Recently the central board of the Reserve Bank of India (RBI) decided to transfer a surplus of Rs 1.76 lakh crore to the government-its highest transfer ever-sparking a fierce debate. The government was, it must be noted, acting on the recommendations of a committee chaired by former RBI governor Bimal Jalan, on capital transfer.
Some economists have welcomed the move as it will help the government counter the shortfall in revenue and tax collection. Since inflationary pressure is low, economists believe that the move will not have a negative impact in the long run. Another group of economists which include the likes of Raghuram Rajan and former RBI governor Urjit Patel said earlier that the move could put RBI in a vulnerable position apart from diminishing its autonomy.
The Reserve Bank of India (RBI) has developed an Economic Capital Framework (ECF) in 2014-15 to provide an objective, rule-based, transparent methodology for determining the appropriate level of risk provisions to be made under Section 47 of the Reserve Bank of India Act, 1934.
Economic capital framework refers to the risk capital required by the central bank while taking into account different risks. The economic capital framework reflects the capital that an institution requires or needs to hold as a counter against unforeseen risks or events or losses in the future.
The Economic Capital Framework consists of two components of RBI’s economic capital – realized equity and revaluation balances.
A significant part comes from RBI’s operations in financial markets, when
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.
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. 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”.
Assuming that total assets consist of Foreign Currency Assets (FCA) and gold, Committee recommended that the GRA + CR (Contingency Reserve) can together be 12.26% of total assets. CR requirements for interest rate risk may be taken as 2% of total assets
Internal reserves for absorbing shocks in external assets should be at least 25% of FCA and gold. 5% of total assets should be set aside towards losses which cannot be absorbed by current earnings. There should be a reserve of 2% of total assets towards systemic risks
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.
Now, the RBI Board accepted the recommendations of a committee headed by former Governor Bimal Jalan on transfer of excess capital. This is 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.
Tax revenue shortfall: With the economy slowing down and the Goods and Services Tax (GST) not kicking in the expected buoyancy, the shortfall may even be higher. The infusion of additional funds, thus, will help the government to substantially overcome this shortfall
Fiscal deficit: government has a control on its expenditure through Fiscal Deficit target. With transfer of surplus of RBIs reserves, target will be within range of government. If, on the other hand, the tax revenue growth picks up, then the government can use the additional money to clear the dues of the Food Corporation of India and fertilizer companies to minimize spillover of deficits to the next year.
Especially after the global financial crisis when central banks had to resort to unconventional means to revive their economies, the approach has been to build adequate buffers in the form of higher capital, reserves and other funds as a potential insurance against future risks or losses.
A higher buffer enhances the credibility of a central bank during a crisis and helps avoid approaching the government for fresh capital and thus maintain financial autonomy.
The decision of the RBI Board must be welcomed as it should help the government in combating the economic slowdown and to conform to the fiscal targets. It is hoped that the government will be prudent in using these funds.
For more information check out the following links :-