Last week, the Reserve Bank of India (RBI) had agreed to transfer Rs 1.76 lakh crore to the government in line with the recommendations of the Bimal Jalan committee. The RBI's fund transfer comprises Rs 1.23 lakh crore of surplus for the year 2018-19 and Rs 52,637 crore of excess provisions identified under the revised Economic Capital Framework.
The move has seen mixed reactions from economists and market experts. While some believe the RBI's windfall will alleviate liquidity concerns in the economy, others think the Rs 1.76 lakh crore bonanza will help the government in meeting the fiscal deficit target. The transfer of surplus reserves has raised many a eyebrow. Questions are being raised if the Modi government is emptying RBI's coffers to fix the deficit problem. Some think it is an attempt to kill the central bank's autonomy, a desperate move to arm-twist the RBI to part with cash.
RBI transfers money to the government each year. Then, what is this hue and cry all about? What is the arithmetic behind the huge pay out? Undoubtedly, the payout is much larger than anticipated. The RBI has never transferred such a large quantum of money to the government since the central bank was set up.
The government is not going to get Rs 1.76 lakh crore, period. This is because the net liquidity injection from the RBI as a result of this exercise will amount to Rs 1,48,051 crore (Rs 1,76,051 crore minus Rs 28,000 crore already paid). "This is against an expectation of normal budgeted dividend of Rs 90,000 crore (assumed RBI dividend component of the Rs 106,042 crore budget number)," says HDFC Securities.
Does this transfer of money impact the RBI's capital, reserves and autonomy? Will the RBI become poorer? "We were deeply concerned when the RBI-government fracas was out in the open. We are glad to note that the recommendations of the Jalan Committee report on the framework to determine the economic capital of the Reserve Bank of India. We have to keep in mind that India remains an emerging market country with its own macro frailties and a government which runs a fiscal deficit on whom the RBI cannot depend on capital infusion if things go bad. The RBI thus needs to have its own sufficiently large capital buffer," says Arvind Chari, head - Fixed Income, Quantum Advisors.
Chari says that the Jalan committee has put this matter to rest by laying down the following:
1) Any surplus due to the government can be paid only from retained earnings and not by using the notional revaluation reserves.
2) The contingent capital buffer has to remain at all times in a band of 5.5% -6.5% of the RBI’s total balance sheet
3) The total economic capital of the RBI needs to be in the range of 20% - 24.5% of the RBI’s total balance sheet
What Happens Now?
The transfer of the RBI's surplus had been one of the biggest pain point between the central bank and the government. Now that the friction has been put to rest, the manner in which the funds will be used will be critical. India Ratings and Research (Fitch Group) believes the surplus transfer by the RBI is likely to provide some respite to the government’s finances. However, a major portion of this amount is likely to be utilized in meeting revenue receipt shortfalls emanating from the weakening economic conditions. "In absence of this transfer, the government would have had to make a trade-off between curtailing government expenditure (below budget estimates) and overshooting its fiscal deficit target. Additionally, curtailing of expenditure in a scenario of weakening growth prospects, resulting from lackluster private sector capex and slowing consumption could engender a vicious cycle in the economy," says India Ratings.
Will RBI become poorer?
The RBI does not become a pauper despite parting with such huge sum. As per the RBI Annual Report 2018, the central bank has assets to the tune of Rs 36.2 lakh crore and has a capital of around Rs 9.59 lakh crore. So, the capital as a percent of the assets is around 27%. The capital reserves of the RBI are well above other leading central banks. Experts think the government must not make it a habit to take money regularly from the RBI. Future dividend payouts should be formula-driven and subject to some constraints with respect to the maintenance of a minimum CRB (Contingent Risk Buffer). Paying out a large sum will impede the RBI’s ability to pay a similar dividend in the coming few years, they aver.
The new formula for distributing future dividends potentially imposes a constraint on the quantum of such distributions. "The Jalan committee has recommended ‘realized equity’ to be 6.5 to 5.5 percent of the balance sheet. It has recommended taking this to lower bound and transferring the entire excess of Rs 52,637 crore so created. As per the suggested surplus distribution policy, only if realized equity is above its requirement will the entire net income be transferable to the government. If it is below the lower bound of requirement, risk provisioning will be made to the extent necessary and only the residual net income (if any) transferred to the government," says Suyash Choudhary, head – Fixed Income, IDFC AMC
How does it impact?
The RBI's transfer of surplus to the government could add liquidity in the system. The banks could cut lending rates since the liquidity is in surplus. As a result, borrowers may enjoy the benefit of lowered interest rates. The issuances of Government Securities (G-Sec) are likely to continue in line with the government’s borrowing calendar.
"We believe that continued contraction in domestic and foreign institutional appetite coupled with reduced likelihood of large OMO purchases could put pressure on the G-Sec yields over the medium term. However, the availability of further headroom to reduce the repo rate could serve as an extenuating factor and mitigate some of the pressure on the yields," says India Ratings. The agency expects the yield on 10year G-Secs (Government Securities) to range between 6.10-6.20% at FY20.
There is a concern in some quarters that the large transfer can translate into higher inflation expectations. But experts say the transfer of money from the central bank to the government results in the creation of base money (M0), which is different from the printing of currency notes. Inflation is a secondary effect of higher government spending, which increases transactional demand for money. If the government starts spending high amount of money, we will have to watch out for inflation.
Many believe spending by the government will largely be non-inflationary. "It is reasonable to expect that the incremental funds will be invested on capital expenditure, primarily in infrastructure and provide a booster shot to the ailing investment as well as the consumption cycle. In our opinion, the windfall revenues from the RBI provides an opportunity to the government to pursue a path of moderate fiscal intervention while not deviating from the long term goals with regards to fiscal discipline," points out Acuité Ratings & Research.
Kruti Shah, economist, Emkay Global Financial Services feels that infrastructure spending will happen if and when the government spends money. "If the government chooses to convert the transferred sum into higher spending, we believe it would tilt in favour of infrastructure spending rather than consumption," says opined in a note to investors.
Will Economic Sentiment Improve?
The RBI's transfer of reserves follows the government’s recent policy measures and may help improve the overall sentiment. "This is positive for bond markets and would aid monetary transmission and rate-sensitive stocks such as banks, autos and real estate. However, we believe more is required to kick-start a virtuous cycle in the economy particularly when global headwinds are significant," says Kapil Gupta of Edelweiss.
How will the government utilize the funds? "The government may use the money to recapitalize PSU banks by Rs 70,000 crore as announced by finance minister Nirmala Sitharaman with the balance transferred to the fisc as already budgeted. This, in turn, should help in cutting lending rates," said DSP Merrill Lynch (India) economists Indranil Sen Gupta and Aastha Gudwani. The overall excess transfer by RBI is Rs 52,000 crore (0.3 % of GDP) and it is this part of the transfer that creates additional fiscal space.
"Ttransfer of such money will provide some relief to the government, especially when the global economy is witnessing slowdown. At the same time, it seems unlikely that the amount would be used only to support fiscal stimulus measures. Once the amount is credited by the RBI, the pending overdues to the PSUs and vendors would be released by the government leading to better rolling of liquidity and economic growth hastening at a good pace, at least for the next few weeks," says HDFC Securities. (The author is a journalist with 14 years of experience)