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Explained: RBI’s payouts to the govt — why, and how much

This is the second year running that the RBI has paid an interim dividend to the government; it had approved an interim payout of Rs 10,000 crore last year.

, Reported by Shaji Vikraman , Edited by Explained Desk | Chennai |
Updated: February 20, 2019 10:54:57 pm
The RBI isn’t a commercial organisation like the banks and other firms that the government owns or controls. (Express Photo by Tashi Tobgyal)

On February 18, the RBI Board at its meeting in New Delhi approved an interim dividend payout of Rs 28,000 crore to the government, which is expected to help keep the fiscal deficit at the projected 3.4 per cent of GDP for 2018-19. This is the second year running that the RBI has paid an interim dividend to the government; it had approved an interim payout of Rs 10,000 crore last year.

So, how does a central bank like the RBI generate profits (or surplus)?

A central bank’s income typically comes largely from the returns it earns on its foreign currency assets, which could be in the form of bonds and treasury bills of other central banks or top-rated securities, deposits with other central banks, the interest it earns on its holdings of local rupee-denominated government bonds or securities; when lending to banks for very short tenures (such as overnight); and management commission on handling the borrowings of state governments and the central government. The RBI buys these financial assets against its fixed liabilities such as currency held by the public, and deposits issued to commercial banks on which it does not pay interest.

A central bank’s expenditure is mainly on the printing of currency notes and on staff; on commissions 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 central bank’s total costs, including expenditure on printing and commissions, is only about a seventh of its total net interest income — which implies that it generates a large surplus.

Does the government have a claim on the RBI’s profits/surplus?

Of course it does. The Government of India is the sole owner of the RBI, just as many other global central banks are owned by the goverments of their countries. The government can make a legitimate claim to this surplus. By virtue of its role as the manager of the country’s currency, the RBI generates more surplus than the entire public sector put together. This surplus, as the former RBI Governor Raghuram Rajan put it, belongs entirely to the country’s citizens. So the RBI has been setting aside what is needed to be retained as equity capital to maintain its creditworthiness, and paying out the remaining surplus to the government.

But aren’t dividends, including interim payouts, usually paid by commercial firms?

The RBI isn’t a commercial organisation like the banks and other firms that the government owns or controls. It was promoted as a private shareholders’ bank in 1935 with a paid up capital of Rs 5 crore, but the government nationalised it in January 1949, making the sovereign the “owner” of RBI. The central bank, therefore, transfers its “surplus” — the excess of income over expenditure — to the government under the provisions Section 47 of the Reserve Bank of India Act, 1934: “After making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation funds and for all other matters for which provision is to be made by or under this Act or which are usually provided for by bankers, the balance of the profits shall be paid to the Central Government.” This is done in early August by the central board of the RBI, after the completion of the bank’s July-June accounting year.

Is there a problem in giving extra dividends?

Rajan has explained that much of the surplus that the RBI generates comes from the interest on government assets, or from the capital gains it makes off other market participants. When this is paid to the government as dividend, the RBI is putting back into the system the money it has made from it — and there is no additional money-printing or reserve-creation involved. But when the RBI pays an additional dividend to the government, it has to create additional permanent reserves — that is, it has to print money. Rajan said that to accomodate the special dividend, the RBI would have to withdraw an equivalent amount of money from the public by selling government bonds in its portfolio.

Why are central banks reluctant to transfer large amounts to the sovereign?

All central banks worry that large payouts can limit their ability to create buffers that would cushion the impact of a crisis. Seeking both financial stability and autonomy/independence, most central banks are reluctant to seek assistance from governments. In India, former Governor D Subbarao wrote in his memoir, the issue of the amount of surplus transferred and the capital requirement of the RBI has been contentious, but never acrimonious: “These arguments (on transfers) go on every year, and a settlement is reached with both sides showing some flexibility.”

What do demands for an interim dividend or extra surplus transfer say about government finances?

It does indicate that finances are under pressure. Last year, the RBI paid out an interim dividend of Rs 10,000 crore; the interim dividend payout announced this week is close to three times that amount. The government is trying hard to narrow its fiscal deficit, as it spends extra even as revenues aren’t booming. The fact is that during periods of high growth, as we saw during the last decade, the government doesn’t make such demands — a sign that high growth in revenues obviates the need to dip into the extra surplus of the RBI.

What is the global practice on payment of surplus by central banks?

Almost all central banks, the US Federal Reserve, the Bank of England, Germany’s Bundesbank, or the Reserve Bank of Australia, are owned by their respective governments, and have to transfer their surplus or profits to the Treasury, or the equivalent of India’s Finance Ministry. The UK has a formal Memorandum of Understanding on the financial relationship between the Treasury and the Bank of England, which lays down a clear framework for passing on 100% of net profits to the government. The US Fed too, transfers all its net earnings to the Treasury.

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