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Modi govt needs a Covid cushion. RBI must transfer more of its surplus funds

The RBI has held back Rs 20,000 crore as provisions. This could have helped the Modi government further at a time of tremendous fiscal pressure.

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The Reserve Bank of India (RBI) has decided to transfer Rs 99,122 crore as surplus to the Narendra Modi government.

In the Union budget for 2021-22, the government had projected the surplus transfer from the RBI, nationalised banks and financial institutions at Rs 53,510 crore. With tax revenues expected to shrink, the surplus transfer will provide cushion to the Centre’s strained finances.

However, the Rs 20,000 crore that RBI has held back as provisions would have helped further.

The profit transfer rationale

Central bank profits, or seigniorage, belong to the government, and are normally transferred back to governments. It consists of the interest that the government transfers to its central bank, which issues currency for the country.

Against the government bonds that sit on the asset side of the central bank’s balance sheet, the central bank issues cash, which are its liabilities.

As a central bank does not have to pay the public any interest on cash, the entire interest paid by the government is part of the income of the central bank. In addition, the central bank has income from banking and other financial institutions that pay an interest on the money they borrow such as in the repo window through which the central bank lends at a higher rate while it borrows from banks at the lower reverse repo rate. 

Similarly the central bank pays no interest to banks for the large part of their funds that are held with it under the requirements of the cash reserve ratio.

Also read: These 4 factors will shape how Indian economy rebounds from shock of Covid second wave

The RBI’s role

In India, as the RBI is also the government’s debt manager, over and above the interest it earns for money creation, the RBI charges a commission from the government for its role as the government’s debt manager.

During the year 2020-21, for which the surplus has been paid, the RBI charged Rs 2,611 crore as agency commission on government transactions.

On the expenditure side, the RBI carries out its operations such as printing money, which cost the RBI Rs 4,012 crore last year. In 2020-21, the RBI paid Rs 4,788 crore towards employee cost.

The RBI decided to maintain its Contingency Risk Buffer (CRB) at 5.5 per cent of the balance-sheet. This amounted to Rs 20,710 crore. No transfers were made to the other discretionary reserves. Consequently, the amount under the “provisions” category of the expenditure statement of the RBI reduced from Rs 73,615 crore in 2019-20 to Rs 20,710 crore in 2020-21.

The RBI expenditure is not audited by the Comptroller and Auditor General, as are other institutions and regulators. This provision was made in British India when the RBI was set up (in 1935) and has continued due to the position the central bank has commanded in the system. 

While other central banks around the world get their accounts approved by the government and they have pressure to reduce expenses, the RBI has no such pressure.

Any attempts by the government to make the RBI accountable and control its expenses have been met with a lot of hue and cry and shrill arguments about its independence.

Also read: How this Covid wave has hurt Indian economy — falling indicators, lower growth expectations

Government’s challenges

The Bimal Jalan committee set up in December 2018 to review the capital framework of the RBI recommended that 5.5-6.5 per cent of the balance-sheet should be maintained as CRB.

This year, in the midst of the worst pandemic seen in a century and one that is pushing India into a humanitarian and economic crisis, instead of paying an additional Rs 20,000 crore to the government, the RBI has decided to hold back the money.

Making these provisions is not necessary and is not done by most central banks as the central bank is fully backed by government and does not need these various reserves.

The Covid-19 crisis has posed a great challenge to debt sustainability in emerging and advanced economies. According to the International Monetary Fund, India’s debt to GDP ratio increased from 74 per cent at the end of 2019 to almost 90 per cent at the end of 2020.

The announced global fiscal measures add up to an estimated $12 trillion or approximately 12 per cent of global GDP. Advanced nations constitute the bulk of the global fiscal measures. Their central banks could purchase government and corporate securities and provide massive stimulus while maintaining lower interest rates and inflation. Their treasuries were able to finance large deficits at low interest rates.

Less developed economies and many emerging economies including India have been in a difficult position both because they have pre-existing financial constraints, or limited room for borrowing.

The Indian central government’s fiscal deficit had widened to 4.6 per cent of GDP in 2019-20. The announcement of higher government borrowings in the current year’s budget put upward pressure on interest rates.

The government is likely to find it challenging to meet its disinvestment target.

Goods and Services Tax (GST) collections are also likely to be hit due to Covid-19 induced state-level lockdowns. The government is reportedly preparing a stimulus package for sectors worst hit by the pandemic.

While the economic impact of the pandemic is not likely to be as adverse as last time, fiscal resources of the government will continue to be under pressure. 

The surplus transfer from the RBI will provide some cushion. But another Rs 20,000 crore should have been better used in buying vaccines or provisioning for indemnity such as being demanded by some vaccine companies. 

The Jalan Committee recommendations, that RBI should be allowed to hold back money for “provisions” regardless of the circumstances in the country, need to be reviewed urgently.

Ila Patnaik is an economist and a professor at National Institute of Public Finance and Policy.

Radhika Pandey is a consultant at NIPFP.

Views are personal.

Also read: Economic indicators show weakness began setting in with April lockdowns


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