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Insights into Editorial: Government should use RBI funds in a prudent manner


Insights into Editorial: Government should use RBI funds in a prudent manner


Context:

On August 26, the central board of the Reserve Bank of India (RBI) 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, it must be noted, acting on the recommendations of a committee chaired by former RBI governor Bimal Jalan, on capital transfer.

Some economists have welcomed the move as it will help the government counter the shortfall in revenue and tax collection.

Since inflationary pressure is low, economists believe that the move will not have a negative impact in the long run.

Another group of economists which include the likes of Raghuram Rajan and former RBI governor Urjit Patel said earlier that the move could put RBI in a vulnerable position apart from diminishing its autonomy.

 

Bimal Jalan committee Recommendations:

  • The surplus from the central bank comprised two components-Rs 1.23 lakh crore of surplus for the year 2018-19 and 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.
  • It suggested that the framework may be periodically reviewed after every five years.
  • It recommended to align the central bank’s accounting year with the financial year, which could reduce the need for paying interim dividend.
  • The panel recommended clear distinction between the two components of economic capital, realised equity and revaluation balances. This is because of the volatile nature of the revaluation reserves.

 

  • Only realised equity built from profits must be distributed. The panel recommended that the Contingency Fund be maintained within a range of 6.5% to 5.5% of RBI’s balance sheet.
  • Hence, the excess from the pre-decided 5.5% level or Rs. 52,637 Cr has been written back, that is transferred to the Centre.
  • Revaluation gains from market fluctuations on foreign currency, gold or other assets must be retained. Revaluation balances were not distributable.
  • Hence bulk of RBI’s legacy reserves are ring-fenced from transfer demands.
  • The Bimal Jalan committee should also be complimented for clearly specifying that the revaluation reserve cannot be used to bridge shortfalls in other reserves.

 

Every year RBI transfer the surplus to government:

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.

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”.

 

What is special about the pay out this time?

Yes, the RBI does transfer its surplus annually to the government, the owner of the institution, after making adequate provisions for contingencies or potential losses.

The profit that is distributed has varied, averaging over Rs 50,000 crore over the last few years.

Now, the RBI Board accepted the recommendations of a committee headed by former Governor Bimal Jalan on transfer of excess capital.

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.

 

What are the sources, RBI generate money?

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.

 

Expenditure for RBI:

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.

 

However, In most countries, 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.

 

Filling the Revenue Gap in the government’s account deficit:

Another 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.

While this is surely a big gain for the government, it will have a tough time justifying the transfer of such a big amount into its kitty.

 

Conclusion:

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 pay-out 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.

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