF (liquidity adjustment facility) operations turning positive after being negative for two years.

In 2016-17, the net interest on LAF operations slipped to a negative of Rs 17,426 crore. Banks flush with funds post-demonetisation lent to the RBI through the reverse repo option under LAF. The interest paid by the RBI to the banks under reverse repo in 2016-17 had eaten into its income. In 2017-18, lower surplus liquidity in the banking system vis-a-vis the previous year led to a lower interest outgo for the RBI under reverse repo window. The RBI’s net interest income from LAF operations, increased by about Rs 7,900 crore in 2017-18, though still a negative Rs 9,541 crore, owing to continuing interest outgo under reverse repo.

It is possible that in 2018-19, the net interest income was positive owing to tight liquidity, leading banks to borrow from the RBI, earning it a tidy income.

Such a steep growth in net income may not necessarily recur, hence limiting the funds transferred to the Centre next year.

Spend prudently

For the current year though, the huge amount handed over to the Centre may just do the trick on the fiscal deficit front. Over Rs 65,000 crore or so of additional non-tax revenues (than what was budgeted for FY20) on account of the RBI’s dividend, can make up for the shortfall in the Centre’s tax collections to a great extent.

Based on CGA provisional figures for FY19 (in which income tax grew by a modest 7 per cent), the estimated growth in income tax collections for FY20 works out to 23 per cent. For April-June, CGA data suggests that the net revenue growth from direct taxes was just 9.7 per cent. There is a lot of uncertainty over goods and services tax (GST) collections too. Hence the RBI’s surplus could boost overall revenue for the Centre and help meet its fiscal deficit target.

However, the manner in which the funds are used will be critical. The share of capital expenditure as a per cent of GDP has been falling in recent years. In India, the bulk of government spending is mostly biased towards boosting consumption rather than investments. This time around, the Centre will need to put the RBI’s surplus funds to productive use, that can have a sustainable multiplier impact on overall growth in the economy.