The reasons for conflict between the RBI and the government are many, including surplus profits transfer. What is surplus profits transfer? How does it work? Why has it put the RBI in a protectionist mode?
Central bank deputy governor Viral Acharya borrowed words from former deputy governor Rakesh Mohan to enunciate the importance of protecting the balance sheet of the Reserve Bank of India.
“…Once again, better sense has prevailed and the government has not raided the RBI’s balance sheet,” Acharya quoted Mohan in his recent speech that put the spotlight on the rumblings going on between the RBI and the Narendra Modi government.
The reasons for conflict are many, including surplus profits transfer to the government. But what is surplus profits transfer? How does it work? Why has it put the RBI in a protectionist mode?
How does surplus profits transfer work?
To begin with, every year the central bank transfers the balance of its profits to its owner, the government, as per the RBI Act, after making provisions for bad or doubtful debts, contribution to staff, depreciation of assets and superannuation funds.
There’s no fixed benchmark for the transfer of this surplus profits. Before every union budget, the government and the RBI discuss the surplus amount. The government, then, puts its surplus expectations in the budget, while the RBI announces the actual amount in August after making the calculation.
How does the RBI generate surplus profits?
In words of former governor Raghuram Rajan, the RBI prints the currency notes held by the people, and issues deposits to commercial banks. Those are fixed liabilities for which the RBI does not pay any interest. However, as the central bank issues these liabilities, it also buys financial assets, in forms of domestic and foreign government bonds, from the market. Now, these assets get RBI interest.
“So we generate a large net interest income simply because we pay nothing on virtually all our liabilities,” Rajan explained on his last day in a speech delivered at St Stephen’s College
The total cost of printing the currency, according to Rajan, is 1/7th of the total net interest income. Besides transferring a part of surplus profits, the RBI also has another task at hand: maintaining an international AAA rating so that its credibility in the market is intact.
What’s the conflict all about?
The RBI does its risk analysis and sets out a part of its surplus profits to be transferred to the government. Now, the reason for the conflict is simple: the government wants more surplus; the RBI wants to make more reserves from profits for unforeseen risks, thus leading to lesser surplus transfer.
Surplus profits transfers in the Modi era
In its 83-year-long history, the RBI transferred highest ever surplus in the year 2014-15, which was Rs 65,896 crore. However, in the year 2016-17, the RBI surplus transfer dropped to just Rs 30,659 crore against the budgeted amount of Rs 58,000 crore, which, economists argue, was due to the higher printing cost post demonetisation.
The central bank, which follows July-June financial year, approved the transfer of Rs 50,000 crore surplus amount for 2017-18. It came as a breather to the government as it was Rs 5,000 crore higher than the budgeted amount of Rs 45,000 crore.
In FY18, the government was reportedly putting pressure on the RBI to give them an additional Rs Rs 13,000 crore, following which the RBI transferred Rs 10,000 crore as interim dividend in March this year. This was a part of Rs 50,000 crore surplus transfer announced for FY18.