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Mains Articles

RBI annual transfer to the government [Mains Article]

The RBI central board has decided to transfer a record surplus — Rs 1.76 lakh crore — to the government which comprises a surplus of Rs 1.23 lakh crore and Rs 52,637 crore of excess provisions made over the years.
By IT's Mains Articles Team
September 04, 2019

Content

  • Introduction
  • Why RBI transfers to the government?
  • RBI reserves
  • What is the current issue between RBI and the government?
  • What are the recommendations of the Bimal Jalan Committee?
  • Positive Impacts of the recommendations
  • Negative Impacts of the recommendations
  • Why are these called ‘transfers’ to governments rather than dividends?
  • How does the RBI generate surplus?
  • How does RBI use its surplus?
  • Why do central banks hold back on transferring large amounts?
  • What can the government do with this huge surplus?
  • Earlier Panels
  • Key Facts
  • Way forward

RBI annual transfer to the government

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Introduction

  • The central board of RBI accepted all the recommendations of the Bimal Jalan committee on its economic capital framework and finalised the central bank’s accounts for 2018-19 using the revised framework to determine risk provisioning and surplus transfer.

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Why RBI transfers to the government?

  • The government runs the RBI which was started in 1934 as a private entity and nationalized in 1939.
  • Since then, as an owner of the RBI, the surplus of the bank is transferred to the government. The government use these transfers to fulfil its promises towards people and to keep the economic momentum going.

RBI reserves

The RBI has two types of reserves:

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Currency and Gold Revaluation Reserve Account: It represents the value of gold and foreign currency that the central bank holds on behalf of India.

Contingency Fund (CF): It is meant to act as a buffer against uncertainties.

  • The surplus reflects the revenue that the RBI has earned on its assets such as interest on securities it holds. It also transfers a portion of its earnings into the CF.
  • Whatever amount is left with the RBI after meeting its needs is transferred to the government.
  • The RBI follows the July to June, a 12- month calendar for accounting purpose.

What is the current issue between RBI and the government?

  • The issue of transfer of surplus or profits has often been contentious where government often asks for higher pay out whereas RBI prefers to keep a large sum of money as reserve any future financial crisis.
  • The level of surplus or profits the RBI pays to the government has been an issue of conflict between the two for long.
  • 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.
  • Finally, the Reserve Bank of India, in consultation with the Government of India, had constituted an expert committee, under chairmanship of Bimal Jalan, to review whether the central bank was holding on to too much of its reserves.
  • In August 2019, the central board of the RBI decided to transfer a surplus of Rs 1.76 lakh crore to the government based on the Jalan committee’s report.

What are the recommendations of the Bimal Jalan Committee?

RBI’s economic capital

  • The committee drew a distinction between what part of the RBI’s surplus capital can be shared and what cannot. It made the clear distinction between the two components of economic capital that are realized equity and revaluation balances.
  • It said that realised equity of RBI (a form of Contingency Fund is built up from its retained earnings) could be used to meet all risks and losses as they were built over a period of time through retained earnings, while revaluation gains were unrealised and hence not distributable.
  • It recommended RBI’s Economic capital framework should be revised every five years and its accounting year (July-June) be aligned with the fiscal year that ends on 31 March.

Size of Realized Equity

  • RBI’s realized equity–a form of Contingency Fund is built up from its retained earnings–stood at 8 per cent of the central bank’s balance sheet, but the expert panel recommended it to be in the range of 6.5-5.5 per cent.
  • The Committee recognized that the RBI’s provisioning for financial stability risks is the country’s savings for a monetary crisis.
  • This risk provisioning made primarily from retained earnings is cumulatively referred to as the Contingent Risk Buffer (CRB).
  • It recommended that RBI should keep 5% to 6.5% of its total assets as the contingency risk buffer (CRB) to meet any emergency fund requirements and transfer the remaining funds to the government.
  • In other words, CRB is a component of RBI’s economic capital which is required to cover its monetary and financial stability, credit and operational risks.
  • Committee recommended to maintained CRB within a range of 6.5 per cent to 5.5 per cent of the RBI’s balance sheet to meet any emergency fund requirements and transfer the remaining funds to the government.
  • The Committee also recommended the development of methodologies for assessing the concentration risk of the forex portfolio as well as jointly assessing the RBI’s market-credit risk.

Surplus Distribution Policy:

  • The Committee has recommended a new surplus distribution policy which targets the level of realized equity to be maintained by the RBI, within the overall level of its economic capital.
  • The economic capital is the combination of realized equity and revaluation reserves.
  • To set the economic capital levels (ECL) within the range of 24.5-20 per cent of the balance sheet.
  • The panel have ensured that the RBI’s core revaluation reserves are untouched and only the realized assets of the RBI-those it earns through foreign bonds, government securities, and gold-will be shared liberally with the government.

Positive Impacts of the recommendations

  • In changing the accounting period, the RBI would be able to provide better estimates of the projected surplus transfers to the government for the financial year for budgeting purposes and will ultimately reduce the need of interim dividends for the government.
  • It will also bring about greater cohesiveness in the monetary policy projections and reports published by RBI.
  • The additional amount of ₹58,000 crores could also be used to provide fiscal stimulus or reduce off-balance sheet borrowings.
  • These excess transfers will likely be used to recapitalize state-run banks by ₹70,000 crores, as announced by finance minister.
  • It could be helpful to reduce lending rates and the large pay out can help the government cut back on planned borrowings too.
  • If the government manages to meet its revenue targets, then the windfall gain can lead to a lower fiscal deficit.

Negative Impacts of the recommendations

  • This move could put RBI in a vulnerable position apart from diminishing its autonomy.
  • Extracting such large amount from RBI as transfers is not a good idea as this could become the norm from now onwards.
  • Whenever the RBI pays additional dividend, it has to create additional permanent reserves or print more money.
  • 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.

Why are these called ‘transfers’ to governments rather than dividends?

  • The RBI is not a commercial organization like banks and other companies owned or controlled by the government
  • 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”.
  • The RBI transfer the surplus which is excess of income over expenditure, to the government.

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 an income from government securities it holds
    • As a return 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 (BIS)
  • 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.

How does RBI use its surplus?

  • 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.
  • It’s total costs, which includes expenditure on printing and commissions forms, is only about 1/7th of its total net interest income.

What can the government do with this huge surplus?

  • The money is transferred to the Consolidated Fund of India (CFI).
  • The salaries and pensions are paid and interest payments are carried on.
  • All the government schemes are funded by using the money in CFI.
  • The government can revive the consumer demand by spending the money in specific public projects.

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.

Earlier Panels

  • In the past, the issue of ideal size of RBI’s reserves was examined by three committees headed by V Subrahmanyam (1997), Usha Thorat (2004) and Y H Malegam (2013).
  • While the Subrahmanyam panel recommended building a 12 per cent contingency reserve, the Thorat panel suggested that it should be maintained at 18 per cent of the total assets.
  • The Malegam panel said the RBI should transfer an adequate amount of its profit to the contingency reserves annually, but did not come up with a particular number.

Key Facts

  • In central banks of US, England, Germany and Japan, the law make it clear that profits should be transferred to the government.
  • 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.

Way Forward

  • RBI now has to closely monitor the market situation in the country and abroad, following which it could take a call on whether to maintain the upper bound or lower bound of the contingency reserve in future.
  • The government should use the transfer amount wisely in boosting investments in core sectors rather than focusing on uplifting consumption.

 

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