RBI's transfer of Rs. 1.76 lac crore to GOI

On Monday 26^th August 2019, Reserve Bank of India (RBI)’s Central board accepted the recommendations of a committee headed by former RBI Governor Bimal Jalan and decided to transfer a sum of Rs. 1,76,051 crore to the Government. Jalan committee was constituted in December 2018 to re-evaluate RBI’s economic capital framework (ECF) and to examine as to how much and in what form RBI should maintain its Capital structure.

What has been done this year is not new. Every year RBI transfers funds to Government representing surplus of income over expenditure. In the last 10 years this amount has varied from  Rs. 18,759 crores (2009-10), Rs. 15,009 crores (2010-11) Rs. 16,010 crores (2011-12), Rs. 33,010 crores (2012-13(, Rs. 52,679 crores (2013-14) Rs 65,896 crores (2014-15),  Rs 65,876 crores (2015-16), Rs. 30,659  crores (2016-17) to Rs. 50,659 crores (2017-18).

What has changed this year is the quantum of sum transferred. This has spurred a general public debate about the validity of RBI’s action. From a layman’s point of view, the issue has to be examined as to how RBI could transfer such a large amount this year, whether this transfer would weaken or impact RBI’s position to regulate any future weaknesses in country’s financial health and lastly what can GOI do with this windfall.

From where this amount has come .

Rs. 1,76,051 crore  consists of two components - Rs. 1,23,414 crore as surplus from FY 2018-19’s income transferred as dividend to GOI and Rs. 52,637 crore from its Reserves. Out of the first component of dividend an amount of Rs. 28,000 crore had already been paid as  interim dividend in February  2019. As Rs. 28,000 crore had already been accounted for as GOI’s income in 2018-19, net income for the current year would be Rs 1,48,051 crore against  budget estimates of Rs. 90,000 crore as per Ms. Sitharaman's budget presented on 5^th July 2019.

Transfer of 2018-19  surplus

RBI’s major source of income is Open market operations, which means regulation of money in the system. In case of shortage of liquidity, it pumps in more money into the market as loans to Banks or Central Government or State Governments and RBI earns interest on such loans,.

RBI’s Annual Report :for the year 2018-19 (RBI’s financial year is from 1^st July to 30^th June)  states that during FY 2019 the Bank registered an income of Rs 1,93,036 crore (including write back of Rs. 52,618 crore)  which was an improvement over previous year’s income of Rs. 78,281 crores  ie a y-on-y increase of 146.59 %. This surge in RBI’s income was contributed mainly by an increase in Other income of Rs 86,199 crores ( Rs. 4,410 crore in FY 18) and Interest income at Rs.1,06,837 crore (Rs  73,871 crore in FY 2018) . Main component of other income were gains from Forex transactions to the extent of Rs. 28,998 crores and write back of excess risk provisions of Rs. 52,618 crores from the contingency fund) Interest income mainly consisted of income earned through Open market operations. Alongwith surge in income, expenditure decreased by Rs. 11,232 crore, yielding a better surplus figure.

As against the previous year when RBI had to suck out excess liquidity in the system and had to pay interest on such operations, this year there was a tight liquidity situation resulting in heavy liquidity injection into the system under liquidity adjustment facility/marginal standing facility  This resulted in additional income of Rs. 20,962 crore as compared to previous year. The massive gain in Other income was a result of write back of excess risk provisions of Rs. 52,618 crores from the contingency fund  and change in accounting norms for forex operations  (impact of ₹21,464 crores with overall gain of Rs 33,065 crores over previous year), whereby the policy was changed to marking of current sale price over average historical acquisition price as against the earlier policy of marking to previous Friday’s market rate.

So RBI generated substantial excess income in 2018-19 as compared to previous years and the surplus of Rs 123,414 crore was transferred to GOI on the basis of Jalan committee’s recommendations for Economic capital.

Transfer from Reserves

Rs 1,76,051 crore transferred to GOI also included Rs 52,637 crore considered as excess provision in terms of revised Economic capital framework as suggested by Jalan Committee. It is important to understand that how Rs 52,637 crores has been identified as excess provision.

RBI’s capital consists of its original/start-up capital and reserves. Whatever surplus is generated by RBI in a year, some of it is transferred to GOI as dividend while the rest is transferred to reserves (like any other commercial organization). Reserves fall under four main heads: Contingency Fund (CF), Currency and Gold Revaluation Account (CGRA), Asset Development Fund (ADF) and Investment Revaluation Account (IRA). By their very nomenclature CGRA and IRA are ‘notional’ in so fart they do not represent any actual cash flows but represent movement in valuation of some assets owned by RBI like Gold, Foreign currency etc. But CF and ADF are created out of actual cash flows resulting from RBI’s profits / surpluses.

CF, as the name suggests takes care of  unforeseen contingencies, which can arise out of systemic or market or operational risks. As it is in the form of a protection fund to guard against any eventuality, it becomes the most important factor in RBI’s Balance sheet and gets directly related to stability in country’s financial systems. ADF is a development fund for acquisition of assets or making investments.  CF and ADF are termed as Realized Equity while CGRA and IRA are called unrealized equity.

Bimal Jalan committee said  that Realized equity  could be used to meet any  risks and losses as it was a net result of retained earnings over a period of time, while revaluation reserves were not reserves created out of cash flows but  unrealized and therefore they could not be touched. The committee further recommended that it would be adequate for RBI  to maintain 5.50 % to 6.50 % of its total assets as the contingency risk buffer (CRB) to meet any contingency requirements and the aggregate reserves (including all ie  CF, CGRA, ADF and IRA), also known as Economic Capital, in the 20.00-24.50 % range. Here it may be pertinent to note that CRB represents RBI’s monetary stability as Central Bank of the country, as it denotes its capacity to meet all its risks.

In its annual report for 2019, RBI stated that “Given that the available realized equity stood at 6.80 % of balance sheet, while the requirement recommended by the Committee was 6.5% to 5.5% of balance sheet, there was excess of risk provisioning to the extent of Rs 11,608 crore at the upper bound of CRB and ‘52,637 crore at the lower bound of CRB. The Central Board decided to maintain the realized equity level at 5.50 per cent of balance sheet and the resultant excess risk provisions of `52,637 crore were written back.”

RBI’s central board was of the opinion that maintenance of CRB at 5.50 % of balance sheet size was adequate. At this level RBI  can take care of systemic risks in about 75 to 80 % of country’s Banking sector. Thus excess risk provisions of ₹ 52,637 crore (difference between 5.50 % and 6.80 % ) were written back and  transferred to GOI.

The Annual report further stated that  “The economic capital as on June 30, 2019 stood at 23.3 per cent of balance sheet. As financial resilience was within the desired range, the entire net income of Rs 1,23,414 crore for the year 2018-19, of which an amount of Rs 28,000 crore has already been paid as interim dividend, will be transferred to the Government of India. This is in addition to the Rs 52,637 crore of excess risk provisions which has been written back and consequently will be transferred to the Government.”

RBI’s press release announcing the acceptance of the Bimal Jalan committee’s recommendations on its ‘Economic capital framework’ (ECF) concluded  “As on June 30, 2019, the RBI stands as a central bank with one of the highest levels of financial resilience globally,”

Deployment of Rs 1.76 lac crore

The most important aspect of this windfall shall be how judiciously these funds are  deployed by GOI.  Finance ministry has not outlined its plans as yet as to how the windfall surplus received from RBI shall be utilized. 

Will these be used for offering stimulus to the flagging economy which is facing a slowdown or the Govt will use it to cut down  its borrowing program or will it be used to capitalize Public sector Banks to strengthen them and increase availability of credit in the market or the money shall be used for investment in  infrastructure sector which may in turn trigger growth in several industries like cement and steel and also generate employment or there shall be a mixed bag with partial allocation to several sectors.

To conclude, although transfer of Rs. 1.76 lac crore by RBI to GOI is as per rule book and prudent, but the crux shall be usage of these funds. It shall be a travesty if the Govt uses these funds to meet its own fiscal deficit target in the face of slowdown in tax receipts instead of using the funds to provide a stimulus to the economy which is need of the hour.