Updated: Nov 9, 2019
It is quite evident as to why the government wants RBI to transfer 1.76 Lakh Crore rupees to it. It is to counter the slowdown that has hit the economy. But is this an appropriate way to address the on-going slowdown? Only time will. But what we can do at this point in time is understand how we have reached this situation, whether the RBI can transfer money to the government? If yes, then how will they transfer? Will it be like a bank deposit we make or is it more complicated. Also, what will be the impact of this transfer and more questions. Hopefully, this article will raise more questions than it answers well because if macro policy decisions were so easy, then we wouldn’t face so many problems.
First of all, let us see why the economy has slowed down i.e. what are the factors that have caused the current slowdown. There were a series of economic factors that caused this:
Oil price reversal from the $30 level – The government had used the falling oil price as an opportunity to remove oil subsidies. So, when the oil prices started reversing in 2016, the impact of that was felt across the economy.
Brexit – The infamous Brexit vote (which was passed with a 48-52 vote) created business uncertainty and its effect was felt across EU (India’s $57 Billion export market)
Demonetisation – There are many reports that suggest that DeMo has knocked-off 2-3 pp from the GDP growth
Global Slowdown – Over the last two years, the global economy has also slowed down largely because of the trade war and lack of economic activity in Europe. All this has caused global slowdown as firms have held back from investing as they wait for more clarity thereby reducing Capex globally.
The above problems have caused a slowdown in the Indian economy which is widely visible through macro data such as GDP growth, IIP, inflation, automobile sales, FMCG volume growth or rural spending and consumption.
At this point, we would like to draw a comparison between the stagflation situation that India faced from 2010 to 2013. We had high inflation and slow growth. It was widely known that it was supply-side constraints holding back the economy. There were infrastructure bottlenecks and people had a lot of disposable income largely stemming from the unprecedented growth from 2003 to 2008. Fast forward to 2019, we are facing a situation somewhat diametrically opposite of that. We have ample capacity and supply available but there is reduced disposable income and spending on the consumer side. This is also affecting the Capex and investment that firms can make. This is visible from the capacity utilisation data of firms and the low inflation.
The above understanding of demand-side problems helps us understand the steps that the government is taking. We have studied the multiplier model in economics where if you want to increase output, it can simply be done by the government spending more. This is the ‘G’ in the C+G+I+(X-M). The government can simply spend more to induce consumption. As it spends more, the people will have more income and the people will consume more, hence kickstarting the economy. There is only one problem with this. In India, the government is always running a deficit (which is completely okay and frankly needed) but the issue is that the government has a deficit of 3.4% of GDP already which more than what global investors and rating agencies are comfortable with. If you include borrowings from all other government-owned entities like the Food Corporation of India (FCI) and National Highway Authority of India (NHAI) the fiscal deficit number shoots up to a whopping 5.8% of GDP from the reported 3.4% of GDP. Therefore, the government is restraining from borrowing from the market in order to spend more.
This where the RBI can come as a saviour. The RBI is technically a department of the government. It has the autonomy to print money and control the monetary policy but nonetheless, all the profit it makes from open market operations, printing money, lending to commercial banks (Repo rate) is all ultimately transferred to the government. Usually, the RBI builds up reserves for contingencies (such as this) and to avoid injecting too much money into the system. The RBI has two types of reserves. One is the currency and gold revaluation account, representing the value of gold and foreign currency that the central bank holds on behalf of the country-this stood at Rs 6.9 lakh crore in 2017-18.
The other is the contingency fund, a specific provision meant to act as a buffer against unexpected exigencies-it stood at Rs 2.32 lakh crore in 2017-18. Whatever amount is left with the RBI after meeting its needs is transferred to the government.
Historically, RBI has been transferring around Rs. 50,000 crores to the government every year. Previously, the highest amount of surplus funds that the RBI had transferred to the government was ₹65,896 crores in 2014-15. The net surplus figures are: ₹52,683 (2013-14); ₹65,896 (2014- 15); ₹65,880 (2015-16); ₹30,659 (2016-17) and ₹50,000 (2017-18). The government insisted on a transfer of Rs. 3.6 lakh crore surplus in the fiscal year 2018-19. The Government felt that the RBI was excessively capitalised and that it needs to transfer these excess funds to aid the government with its developmental plans. However, when the RBI disagreed to do the same, the government threatened to invoke Section 7 which hugely undermined the autonomy of RBI. It caused a huge tussle between the RBI and the government which ultimately led to the exit of the then RBI governor Urjit Patel. There are two components of this transfer: the first is surplus before the adjustment to excess risk provision amounting to ₹1,23,414 crore, and the second is the amount written back from contingency reserve fund aggregating ₹52,637 crores.
A committee headed by former RBI governor Bimal Jalan was formed on December 26, 2018, as per the decision of the RBI’s central board to review the Economic Capital Framework for transfer for reserves from RBI.
The committee drew clear distinctions between the two components of economic capital - realised equity and revaluation balances. Realised equity is primarily built up from retained earnings and could be used for meeting all risks/ losses. Revaluation Balances represented unrealised valuation gains and hence were not distributable. The committee recommended that the risk provisioning made primarily from retained earnings (realised equity), which is cumulatively referred to as the Contingent Risk Buffer (CRB), should be maintained within a range of 6.5 % to 5.5 % of the RBI’s balance sheet. The Central Board has decided to maintain it at the lower bound of 5.5 %. Since the current level of realised equity was at 6.8%, there was excess provisioning to the tune of Rs. 52,637 crore which was also transferred to the government.
Earlier, the quantum of transfer would be decided based on discussion between the government and the RBI. However, this new formula-based calculation which is more transparent will be followed for the future transfer of surpluses as well. This would help to narrow the differences between the government and the RBI.
The overall surplus transfer of ₹1,76,051 crore in 2018-19 as against ₹50,000 crore in the previous year represents an increase of around 252 per cent. This is because the net income was higher with an increase in gross income by 146.59 per cent and a decline in the expenditure by 39.72 per cent.
The total income of the RBI (amounting to ₹1,93,036 crore) comprised interest income of ₹1,06,837 crore and other income — comprising (broadly) commissions, rent realised, profits or loss on the sale of bank’s property, provisions no longer required and miscellaneous — of ₹86,199 crores.
The surplus transfers to government amounting to ₹1,76,051 crore will be recorded as a non-tax revenue in the government account. With this additional amount, the non-tax revenue in 2019-20, will be almost double at ₹4,89,166 crore as compared with the previous year’s (₹2,46,219 crores).
The net impact on the Budget will be, among other things, a reduction in the revenue deficit and fiscal deficit to 1.5 per cent and 2.5 per cent of GDP, respectively, in 2019-20. In academic literature, the bonanza received from the RBI by the government is known as the quasi-fiscal deficit. This practice of managing the Budget goes against the basic principle of prudent fiscal management. Further, it sends a negative signal to foreign investors and Credit rating agencies.
In an ideal world, this is merely a book-entry, left-pocket/right-pocket stuff — after all RBI is part of the government (almost akin to a department of the Central government). Conceptually, revenues and assets of the RBI belong to the sovereign. But the world isn’t ideal, and optics of book entries and accounting do matter. Ergo, the immediate impact is for real. First, math. The real number isn’t the media headline of Rs 1.76 lakh crore. Rs 28,000 crore have already been paid as interim dividend. Further, the Union Budget estimated Rs 90,000 crore as dividends from RBI. The incremental pay-out is Rs 58,000 crore. This isn’t a trivial sum either but is much lesser than the headline Rs 1.76 lakh crore suggests.
Now the question boils down to how the does the government spend this money. A likely course of action is bank recapitalisation but nonetheless, we will have to wait and see how does the government choose to spend the money. So now we are aware that why did the government have to ask the RBI to transfer its reserves and how will this be done.