Need to watch keenly what govt does with RBI bonanza

Imagine the joy of unexpectedly finding a 500 rupee note in the pockets of your old pair of jeans when you are broke. It was something similar for the government this week, except that the amount was slightly larger, and it was not unexpected, but nearly forcefully taken from the Reserve Bank of India (RBI).

The RBI, acting upon the recommendation of the Bimal Jalan Committee, will transfer a sum of Rs. 1.76 lakh crore to the Union government in the current fiscal year, providing it much needed respite at a time when its finances are on shaky ground. The RBI had already given an interim dividend of Rs. 28,000 crore and the remaining 1.48 lakh crore will be transferred in this fiscal, which could greatly help make up the shortfall in tax collections and other revenue.

The Union government, in its budget, had projected a nominal GDP growth rate of 12 per cent and an increase in tax collections of 20 per cent, both of which are highly unrealistic and optimistic numbers. Further, in the previous year, the fiscal deficit was estimated to be far higher than the reported 3.4 per cent and a slowing economy and falling tax rates will not help the situation. The government’s desperation to get their hands on RBI’s excess reserves can be better understood in this context.

Before discussing the merits of the move, it would be useful to understand the source of this surplus amount.

Where did the money come from?

The RBI makes a profit from its operations primarily because it almost pays no interest on its liabilities – primarily the paper money that it prints. However, it earns interest on the assets it owns – domestic and foreign government bonds. It also earns an interest on the money it lends to banks and the profit from holding other assets such as gold and foreign currency.

In usual circumstances, the earnings of the RBI would be transferred to its reserves, which mainly consist of four components – currency and gold revaluation account (CGRA), the investment revaluation account (IRA), the asset development fund (ADF) and the contingency fund (CF). The CGRA makes up the chunk of the reserves and has gone up substantially since 2010 – at a compounded annual growth rate of 25 per cent to Rs 6.91 lakh crore in 2017-18. In essence, the CGRA reflects RBI’s unrealised profits or losses due to revaluation of gold and forex prices. If, for example, the price of gold appreciates, then the value of RBI’s gold holdings increases or if the rupee depreciates, RBI potentially makes a profit from the increased valuation of foreign currency denominated bonds.

Next, the contingency fund is a specific provision made for meeting unexpected contingencies from exchange rate and monetary policy operations. The Bimal Jalan committee has recommended that the CF should be maintained in the range of 5.5 per cent to 6.5 per cent of the total balance sheet.

While the Committee has not removed any money from the CGRA account, it has deemed that the reserves held (at 23.5 per cent of total RBI balance sheet) were adequate. Thus, the entire net income of the RBI of Rs 1,23,414 crore for the fiscal has been transferred to the union government as surplus. Further, the contingency fund stood at 6.8 per cent of the balance sheet and the Committee decided to stick to the lower threshold of 5.5 per cent of the acceptable range and the excess amount, equal to Rs 52,637 crore was transferred to the union government. Thus, a total of Rs 1,76,051 crores (1,23,414 + 52,637) was transferred.

Is this a problem?

Well, yes, no, and it depends.

This practice can be viewed as being acceptable (to an extent) only because it has been done in the past. The RBI has been transferring almost all of its income to the union government since 2013-14, before which the money would go into the various reserve accounts.

What has changed this year is the magnitude and source of the transfer. Since fiscal year 2013, the average transfer amount was around Rs. 50,000 crore, with the highest amount in 2015 (Rs 65,896 crore) and the lowest in 2017 (Rs 30,659 crore). The fact that the transfer is three times the average of the preceding years has definitely caught people’s attention. Further, this is the first time that money has been actually taken out of the contingency fund in order to boost the government’s finances. This might leave less manoeuvring space for the RBI in case of an international crisis.

The Union government has been eyeing the ‘excess’ reserves from the contingency fund and other accounts for some time and it is speculated that the previous two RBI governors’ untimely departures and rift with the government was based on this very issue. Treating the RBI like other public sector units (like LIC, Coal India and others) and forcing it to pay ‘dividends’ and bail out the government is indeed worrisome.

The big question mark hanging over the entire exercise is regarding the usage of the funds. Now that the government has gotten hold of the bonanza, what exactly will it be used for? The final assessment will presumably depend largely on this question. There are broadly four options: Spend it on revenue expenditure, spend it on capital expenditure, use it for bank recapitalisation or use it to reduce debt. Of these, the worst possible outcome would be if the government used it on revenue expenditure (such as farm loan waiver or NREGA) that will not create any productive asset for the future.

Realistically, it could use the money to recapitalise the banks, which are facing a huge stressed assets problem. However, any form of recapitalisation, irrespective of the source of funds, without truly reforming the banking sector (privatising the ailing public sector banks, professionalising the board and management, etc.), could only worsen the problem of bad lending. The other sensible option is to reduce the balance sheet and off-balance sheet borrowings to get the fiscal deficit back on track.

Regardless, it should be emphasised that such a windfall gain is a one-time affair and cannot be recurring. It cannot be seen as a solution to the underlying problem of excessive government spending and low revenue collection. The government has got to stop finding innovative solutions to cover its expenses and carry out the only real long-term solution, which is to act in a fiscally responsible manner.

(Anupam Manur is an Assistant Professor at the Takshashila Institution)

The views expressed above are the author’s own. They do not necessarily reflect the views of DH.