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How and why RBI transfers to government (Relevant for GS Prelims & Mains Paper III; Economics)

Source: Indian Express

Bank’s Central Board has decided on a record transfer of Rs 1.76 lakh crore. On what basis are such transfers made? Why has it been sometimes contentious, and how was the amount settled this time?
On Monday, the RBI Central Board decided to transfer a record surplus — Rs 1.76 lakh crore — to the government. The issue of transfer of surplus or profits has often been contentious. The government often pitches for a higher payout, arguing it needs to spend to deliver on promises and to keep the economic momentum going; while a conservative central bank prefers to keep a good portion of the profits for bad times. Seldom has this battle been as bitter as it was last year when Urjit Patel was the RBI Governor and Subhash Garg was the Secretary, Economic Affairs in the Finance Ministry. At stake was the level of reserves the RBI should hold or maintain and the quantum of profits to be distributed. On Monday, the issue was settled.

The RBI transfers its surplus to the government every year. So what is special about the pay out this time?
Yes, the RBI does transfer its surplus annually to the government, the owner of the institution, after making adequate provisions for contingencies or potential losses. The profit that is distributed has varied, averaging over Rs 50,000 crore over the last few years.

On Monday, the RBI Board accepted the recommendations of a committee headed by former Governor Bimal Jalan on transfer of excess capital. Based on the panel’s report, the Central Board decided to transfer a surplus of Rs 1.23 lakh crore and Rs 52,637 crore of excess provisions made over the years. This marks the first time the RBI will be paying out such a huge amount, a one-off transfer. Earlier, the government had budgeted for Rs 90,000 crore from the RBI as dividend for this fiscal year.

On what rationale was such a huge payout approved?
The level of surplus or profits the RBI pays to the government has been an issue of conflict two for long. Over the last decade or more, the government had sought higher payouts saying the RBI was maintaining reserves or capital buffers that were much higher than many other global central banks’ buffers. The government has argued that such relatively lower transfers crimped public spending for infrastructure projects and social sector programmes, considering the pressure to meet deficit targets and to provide space for private firms to borrow. With the government amplifying its demand for a higher transfer, the Jalan committee reviewed the capital structure, statutory provisions and other issues relating to the RBI balance sheet. After making a distinction on the RBI’s capital structure especially on unrealised gains (which are essentially gains not booked) and taking into account the role of the central bank in ensuring financial stability, potential risks and global standards, the committee suggested a total transfer of Rs.1.76 lakh crore.

How does the RBI generate surplus?
A significant part comes from RBI’s operations in financial markets, when it intervenes for instance to buy or sell foreign exchange; Open Market operations, when it attempts to prevent the rupee from appreciating; as income from government securities it holds; as returns from its foreign currency assets that are investments in the bonds of foreign central banks or top-rated securities; from deposits with other central banks or the Bank for International Settlement or BIS; besides lending to banks for very short tenures and management commission on handling the borrowings of state governments and the central government. RBI buys these financial assets against its fixed liabilities such as currency held by the public and deposits issued to commercial banks on which it does not pay interest.

The RBI’s expenditure is mainly on printing of currency notes, on staff, besides commission to banks for undertaking transactions on behalf of the government and to primary dealers that include banks for underwriting some of these borrowings. The central bank’s total costs, which includes expenditure on printing and commissions forms, is only about 1/7th of its total net interest income.

Why are these called transfers to the government, rather than dividends?
That is because the RBI is not a commercial organisation like banks and other companies owned or controlled by the government to pay a dividend to the owner out of the profit generated. Though it was promoted as a private shareholders’ bank in 1935 with a paid-up capital of Rs 5 crore, the government nationalised it in January 1949, making the sovereign the “owner”. What the RBI does is transfer the surplus — excess of income over expenditure —to the government. Under Section 47 of the RBI Act, “after making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation funds and for all other matters for which provision is to be made by or under this Act or which are usually provided for by bankers, the balance of the profits shall be paid to the Central government”. This is done in early August by the Central Board.



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