The RBI’s dividend transfer provides a substantial fiscal cushion to the cash-strapped Government, but it must be prudent in fiscal management and resource allocation

In the amendment to the Fiscal Responsibility and Budget Management (FRBM) Act through the Finance Bill 2018-19 (the amendment was based on the recommendations of Dr N K Singh’s committee mandated to review the FRBM Act (2003)), the Modi - the Government had pledged to achieve fiscal deficit or FD (excess of total expenditure over total receipts) of 3 per cent of gross domestic product (GDP) by the FY 2020-21. Following the Corona pandemic that played havoc with the economy leading to plunging revenue and ballooning expenditure during 2020-21 and the resultant zooming of FD to 9.1 per cent, it changed this fiscal glide path.

In her budget speech for FY 2021-22, Union Finance Minister Nirmala Sitharaman announced the Government’s decision to achieve FD of 4.5 per cent by FY 2025-26. From 9.1 percent during 2020-21, the FD descended to 6.7 percent during 2021-22; 6.4 percent during 2022-23 and 5.8 percent during 2023-24. For 2024-25, in the interim budget presented by her on February 1, 2024, she has set the target at 5.1 per cent. If the Government can achieve this target, then 4.5 per cent for 2025-26 should be within easy reach.

Against this backdrop, the Reserve Bank of India (RBI) has come up with a bonanza for the Centre. The RBI Board has approved a record dividend transfer of Rs 210,000 crore to the Centre for its (read: RBI) FY 2023-24. This will be reflected in the accounts of the central Government for the FY 2024-25. This amount is 2.4 times the dividend transfer of about Rs 87,400 crore made by the RBI for its FY 2022-23 and available for use by the Centre during 2023-24.

Even when compared to the provision of about Rs 80,000 crore made by Sitharaman in the interim budget for 2024-25, the dividend amount available from the RBI i.e. Rs 210,000 crore for use by the central Government during the year will be over two-and-a-half times. This gives a cushion of Rs 130,000 crore (210,000-80,000). This translates to about 0.4 per cent of the GDP.

While this should give substantial leeway to the Government in managing its fiscal situation and ensuring easy compliance with the 5.1 per cent target, there is no room for complacency.

First, it shouldn’t forget that the new glide path of 4.5 per cent for 2025-26 is way behind the original FD target of 3 per cent for 2020-21 as per the FRBM (Amendment) Act 2018. The Corona pandemic of 2020 was once in a lifetime event. Its impact was transitory and it won’t be logical to use it as a basis for altering the medium-term fiscal trajectory. This is all the more when from 2021-22 onward, the economic situation was more or less back to normal.

The Government ought to be aiming at an FD target of 3 per cent by 2025-26 and going by this benchmark, it has still a long way to go.

Second, we need to assess things from the RBI perspective. Unlike a public sector bank (PSB) or any other public sector undertaking (PSU), the RBI is not a commercial enterprise hence, is not expected to pay any dividend. Instead, it is a “full service” central bank.

Apart from managing the currency and payment systems and keeping inflation/prices in check, it is also mandated with managing the borrowings of the Union Government and State Governments; and supervising or regulating banks and non-banking finance companies (NBFCs). While carrying out these functions or operations, it generates a surplus.

Typically, the RBI’s income comes from the returns it earns on its foreign currency assets (FCA) — which could be in the form of bonds and treasury bills of other central banks or top-rated securities and deposits with other central banks. It also earns interest on its holdings of local rupee-denominated Government bonds or securities and while lending to banks for very short tenures, such as overnight. Its expenditure is mainly on the printing of currency notes and staff, besides the commission it gives to banks for undertaking transactions on behalf of the Government across the country and to primary dealers, including banks, for underwriting some of these borrowings. The excess of income over expenditure is the “surplus”.

After making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation fund, etc. and for all matters provided for under the RBI Act (1934), the balance of surplus is paid to the Union Government by Section 47 (Allocation of Surplus Profits) of the Act. Apart from this routine stuff, the financial crisis in the early 90s, when India’s foreign exchange reserves had plummeted to a level barely enough to buy two weeks of imports, brought to the fore a dire need to prepare the RBI for dealing with ‘unexpected’ and ‘unforeseen’ events by enhancing its capacity to absorb financial shocks, ensure financial stability and provide confidence to the markets. So, it started transferring part of the surplus to a ‘Contingency Fund’. This was in line with the recommendation of a committee to build contingency reserves (CR) of 12 per cent of its balance sheet.

In 2013, a panel led by Y H Malegam, then a member, of the RBI board, also reiterated the need for building CRs. Subsequently, in its annual report for 2015-16, the central bank alluded to a “draft economic capital/provisioning framework to assess its risk-buffer requirements in a structured and systematic manner.”Meanwhile, in 2018, the RBI set up a Committee on Economic Capital Framework (ECF) under Dr Bimal Jalan. The Committee recommended that the RBI should maintain a minimum contingency risk buffer (CRB) of 5.5 - 6.5 per cent of its balance sheet as risk buffer. The ECF was to remain in force for five years. The RBI adopted the ECF on August 26, 2019. During accounting years 2018-19 to 2021-22, it determined the surplus transferred to the Union Government taking the CRB at the lower end of the range i.e. 5.5 percent of its balance sheet. For arriving at the transferrable surplus during 2022-23, the CRB was increased to 6 per cent. However, for calculating the amount for 2023-24, it has used the higher end of the band prescribed by the Committee i.e. 6.5 per cent.

The surge in dividend transfers for 2023-24 over 2022-23 despite the increase in CRB is due to the substantial increase in the RBI’s interest. income from foreign securities as well as exchange gain from foreign exchange transactions (according to the State Bank of India (SBI), these two factors accounted for 60 - 70 per cent of the increase in income of the RBI from Rs 235,000 crore during 2022-23 to around Rs 375,000 - 400,000 crore during 2023-24). This in turn was due to a sharp hike in interest rates by the US Fed and central banks of other developed countries; the hikes were prompted by the dire need to bring down high inflation in those countries. But the situation may not be sustained as the US Fed prepares to move the interest rate ‘south’ from the latter half of 2024 and other central banks follow suit. Even if it doesn’t happen so soon and RBI repeats its performance during 2025-26, it would do well to retain more surplus with itself in the CRB. As a matter of prudent policy, the Centre should avoid riding piggyback on the RBI for managing its FD.

(The writer is a policy analyst, views are personal)