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Sailing through headwinds: RBI fund transfer to Government

Sailing through headwinds: RBI fund transfer to Government

Sailing through headwinds: RBI fund transfer to Government
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Kathir WebdeskBy : Kathir Webdesk

  |  31 Aug 2019 9:05 AM GMT


The RBI on 26/08/2019
decided to transfer Rs. 1.76 trillion to the government which includes an
amount of Rs. 52,637 crores from the Contingency Fund in addition to the Rs. 1.23
trillion of surplus lying with the RBI. This decision comes in light of the
recommendations given by a committee headed by former RBI Governor Bimal Jalan.
It had proposed that the RBI’s Contingency Fund that has accumulated over the
years, be maintained at 5.5-6.5% of the balance sheet, which
currently stands at 6.8% to handle risks. The RBI has decided to go with the
lower limit of 5.5%. The difference between 6.8% and 5.5% amounts to Rs. 52,637
crores. This excess money that lies idle with the RBI can now be used by the
government to give the much needed impetus to the economy.


This is a
routine activity undertaken by the RBI where the government is given the
surplus money. But, there has been a rhetoric going around certain sections of
the media, especially Tamil media and political parties that the government has
‘looted’ the money to cover its mismanagement of the economy. For starters, let us understand what RBI is, what its functions are and from where
it gets the money.


RBI is the
banker of banks and also the government’s bank. Apart from printing currencies,
giving licenses to banks and framing monetary policies, one of its important
functions is to act as the banker to the Government of India. To be a banker,
it needs to have money. How does it get money to give to the Government of
India? There are various ways through which RBI earns. For example, the selling
price of a 2000 rupee note is Rs. 3.53. The
balance Rs. 1996.47 goes as profit to the RBI. The
RBI also earns from interests given out as loans to various entities. It also
earns through open market operations (selling government bonds in the open
market to banks) and through foreign exchange market. This is how RBI generates
income. Its expenditures are incurred in printing notes, paying salaries to
employees, interest payments on loans, etc. This expenditure minus the income
generated gives the profit earned by RBI.
Just like how a company pays dividends to its shareholders when it earns
profit, the RBI too pays dividend to the government. The remaining portion of
the profit is kept as reserves in Contingency Fund and Asset Development Fund. Reserves
accumulated through foreign exchange and bullion market goes into the Currency
and Gold Revaluation Account (CGRA). The Contingency Fund is used to maintain
monetary and financial stability in the case of risks like a balance of payment
crisis. The question is not whether the government can use the Contingency Fund
but how much of it can be used to stimulate the economy. This had been the
point of contention between the government and previous RBI Governors like
Raghuram Rajan and Urjit Patel as they felt that the government was intruding
into the autonomy of the RBI by asking for utilisation of reserves parked with
the RBI. It is to be noted that the RBI holds reserves more than the prescribed
global norms. It is the excess funds lying in the Contingency Fund that the
government is seeking access to.


However, the
government cannot just take money from the RBI at its whim. To resolve this
issue, the government in November 2018 constituted a committee comprising of former
and current officials of RBI, senior bureaucrats and economists headed by Bimal
Jalan whose recommendations have been accepted by the RBI. In its assessment of
the amount of economic capital with the RBI, the committee has clearly
distinguished between the reserves that can be realized and unrealized. Only a
portion of the Contingency Fund is considered as realized while the proceeds
going to CGRA are unrealized reserves. The committee has also recommended that
the Economic Capital Framework for the RBI be revised every five years.


The routine
fund transfer between the RBI and the government has received media attention
because of the quantum of transfer involved. The RBI has reported a surplus of Rs.
1.759 trillion for the year 2018-19 which is a 250% increase from Rs. 0.5
trillion reported in the year 2017-18. It is but natural that if the profit
earned by RBI increases, the dividend paid to the government also increases.
After the transfer, the amount of money the RBI will have to deal with economic
risks will be in the range of 25.4% to 20.8% of the balance sheet which is
still one of the highest among central banks globally.


What is
the need for the government to get these reserves and what will it do with it?
The government for sure knows that this is a one-time bonanza as it cannot
approach the RBI in the near future for financial relief. But internal and
external headwinds compel the government and the RBI to equip itself with
adequate fiscal and monetary measures respectively. Globally, economic growth
has been impacted by Brexit, US-China trade war, sanctions on Iran by US and
cut in oil supply by OPEC countries. Advanced economies like Germany and
Britain have recorded negative growth rate. But India has been successful in
using the diplomatic route to counter effects arising out of some of these
external headwinds. But the internal headwinds because of cyclical and
structural issues need the government’s attention. We’re a consumption driven
economy unlike China which is export oriented. Consumption demand, especially
in rural areas are seeing a downward trend due to poor monsoon in some states.
To revive consumption, purchasing power of people needs to be enhanced. Various
sectors like agriculture and MSME need to be revived through extension of
credit. The RBI recently reduced the repo rate by 35 basis points to 5.40%.
Following the Finance Ministry’s directive, all banks have agreed to pass on
rate cuts to enable easy credit availability. NBFCs needs to be supported which
will help in giving a thrust to consumer demand and private investment. As I
write this piece, the government has announced merger of ten public sector
banks into four. This will be followed by recapitalization of these merged
entities to pull out of its NPA mess. All these will require additional revenue.
Increasing GST rates or direct taxes like income tax and corporate tax is not a
viable option as it will reduce the purchasing power and thereby demand. The
government has found a smart way to source revenue without burdening the
population by tapping into the reserves of RBI that would be lying idle without
earning interest. This will allow the government to give the necessary stimulus
to the economy while meeting its fiscal targets.


When there is a
strong headwind approaching, sailing ships resort to what is known as tacking.
Tacking is a sailing manoeuvre by which the ships achieve their desired course
of direction without heading into the wind. With headwinds approaching India’s
growth trajectory, the government should use this amount to tack and stay on
course of becoming a 5 trillion dollar economy.


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