RBI's Surplus Fund and its Transfer - All You Need to Know

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In August 2019, the Reserve Bank of India transferred a record amount of surplus to the Government. The 1.76 lakh crore INR transferred is the highest ever transfer by the apex bank. This amount includes a portion from the RBI’s dividends and a portion from excess surpluses.

Contents

What is RBI?

RBI is the apex bank of India. It was established as an entity held by private stakeholders in 1935. In 1949, the Reserve Bank of India was nationalised and currently has the government as its sole owner.
It functions under the RBI Act, 1934.
Its functions include financial management, the lender of last resort, government’s banker, issues currency, forex reserve management, etc.

What are the sources of RBI’s income?

RBI has several income sources:

Open Market Operations/ OMO: the RBI may buy government bonds from the public and earn interests on it from the issuer i.e. government.
Interest on loans.
Interests on overseas deposits.
Forex market operations: the RBI buys and sells foreign currency like the dollar by speculation.
Sovereign Seigniorage: this is the income that the central bank earns by printing currency.

Unlike commercial banks, the main objective of RBI is not to earn profits but to preserve the Rupee’s value.
Another difference between RBI and any commercial bank is that it does not pay income tax to the government. This is by the provision of section 48 of the RBI Act which exempts it from income tax and super tax.
The expenditure by the RBI is mainly for minting currency, paying its staff, commissions to banks for certain services, etc.
The RBI holds reserves in the form of Contingency Fund/ CF and Currency and Gold Revaluation Account/ CGRA.
The CGRA is the value of gold and forex assets owned by the RBI (on behalf of the Indian government). This is the Revaluation Reserves. This is a major portion of the reserve.
The CF is the reserve held as a safety measure against any unforeseen risk/ crisis. It’s called as the realized equity or contingent risk buffer/ CRB. The CF reserve held by the RBI is inversely proportional to the surpluses generated that year.

RBI balance sheet:

Minting currency accounts for more than 50% of its liabilities.
About 26% lies in the reserves (CGRA and CF).
Gold and forex assets account for about 77% of its assets.

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Why and how does the RBI transfer surpluses to the Government?

Every year, the RBI transfers the surplus amount i.e. that which is deemed beyond its need for operational and contingency fund, to the government.
Section 47 of the RBI Act says that only the surplus of the profit can be transferred to the government. The surplus is the fund left out after making provisions for doubtful and bad debts, depreciation, contributions to staff and superannuation funds.
If reserves are to be used, the act is to be amended.
There is no explicit policy governing the amount of surplus transferred. Prior to the recent Jalan committee, several panels had been constituted to deal with this aspect:
V Subrahmanyam Committee of 1997 recommended the reservation of 12% of the assets.
The Thorat Committee of 2004 recommended 18% to be held as a reserve. This was not accepted by the RBI.
The Y H Malegam committee of 2013 recommended maintaining the surplus transfer percentage at the existing level.
Some economists had opined that the reserve held by RBI is far more than what is required to cover any risk. Former economic adviser Arvind Subramanian in the 2016-17 economic survey said that the RBI is ‘exceptionally highly capitalized’.
Earlier, the RBI used to transfer a part of its surpluses to CF and another part to Asset Redevelopment Fund. The ARF is to meet the internal capital expenditure and investments. This was in line with the requirement to reserve 12% of the asset.
Prior to Bimal Jalan report, the RBI held a reserve of 27%. The rest was transferred to the government as surplus.
The government has been calling for more surplus transfer quoting the global norms of 14% maintained by many central banks around the world.

What is the Bimal Jalan committee report?

In 2016-17, the dividend paid by the RBI to the government had dropped. This drop from 65,896 crore INR from FY 2015-16 to 30,659 crore INR for FY 2016-17 was attributed to the drop in RBI income due to demonetisation and the subsequent need to replace all the old currency notes.
The then RBI Governor had refused to transfer payments from the contingency funds to the government.
As a result, the government and RBI setup the Bimal Jalan committee to review the Economic Capital Framework/ ECF.
Economic capital is the capital that must be held in reserve by the RBI to sustain its stability in times of an unforeseen crisis or risks. The committee expressed the economic capital as a combination of realized equity and revaluation reserves.
This six-member committee had recently submitted it recommendations which were accepted by the RBI.
The recommendations include the following:
It recommended a periodic review of ECF every 5 years.
It also recommended a greater portion of the surplus to be transferred to the government over a period of 3 to 5 years.
It recommends interim dividend pay-outs to the government.
It changed the realized equity/ CBR level from the current 6.8% to a range of 5.5% to 6.5%.
If the CBR is below 5.5%, sufficient risk provisions are to be made.

What are the reasons for the record high surplus generated by the RBI?

The surplus transfer component of the total transfer made by RBI to the government is 123,414 crore INR. The remaining 52,631 crore INR was transferred for excess provision identified according to the revised ECF.
The highest record of the surplus transfer before this was in FY 2014-15 at 65,896 crore INR.
The reasons for the record surplus transfer are:

The RBI has been increasingly intervening in the forex market by selling the dollar at high profits. Eg: in July, RBI was a net seller of dollars.
RBI has also been increasingly involved in open market operations. About 3 trillion INR worth of bonds had been purchased by the apex bank from the secondary market and the interests had paid-out well.
The Bimal Jalan recommendations have been accepted by the RBI and the transferred surplus has increased.

What is the global situation with respect to central banks’ reserves?

Central banks around the world maintain an adequate reserve to ensure economic and financial stability and avoid balance of payment crisis.
The IMF (International Monetary Fund) has a metric for assessing the reserve adequacy in different economies. It has been giving out new reforms in the assessment since 2011.
The IMF holds that the reserve adequacy is country-specific and depends on the state’s financial and economic conditions. No uniform threshold would be applicable to all countries.
The international body had hence put forth 3 categories that are largely in sync with the per capita income classification:

Mature Markets
Deepening Financial Markets
Constrained Market Access

Within this classification, country-specific conditions are to be considered while assessing the adequacy of the reserve.
The global average when it comes to reserves held by central banks is about 13% to 14%. Eg: the USA holds 13% and the UK holds 14%
In some countries like Russia, the central bank holds more than 27% of its assets in reserve.
Around the world, the surplus transfer amounts to 0.5% of the country’s GDP on average.

Way forward

The surplus transferred could be used by the government in several ways.
The government may use it to reduce the fiscal deficit. Use of surplus funds to address the deficit is not the most efficient way to maintain intergenerational equity, even though the temptation is high.
Fiscal deficit financing using surplus funds is not very deleterious when it is a one-time affair. However, it will become unsustainable when recurrent.
Some economists maintain that the transfer was not to close the deficit but rather a long overdue dividend pay-out from the RBI to the government. The record surplus transfer is even being termed a ‘goodwill gesture’.
The money may be used as a stimulus package, given the on-going economic slowdown. It could be used to generate much-needed credit to re-infuse life into the economy and give the government more elbow room.
The funds may be used by the government to recapitalize the banking system. This is a better alternative than deficit financing, especially given the below-average net worth of the Indian banking system. Nodal agencies like NABARD could be recapitalized, leading to the betterment of rural India.
The most ideal use of the funds is its investment in infrastructure Using it to finance connectivity projects like roadways and railways would yield more sustainable returns.
It must be remembered that the surplus fund from RBI is a borrowed reserve. The state needs to build it from current account surplus of the country.
There is a need to differentiate between recurring and non-recurring funds as the government spending in most cases tends to be public demand-driven. This is in context of the provisions of article 266 that dictates the character of the consolidated fund of India.
An issue to be considered while comparing the reserve percentage held by other countries like the US with India’s reserve holding is that unlike India, developed countries can borrow in their own currency. There is a need to take multiple parameters into account while setting the reserve adequacy.
An issue flagged is the dilution of RBI’s powers and autonomy. While the central bank may be no more risk-prone than before, the real damage would be to its autonomy in setting the monetary policy. This needs to be addressed given that a less independent central bank drastically affects investor confidence.