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RBI’s transfer to government and from where do the RBI’s earnings come from? (Relevant for GS Prelims & Mains Paper III; Economics)

Source: The Hindu

On August 26, the Reserve Bank of India (RBI) central board decided to transfer Rs. 1.76 lakh crore to the government (including a sum of Rs. 52,637 crore from its contingency reserve), a move that is likely to address the Central government’s precarious fiscal situation. The transfer amount included the payment of dividend worth Rs. 1.23 lakh crore, and funds from its reserves, as identified under a new economic capital framework (ECF) adopted by the RBI board. The RBI had formed a committee chaired by former RBI Governor Bimal Jalan to review its ECF last year.

Why is the RBI payout different this year?
Each year, the RBI transfers to the government any money in its balance sheet that it deems to be beyond its operational and contingency needs. The RBI’s transfer of funds to the government per se is nothing new. But what has raised eyebrows this time is that the amount of funds being transferred by the central bank to the government this year is much higher than earlier — 146.8% more than what it had paid out last year, when it transferred Rs. 50,000 crore as dividend. Previously, the highest amount of surplus funds that the RBI had transferred to the government was Rs. 65,896 crore in 2014-15. The net surplus figures are: Rs. 52,683 (2013-14); Rs. 65,896 (2014-15); Rs. 65,880 (2015-16); Rs. 30,659 (2016-17) and Rs. 50,000 (2017-18)

What is the controversy around the transfer?
The massive payout has raised concerns that the government may be confiscating money from the RBI to meet its urgent spending needs, thus effectively turning the central bank into a banker for the government. Central banks such as the RBI, however, are supposed to be independent from all forms of government influence. In reality, governments across the world try to influence decision-making by their respective central banks in various ways.

When appointing members to the central bank, such as to the post of Governor for instance, governments tend to pick bureaucrats who have been loyal to them over time.

Is this a part of larger policy of government?
Many also view the move to get the RBI to let go of a portion of its accumulated reserve as part of a wider campaign by the government to strip the powers of various independent regulatory bodies. In July, the government amended the Finance Bill to ensure that the Securities and Exchange Board of India (SEBI) transferred surplus funds in its custody over to the government.

Some economists argue that the government has the right to make use of funds in the custody of public institutions such as the RBI to meet its fiscal needs. Critics, however, argue that stripping the financial assets of regulatory institutions such as the RBI and SEBI can compromise their independence.

How does the RBI earn money?
The RBI earns money in a variety of ways. Open market operations, wherein a central bank purchases or sells bonds in the open market in order to regulate money supply in the economy, are a major source of income for the RBI. Apart from the interest received from these bonds, the RBI may also profit from favourable changes in bond prices. Dealings in the foreign exchange market that the RBI engages in may also contribute to the bank’s profits. The RBI, for instance, may buy dollars cheaply and sell them dear in the future to pocket profits. It should be noted, however, that unlike commercial banks, the primary mandate of the RBI is not to earn profits but to preserve the value of the rupee. Profit and loss are thus merely a side effect of its regular operations to shape monetary policy.

Are the RBI’s powers being diluted?
The primary issue with the transfer of surplus funds is the damage that it does to the credibility of the RBI as an independent central bank. The government has been criticised for taking steps since last year to progressively dilute the powers of the RBI. The government had tried to convince the central bank to part with more than ₹3 lakh crore from its reserves last year. It appointed a committee headed by Mr. Jalan to overhaul the economic capital framework. The government argued that the quantum of reserves accumulated by the RBI over the years was well beyond the needs of the central bank. This, it is believed, caused friction between the government and the then Governor of the RBI, Urjit Patel, who resigned from his post last December. Some believe the government will still manage to get hold of the initial corpus of funds that it wanted from the RBI, but over the next few years. Some have raised concerns about the RBI’s ability to meet emergencies with its now depleted reserves. These concerns, however, may be unwarranted since, as the sole and sovereign issuer of the rupee, there is effectively no limit to the amount of rupees that the RBI can create to deal with an emergency. The real impact that the forced transfer of funds will have is on the RBI’s independence in setting monetary policy. The transfer of surplus reserves to the government is in effect a forced injection of extra liquidity into the economy. The increased demand to meet the government’s fiscal needs will thus compromise the RBI’s ability to fulfil its primary mandate — to preserve the value of the rupee by reining in inflation, by retaining full and final control over the supply of rupees in the wider economy.

What lies ahead?
The government is expected to achieve its 3% fiscal deficit target this year with the help of the funds it has received from the RBI. The fresh funds will also help the government to spend more on any fiscal stimulus plan that it may decide to implement in order to tackle the slowdown in the economy. The transfer of money from the vaults of the RBI to fund government spending will increase the amount of money supply in the economy, thus exerting an upward pressure on prices. The RBI’s transfer of surplus funds to the government could thus effectively turn into a monetary stimulus for the economy which has been slowing down for several consecutive quarters now.

Former RBI Deputy Governor, Viral Acharya (whose resignation earlier this year was linked to his conflicts with the government), warned in a speech last year that governments that do not respect the independence of the central bank will eventually be punished by financial markets. His warning might turn out to be prescient in the coming years if the RBI is turned into a piggy bank to fund the government’s increasing spending needs. It can cause investors to lose confidence in the RBI’s ability to preserve the value of the rupee and force them to ditch the currency.



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