In the last five years, there has been a sea change in the quantum of transfers. The surpluses have increased manifold and hence resulted in a bounty to the government.
The payment of an interim dividend by the Reserve Bank of India (RBI) to the government is significant because it is the second time that this has been done, and that too in successive years. The surpluses of RBI have hence come to occupy a very important position in managing the Centre’s fiscal balances. Interestingly, the surpluses of RBI in the past were not really considered to be important as most of the so-called profit is notional. But, today, the contribution to the exchequer is quite critical and the interim dividend manifests this phenomenon.
RBI earns money by virtue of being the custodian of forex reserves and conducting monetary policy operations. As forex reserves finally reside with the central bank, they are invested in safe avenues and earn an income. Similarly, the Government Securities (G-Sec) held by RBI that are used to draw liquidity out of the system when required for OMOs (sale) earn revenue for the central bank. Further, when RBI conducts the repo and term repo operations when liquidity conditions are tight, banks pay them interest at the repo-related rate. Hence, the central bank runs a very profitable balance sheet as the liabilities do not quite exist and can be created by a fiat. Assets earn income from banks and the government and the surplus gets transferred to the Budget as surplus. For 2017-18, the surplus transferred was `40,000 crore while the domestic interest earned was around `38,000 crore.
In the last five years, there has been a sea change in this quantum of transfers. The surpluses have increased manifold and hence resulted in a bounty to the government, since as per the statute the entire balance goes to the government after making statutory transfers. This has helped in fiscal management as the deficit gets reduced to a significant extent. In the five-year period 2009-10 to 2013-14, the average surplus was `21,560 crore, with a maximum of `33,010 crore in FY14. In the period 2014-15 to 2018-19, the average surplus was `58,622 crore, with the peak being `68,000 crore for FY19. In fact, in three of the last four years, the surplus was above `60,000 crore, with FY18 being the exception, when demonetisation came in the way as both income was lower (surpluses with banks had to be paid the reverse repo rate) and the expenses were higher. The accompanying graphic gives the ratio of RBI surplus transferred to the government to gross fiscal deficit.
In these two phases, the average ratio of RBI surplus to gross fiscal deficit has doubled from 4.8% to 10.5%, which is quite significant as the budgetary support provided has increased sharply. This has also provided elbow room to the government to run a higher fiscal deficit as there is support that comes from RBI.
RBI’s cost of operations is more or less fixed, and the clue going ahead is to increase the income that comes from the two sources. As long as forex reserves increase, there will be an increase in income for RBI. Around `35,000 crore came in 2017-18 from investments of forex assets; and as interest rates increase in the West, the Fed bonds and others would provide higher revenue for RBI. The average return here is still very low at 1.09% for 2017-18, as per the RBI Annual Report, given the safe investment avenues chosen. Doubling this return would provide higher revenue, which can be further used to manage the budget deficit. A thought here is whether or not RBI should get involved in treasury operations to earn more income on deployment of forex reserves.
The other source of income is the interest on domestic securities, which was slightly higher at around `39,000 crore in 2017-18. Here, it will be important to note that the repo rate announced will have a bearing on the earnings as well as the liquidity situation. When the liquidity situation is tight and RBI induces progressively large amounts through the repo window on a continuous basis, income would tend to increase. In a state of lower interest rates, this revenue would also come down. The same holds for OMOs when RBI buys back bonds from banks where the effective yields also move with the repo rate movements. This would be largely exogenous over which RBI will have little control being linked with liquidity and monetary policy decisions that are driven by extraneous factors.
RBI as a source of revenue for the government is important as it could account for almost 20-25% of total non-tax revenue. In fact, at a broader level, two observations can be made. The public sector is an integral part of the budget exercise because it contributes a lot to the revenue collections. Currently, public sector banks are not making profits but otherwise have been transferring their surpluses to the government in proportion to the latter’s ownership. The same holds for other PSUs in oil, power, finance, etc, which are profitable. This is one reason why full disinvestment is not a possibility as it would remove one source of revenue.
The second relates to RBI and the use of reserves. While the high-level committee will decide on the use of past reserves, intuitively it can be seen that such funds can be used to take on certain expenses of the government outside the balance sheet, like bank capitalisation. Last year, the recap bonds were used wherein bonds were issued to banks where the accounting money was used to recapitalise them by the government. The central bank reserves, too, can be used in a similar manner.
Interestingly, with the interim dividend being paid in the last two years, there is scope for having such rolling amounts here too. RBI has a financial year of July-June; the government follows the conventional April to March. The dividend is hence paid in July after the results are out and, therefore, the 2017-18 outcomes get into the Budget of 2018-19. The interim dividend paid for fiscal 2018-19 would get reflected in the 2018-19 accounts of RBI, which is for the previous year being a lagged payment. This can be a useful way of rolling in the transfers too.
With the expenditure commitments of the government increasing in recent times and with the increasing focus on welfare, revenue generation is always a challenge, given the reforms being undertaken like GST or maybe even the direct taxes code at a later date. In such a situation, transferring higher amounts of RBI surpluses becomes a useful way of managing the Budget, as it provides room within the perimeter laid down by the FRBM framework.
The author is chief economist, CARE Ratings. Views are personal