RBI’s Expensive Gift to the Government: A Birds Eye View of the Transaction

RBI’s decision to handover a hefty pay check to the Government from its surplus capital has got many heads rolling and why not, after all it’s the first time in the history that such a huge amount of Rs 1.76 lakh crore (more than double the Rs 68,000 crore it transferred in the previous year) has been transferred by our Central Bank to the Central Government. This sum includes Rs 1.23 lakh crore as dividend to the government and Rs 52,637 crore as transfer from its surplus capital. The dividend payment of Rs 1.23 lakh crore includes interim dividend of Rs 28,000 crore already transferred to the government in February 2019.

Reserve Bank of India took this decision after its central board approved the recommendations made by the Bimal Jalan committee on its ‘Economic Capital Framework’ (ECF). In the following paragraphs we would first like to give a brief background of the formation of the Bimal Jalan committee and then delve into the maths behind the recommendation.

Formation of the Bimal Jalan Committee:

Sir Winston Churchill once famously said ‘’If you put two economists in a room, you get two opinions, unless one of them is Lord Keynes, in which case you get three opinions.’’ Somewhat similar was the case with the idea of using RBI’s surplus capital for government’s fiscal expenditure requirements wherein economists had divergent views and so was the situation at the mint street and the finance ministry.  The dispute caught public attention in 2018 when former deputy governor Shri Viral Acharya raised it in public and the government countered his view. While the RBI top brass was of the opinion that RBI’s surplus capital should be reserved as a cushion against any financial catastrophe, government on the other hand thought that RBI was holding on to extra capital which may be unlocked and utilised more judiciously by the government towards its fiscal needs.

In order to arrive at a consensus, the RBI, in consultation with the government constituted a six member panel led by Shri Bimal Jalan (former RBI governor). The panel included former deputy RBI governor Shri Rakesh Mohan as its vice chairman, economic affairs secretary Shri Subhash Chandra Garg, RBI central board members Shri Bharat Doshi and Shri Sudhir Mankad and deputy governor Shri NS Vishwanathan. Its mandate was to review “the need and justification of various provisions, reserves and buffers” that RBI has maintained for contingency purposes and suggest an adequate level of risk provisioning. The central bank in its statement had said that the panel will “propose a suitable profits distribution policy taking into account all the likely situations of the RBI, including the situations of holding more provisions than required and the RBI holding less provisions than required.”

Recommendations of Bimal Jalan Committee:

The Bimal Jalan committee recommended that RBI should keep 5.5% 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. Now let us understand the type of reserves maintained by the Reserve Bank.

The RBI classifies its liabilities under 6 major heads:

1. The initial capital *
2. Reserve Fund *
3. Other Reserves (National Industrial Credit Fund & National Housing Credit Fund)
4. Deposits (from Government, Banks, Financial Institutions outside India, Mutual Funds etc)
5. Other Liabilities and Provisions
6. Notes Issued

*The original capital of Rs 0.05 billion was created in terms of Section 46 of the RBI Act, 1934 as contribution from the central government for the currency liability of the then sovereign government taken over by the Reserve Bank. Thereafter, an amount of Rs 64.95 billion was credited to this fund from out of gains on periodic revaluation of gold up to October 1990, taking it to Rs 65 billion. The fund has been static since then as the unrealised gain/loss on account of valuation of gold and foreign currency is since being booked in the Currency and Gold Revaluation Account (CGRA) which appears under ‘Other Liabilities and Provisions’ (Source:RBI Annual Report)

Presently, we shall be focusing on the reserves classified under ‘Other Liabilities and Provisions’ (as it forms the basis for the present dividend distribution) which is detailed under schedule 3 of RBI balance sheet and is distinct from the deposits held by the Central Bank and the currency in circulation. The RBI’s reserves under schedule 3 may further be categorized into four major heads:

– Currency and Gold Revaluation Account (CGRA),

– Investment Revaluation Account (IRA)

– Asset Development Fund (ADF)

– Contingency fund (CF)

The CGRA which reflects the unrealized gains or losses on the revaluation of forex and gold contributes the highest to the RBI reserves and has grown substantially since 2010 at a compounded annual growth rate (CAGR) of 25 per cent to Rs 6.91 lakh crore in 2017-18.

The IRA may be further sub-divided into IRA-foreign securities (IRA-FS) and IRA-rupee securities (IRA-RS). IRA-FS reflects the unrealised gain or loss on the mark-to-market of foreign securities while IRA-RS is mainly on account of marking rupee securities.

The ADF has been created primarily to meet RBI’s internal capital expenditure including making investments in subsidiaries and associated institutions. The IRA and ADF constitute a small portion 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 apportions a considerable part from its profit to the CF.

CGRA and CF form the bulk of RBI reserves under its schedule 3. A comparative table of these reserves for the past 10 years is given below which indicates that CF as a percentage of total assets has been continuously coming down over the past decade:

The amount of surplus that the RBI must transfer to the Centre is determined based on ‘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). CRB is a component of RBI’s economic capital required to cover its monetary and financial stability, credit and operational risks. This is essentially the existing amount in the RBI’s CF.

RBI informed that presently its CRB stood at 6.8% of the balance sheet. The Jalan panel has recommended that the CF be maintained within a range of 6.5% to 5.5% of the RBI’s balance sheet, hence, there was an excess of risk provisioning to the extent of Rs 11,608 crore at the upper band of CRB (6.5%) and ₹52,637 crore at the lower band of CRB (5.5%).

At the consolidated level, the panel suggested maintaining the economic capital i.e. realized equity and revaluation balances (essentially CGRA) at a range of 24.5% to 20% of RBI’s balance sheet. As this figure stood at 23.3% as of June 2019 i.e. 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.

Here, it is also important to note that the Bimal Jalan committee has clearly drawn a distinction between what part of the RBI’s surplus capital can be shared with the government and what cannot. The committee recommended that only realised equity of RBI could be used to meet all risks and losses as they were built over a period of time through retained earnings, while revaluation gains (essentially CGRA) were unrealised and hence not distributable.

What Next:

This windfall gain to the government comes at a time when the markets are expecting a possible recession as signalled by the falling GDP growth rate, high levels of unemployment, production cuts in the auto industry, lower tax collection and the list goes on. Hence, it becomes all the more important for the government to use this surplus money in the most judicious way to revive economic growth.

Let us now look at the various options in the hand of the government wherein it may utilise the said amount:

• Increase its infrastructure spending: Higher infrastructure spending is the need of the hour for a developing country like India. Infrastructure projects go a long way in generating job opportunities (especially for the labour class) on one hand and creating demand for industrial products like cement and steel on the other.  It will also help in improving the week sentiments currently gripping these sectors and would have a ripple effect on some of the other related sectors like mining, auto, construction etc.

• Recapitalising the Public Sector Banks (PSB): Government has recently announced the merger of 10 PSB’s thus bringing the number of PSB’s to 12. The next step should be to induct the Rs 70,000 crore capital already announced by the finance ministry into the PSB’s so as to kickstart the credit off take which has not been happening for a long time now. Firstly, the credit off take got hampered as many of these public sector banks were placed under the prompt corrective action (PCA) framework of the RBI. Thereafter, the issues in the NBFC space and now the week domestic and global sentiments are making the banks a bit averse to lending.

• Incentivising the Private Sector: The Government may come out with some innovative capital/tax incentive schemes for the sectors like construction, auto, textiles, agriculture etc which employ the masses. The government may also focus on releasing the legitimate dues (vendor payments which are held back by many government department/agencies) to the private sector so that the private players may get the much needed cash to improve their already stretched working capital requirements.

• Postpone its borrowing and stake sale plan: In order to increase government spending on infrastructure projects and also honour the fiscal deficit targets the government was planning to borrow funds (both from domestic and foreign markets via the bond route) on one hand and sale its stake in leading PSU’s on the other. However, as the one time gift from RBI may not be available next year the government may think of postponing some of its borrowing and stake sale programs to the next fiscal year.

Conclusion:

A lot of economists and market experts have written in favour of the RBI decision while some including former RBI governor Raghuram Rajan have warned about the possible risks to the RBI autonomy and the Indian economy if such transactions are to set a trend. However, a general consensus is that the transaction is a onetime benefit that the present government has received in difficult times and may be used to cover up the deficit in tax collections due to subdued revenues in some of the leading sectors like auto which contribute significantly to the tax kitty of the government.

The windfall gain sets an opportunity for the government to revive the ailing economy which is presently in dire straits and hoping for a speedy recovery.