RBI’s Surplus Transfer

The Reserve Bank of India has transferred a surplus of Rs. 1.76 lakh crores to the Indian Government. This payment, which is equal to 1.25% of the Indian GDP (in nominal rates for 2018-19) aims to provide some breathing space for the Indian government and allow it to make a higher capital expenditure on infrastructure and social programs, the former of which is required to attain the growth rates necessary for India’s USD 5 trillion economic dream.

Why is this happening?

The Reserve Bank of India had constituted a special committee which was headed by the erstwhile head of the RBI, Bimal Jalan. This committee, constituted with the concurrence of the Government of India was to review the present situation of the extant economic capital framework of the Reserve Bank of India. The Bimal Jalan committee had recommended the transfer of surplus funds to the Reserve Bank of India.

What were the recommendations of the Bimal Jalan Committee based on?

The recommendation to transfer the surplus funds of the RBI to the Central Government were based on a comprehensive evaluation carried out by the committee members who not only evaluated the role of financial resilience of the Reserve Bank of India but also the existing policies in India and abroad. A detailed survey of the various statutory provisions and the anticipated impact of RBI’s public policy mandate was also taken into consideration by the committee. Finally, it gave a special thought to the existing operating environment of the fund transfer on the RBI’s balance sheet and the likely risks involved.

What are the recommendations of the Bimal Jalan Committee?

There were primarily 2 key recommendations made by the Bimal Jalan Committee. The committee has given a distinct demarcation between the two components of any economic capital in a country for a central bank. These are the realized equity and revaluation balances. The Bimal Jalan committee is of the view that the realized equity can be used to make up for the shortfall of all risks/ losses which mainly derive from the retained earnings. The reevaluation balances of the RBI can be thought of only as a risk buffer to be hedged against market risks. The reevaluation balances are the unrealized valuation gains and thus, not readily distributable in their present format.

What does the Bimal Jalan committee propose?

The Bimal Japan committee has proposed the entire net income to be transferred to the Indian Government’s exchequer on the condition that the realized equity is above the slated requirement. If the realized equity is lesser than the lower limit bound of the specified requirement, the funds must be transferred for the provisioning of risk. It such case only the residual net income (if any left after the provisioning of the funds) will be transferred to the Government.

The Indian Government has accepted this proposal.

Where will the money come from?

The corpus to be transferred comes from two sources primarily. These are the surplus funds which amount to Rs 1,23,414 crore for the financial year 2018-19 and another Rs 52,637 crore which is part of the excess provisions which were identified as per the guidelines of the revised Economic Capital Framework (ECF) adopted by RBI’s board.

How does the RBI hold its money?

There are four heads under which the RBI holds it money. These are the

  • contingency fund,
  • the currency & gold reevaluation account,
  • asset development fund and
  • investment reevaluation account.

The maximum amount of money by the RBI is held in the currency & gold reevaluation account and the contingency fund.

How does the RBI earn its money?

RBI earns money via several channels. One is the income which it generates on the interest of the Government bonds which are held for conducting open market operations. It also earns the fees from the Government’s market borrowing endeavors. It also retains some earnings after the transfer of dividends to the Indian Government. RBI also earns from the interest which it generates after the investment in foreign currency assets. Finally, the cash pile of RBI also increases & decreases depending on the revaluation of the cash & gold pile held by it.

Why does the RBI need this amount of money?

  • The RBI is the Central Banker to the Government of India. There are primarily 5 reasons for a Central Bank to maintain large reserves of capital.
  • All central banks need to have some foreign assets which need capital to mitigate any potential losses arising from dynamic market forces.
  • A Central Bank also needs some money in reserve to adequately shield the national economy from any sudden monetary and financial shocks.
  • A Central Bank needs a lot of cash in case a government becomes unstable as this would prompt the foreign investors to pull out of the country. Surplus cash can then be used to stabilize the national economy.
  • The central bank maintains a large surplus to allow it to exercise its basic functions like the price and exchange stability.
  • A large pile of cash allows the central bank to maintain its independence from a national government. This allows the Central bank to maintain & implement policies which are in national interest and not constrained by ideological dogmas.

What does the law say on this?

The primarily law related to the Reserve Bank of India, the RBI Act is silent on the quantum of the amount transfer which can be made to the Indian Government. Being a national central bank, RBI has the luxury of operating even with a negative net worth though such a situation is neither desirable nor sustainable in the long run.

What happens globally?

The Central Banks abroad also have the provision to transfer any surplus funds to the treasury of their National economy. In the United States, the US Federal Reserve transfers all its surplus over a specified threshold. This transfer is governed by the two laws- Federal Reserve Act and the Consumer Protection Act. The US Fed Reserve had transferred over USD 19 billion to the US Government in the year 2017 to finance the transport projects.

In the United Kingdom, the Bank of England maintains a special understanding with the UK treasury for surplus cash transfers.

How the Indian Government Benefits from this?

The Indian Government can use these funds to extract a higher divided from the RBI over the coming years or take a one-off payment to meet some of its immediate cash obligations. It is overall, a good proposition for the Indian Government.

How the Indian Government can use this cash pile?

While there is no consensus on how the Indian Government may spend this amount of money, it is anticipated that the Indian government is most likely to use this money to mitigate an anticipated shortfall in the Government’s budgeted tax revenues instead of using this money to fund any additional spending plans or reducing the borrowings planned for the year.

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