In tussle over size of surplus, differing views of prudence

The RBI was taking a hit on account of having provided foreign exchange guarantees for bank deposits from overseas Indians under the Foreign Currency Non-Resident Accounts or FCNR(A) scheme — which had been designed in the 70s to boost India’s balance of payments situation.

Written by Shaji Vikraman | Updated: August 14, 2017 9:52 am
RBI, reserve bank of india, RBI government surplus, government surplus transfer, RBI profit, profit transfer As RBI’s balance sheet expanded and its surpluses rose, the government started to stake claim to a larger share of the surplus. (File)

Two years into the economic reforms programme begun in July 1991 by the P V Narasimha Rao government, the Governor of the Reserve Bank of India, Chakravarthi Rangarajan, and his deputy, S S Tarapore, began discussions with senior Finance Ministry officials led by Finance Secretary Montek Singh Ahluwalia and Chief Economic Advisor Shankar Acharya on an issue that was troubling the central bank.

The RBI was taking a hit on account of having provided foreign exchange guarantees for bank deposits from overseas Indians under the Foreign Currency Non-Resident Accounts or FCNR(A) scheme — which had been designed in the 70s to boost India’s balance of payments situation. The Bank had built up some provisions, but it was still losing a large chunk of its income due to foreign exchange fluctuations.

A deal was struck — the government agreed to bear the exchange risk under the scheme; in return, RBI acceded to transfer to the government profit over and above what it transferred normally. It was important to compensate the sovereign, which would otherwise have been forced to make provisions in the Budget. Starting 1993-94, RBI began to make annual transfers other than the normal surplus to make good the Rs 12,850 crore loss on the scheme.

This was the beginning of a major shift in policy. As the reform process gained momentum and foreign exchange reserves started to rise, the size of the RBI’s balance sheet also expanded. The RBI started to build up reserves — such as the Contingency Fund for unforeseen situations, and the Asset Development Reserve — based on advice from its auditors. During 1997-98, an informal group headed by an RBI official recommended an indicative target of 12% of the Bank’s assets for the contingency reserve by 2005, which was approved by the Board, and achieved.

At this time, there was still no clarity or explicit mention of transfer of surplus to the government. But as the RBI’s balance sheet expanded and its surpluses rose, the government, which is the “owner” of the Bank, started to stake claim to a larger share of the surplus.

For long, the RBI resisted, and its reserves kept rising. The government’s view was that the buffer built by the central bank was more than adequate — and the sovereign would, in any case, be available to provide support in the event of a crisis.

Read | Understanding RBI-govt surplus transfer: Why, how, how much

Successive Governors after Rangarajan — Bimal Jalan, Y V Reddy, Duvvuri Subbarao, Raghuram Rajan — faced pressure to scale down allocations to reserves to ensure a higher surplus to the government. In his book Who Moved My Interest Rate: Leading the Reserve Bank of India Through Five Turbulent Years, Subbarao wrote of the pressure, and acknowledged he had been on both sides of the table — as Finance Secretary, demanding a higher transfer, and resisting it as RBI Governor.

In 2007-08, when the UPA government headed by Manmohan Singh proposed a farm loan waiver plan, Governor Reddy was not enthusiastic — and insisted that the government make a provision for the banks. But in negotiations that mirrored another from a decade ago, the RBI, after discussions with Finance Minister P Chidambaram, agreed to transfer a higher surplus to the government.

But by 2013, with increasing pressures on the fisc, the government sought a much bigger surplus transfer. Governor Rajan tried to reason that more funds needed to be set aside for the Deposit Insurance and Credit Guarantee Corporation, an arm of the central bank, for contingencies such as a potential big bank bust or other unforeseen events. But the Finance Ministry remained convinced that reserves were more than adequate, and that the government would step in, should the need arise.

That was when it was agreed that the RBI would transfer the entire surplus to the government for the next three years, after which a review would be carried out. Since 2013-14 then, the RBI has been transferring 99.99% of its surplus to the government, a huge jump from 37.20% in 2011-12 and 53.40% in 2012-13. The payout in 2015-16 was Rs 65,876 crore — but the halving of the surplus in the year ended June 2017 is a commentary on the fiscal situation of the economy, as also an indicator of the importance of the surplus.

In his memoir, Advice and Dissent: My Life in Public Service, Governor Reddy recalled that Prime Minister Manmohan Singh had once told him that “the excess profits of a central bank is a reflection of the profligacy of the government”. No one would know this better than the man who was not just the Head of India’s government but also a former Governor of its central bank.

shaji.vikraman@expressindia.com

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