RBI’s Transfer of Rs 1.76 Lakh Crore to The Government: How will The Surplus Funds Affect The Indian Economy?

On August 26, 2019, the central board of the Reserve Bank of India (RBI) decided to transfer Rs 1.76 lakh crore to the Government of India. The total fund includes Rs 1.23 lakh crore of surplus for the financial year 2018-19 and Rs 52,637 crore of excess provisions identified as per the revised Economic Capital Framework (ECF).

What is Economic Capital Framework (ECF)?

Economic capital framework is defined as the risk capital required by the RBI. To put it simply, it is the capital required by the central bank to counter unforeseen risks or events or losses in the future. These risks include currency fluctuations, credit risk arising from its function as the lender of last resort, possible decrease in the value of bonds, costs regarding open-market operations and other risks due to increase in its expenditure. The RBI has maintained that it needs to maintain a strong balance sheet to prevent any monetary/financial crisis. RBI’s balance sheet showed an 11.6% increase for the financial year 2018-2019, while its net disposable income grew by 146% as compared to 2017-2018.

Why was the ECF revised?

The government wanted the RBI to provide its surplus reserves because of shortfall in revenue collections. Transfer of funds had remained a bone of contention between the government and the RBI with the government believing that RBI was sitting on much higher reserves than actually required to tide over any financial emergency.

The revised ECF implies larger funds, which in turn will allow the government to meet deficit targets, infuse capital into weak banks to boost lending and fund welfare programmes.

Earlier, the union government has constituted an expert committee under former RBI governor Bimal Jalan to review the existing risk provisioning and surplus transfers of the central bank. It submitted its recommendations after considering various aspects like the role of the RBI as the central bank for monetary, financial and external stability along with the existing provisions of laws under the RBI Act and standard practices followed in other countries. The RBI also considered its present balance sheet along with future risk factors.

Recommendations of the committee: For risk provisioning, the committee recommended maintaining the realised or existing equity of the central bank between 5.5% and 6.5% of the balance sheet. After implementing the recommendation, the RBI board decided to maintain existing equity as 5.5%. It then transferred the surplus of Rs 52,637 crore to the government.

The committee also recommended maintaining an economic capital level within the range of 20% to 24.5% of the balance sheet. The economic capital of the RBI on June 30, 2019 was 23.3% of its balance sheet. So, in accordance with the recommendations, the entire net income of Rs 1.23 lakh crore for the year 2018-2019 was transferred to the government. Earlier, before implementing the committee’s recommendations, the RBI had already provided the government with Rs 28,000 crore as interim dividend.

How will the additional Rs 1.76 lakh crore affect Indian economy?

Recently, the Indian economy has witnessed decline in some of the key macroeconomic parameters. In the June quarter of the present financial year, India’s GDP growth has decreased to 5%. This is the lowest in the last six years. The present sluggishness is the result of a decrease in manufacturing output, weak consumer demand and deceleration in private investment. Manufacturing, automobile and real estate sectors have been particularly hit by this economic downturn. The RBI surplus transfer would help the government to meet the cost of public capital expenditure and its infrastructure development projects. The increased public capital expenditure would pump liquidity in the market, and boost demand. The surplus funds are also expected to help the government meet its fiscal deficit target. Fiscal deficit means the shortfall in a government’s income compared with its spending. The government has set a fiscal deficit target of 3.3% of the GDP in the present financial year.

The government is expected to use the addition funds in:

• Infrastructure financing: The additional funds can be used for the requirements of infrastructure projects, which are facing scarcity of funds.
• Providing capital to nodal agencies: The government is expected to provide capital to banks and government intermediaries like National Bank for Agriculture and Rural Development (NABARD), Small Industrial Development Bank of India (SIDBI) and National Housing Bank (NHB).
• Reduction of market borrowings: The government plans to borrow Rs 4.48 trillion from the market in 2019-20. By June 2019, market borrowings of the government has already reached the figures of Rs 2.54 trillion.The additional funds could be used for reduction in borrowings, which would release more funds for the private sector.
• Recapitalization of Public Sector Banks (PSBs): The additional funds are expected to provide capital to weak and under-capitalized banks, which are under the Prompt Corrective Action (PCA) framework of the RBI.

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