The transfer of Reserve Bank of India’s (RBI) surplus to the government is a routine matter, in accordance with Section 47 of the RBI Act, 1934. Every year, after the finalisation of the accounts of the RBI, the excess of its income over expenditure is transferred to the Central government. Normally, an estimate is decided informally between the RBI and the government and is mentioned in the Budget estimate. So, if the surplus fund transfer is an annual exercise, why is it that it is making the headlines this year?
One can easily answer the question by looking at the magnitude of the transfer; ₹1.76 lakh crore! To give some context, the maximum surplus that has been transferred in the past five years is ₹66 thousand crores. Even if we exclude the transfer of the excess reserves amounting to ₹53 thousand crores, the remaining surplus is still double the previous maximum. Hence, the news coverage.
It’s not only the exorbitant amount. Talks over the RBI’s reserves have been in the news for quite some time now. The disagreement between the RBI and the Centre over it led to the resignation of the ex RBI Governor, Urjit Patel and subsequently the RBI Deputy Governor, Viral Acharya. The government was of the view that the annual dividend to the Centre could increase if the RBI did not transfer the surplus to the contingency reserve. Not only did the RBI have enough reserves and was well above the median, but redeploying some of the extra capital could prove to be more productive by using it for the resolution of bad debts. The RBI, on its part, prefers to be more cautious and build its reserves to deal with a possible crisis and external shocks. The RBI argued that if it were to reduce its assets, the RBI’s ability to absorb government borrowings would decrease. Also, it is necessary to keep adequate reserves and capital to maintain the public’s confidence in the central bank. Many felt that by pressurising the RBI to transfer its reserves, the autonomy of the central bank was being threatened.
So what changed? A six-member panel, headed by former RBI governor Bimal Jalan, was constituted to review the economic capital framework (amount of capital required to ensure solvency given the risk profile, i.e. size of capital reserves in this case). The objective of the economic capital framework was to build harmony between the central bank’s need for autonomy and the government’s objectives of the development. The committee believed that the existing framework was based on a conservative assessment of risk and that a review of the framework would result in excess capital being freed, which it did.
Not to go into the technicalities, but the calculations made to arrive at the desired magnitude of the reserves took into account relatively extreme probabilities. The new economic capital framework does not make the RBI more vulnerable and thus, the recommendations of the committee were accepted by it. Of course, the final impact of such actions on the independence of the RBI would depend upon how the surplus is utilised by the government.
In India, the bulk of government spending is mostly biased towards boosting consumption rather than investments. However this time, 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. There is a distinct slowdown in the economy which can be attributed to tighter funding conditions, decline in consumer confidence and global headwinds in general. Hence, the government could utilise this amount for specific expenditure outlays.
- Public sector banks are under-capitalised due to which channels of credit disbursement are choked. The government can go in for bank recapitalisation and provide comfort to the banks.
- The surplus can also be used to fund welfare programs. The government has been supporting farmers, agriculture, and micro-entrepreneurs, but the burden is falling on banks as they are not getting any refinancing support from government agencies. Thus, government intermediaries can be well-stocked with capital to help make these programs successful.
- The money could also be used to give a leg up to public capital expenditure and infrastructure. It has a potential big multiplier effect and would potentially lead to job and income growth which is significant for economic revival.
- The government borrowings have been rising year after year. A part of the surplus can be used to reduce further government borrowings. This will not only release more funds for the private sector but help in better transmission of interest rates. The government also need not borrow through an overseas bond issue which comes with an exchange rate risk.
No matter where the government deploys the funds, the transfer of money from the vaults of the RBI to fund government spending will increase the amount of money supply in the economy, exerting upward pressure on prices. Thus, the transfer could effectively turn into a monetary stimulus for the economy which has been slowing down for several quarters now.
Alternatively, the government might not spend the windfall gain to propel growth. Given the slowdown, there is a downside risk to tax collections. Thus, the surplus from RBI should help offset the expected shortfalls in tax revenues in 2019-20 and help the government in meeting its fiscal deficit target at 3.3 percent of the GDP. Using the windfall to balance the fiscal for this year instead of some spending program would also prove comforting for the bond market. This is because bond yields will soften as the government will not need to borrow more to meet its requirements. Lower bond yields result in lower interest rates which would benefit the corporate sector and thus improve stock market sentiments.
It can be concluded that the government needs to be strategic about the spending of the capital transfer. The idea is to rev up the economy without breaking fiscal discipline. The government should not rely on transfers of such magnitude in the future as well. This opportunity should not be turned into another ‘goose and the golden egg’ story.